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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
Amendment #1
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934 [Fee Required]
For the fiscal year ended DECEMBER 31, 1998 Commission File Number: 000-23413
MEDICAL SCIENCE SYSTEMS, INC.
(Name of Small Business Issuer in its Charter)
TEXAS 94-3123681
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 N.E. LOOP 410, SUITE 820
SAN ANTONIO, TEXAS 78216
(Address of principal executive offices)(Zip Code)
Issuer's Telephone Number: (210) 349-6400
Securities registered under Section 12(b) of the Exchange Act:
(Title of each class) (Name of each exchange on which registered)
COMMON STOCK, NO PAR VALUE BOSTON STOCK EXCHANGE
Securities registered under Section 12(g) of the Exchange Act:
(Title of each class)
COMMON STOCK, NO PAR VALUE
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES (X) NO ( )
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. ( )
State issuer's revenues for its most recent fiscal year: $412,942.
As of March 23, 1999, the aggregate value of the Registrant's Common Stock held
by non-affiliates, based upon the average bid and asked price as of such date,
was $2,649,732.
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: There were 5,548,470 shares of the
Registrant's Common Stock issued and outstanding as of March 23, 1999.
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ITEM 1. DESCRIPTION OF BUSINESS
CERTAIN STATEMENTS CONTAINED IN THIS FORM 10-KSB ARE "FORWARD-LOOKING
STATEMENTS" WITHIN THE MEANING OF THE SECTION 27AOF THE SECURITIES ACT OF 1933,
AS AMENDED AND SECTION 21E OF THE EXCHANGE ACT OF 1934, AS AMENDED.
SPECIFICALLY, ALL STATEMENTS OTHER THAN STATEMENTS OF HISTORICAL FACT INCLUDED
IN THIS FORM 10-KSB REGARDING THE COMPANY'S FINANCIAL POSITION, BUSINESS
STRATEGY AND PLANS AND OBJECTIVES OF MANAGEMENT OF THE COMPANY FOR FUTURE
OPERATIONS ARE FORWARD-LOOKING STATEMENTS. THESE FORWARD-LOOKING STATEMENTS ARE
BASED ON THE BELIEFS OF THE COMPANY'S MANAGEMENT, AS WELL AS ASSUMPTIONS MADE BY
AND INFORMATION CURRENTLY AVAILABLE TO THE COMPANY'S MANAGEMENT. WHEN USED IN
THIS REPORT, THE WORDS "ANTICIPATE," "BELIEVE," "ESTIMATE," "EXPECT" AND
"INTEND" AND WORDS OR PHRASES OF SIMILAR IMPORT, AS THEY RELATE TO THE COMPANY
OR ITS SUBSIDIARIES OR COMPANY MANAGEMENT, ARE INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS REFLECT THE CURRENT VIEW OF THE
COMPANY WITH RESPECT TO FUTURE EVENTS AND ARE SUBJECT TO CERTAIN RISKS,
UNCERTAINTIES AND ASSUMPTIONS RELATED TO CERTAIN FACTORS INCLUDING, WITHOUT
LIMITATION, COMPETITIVE FACTORS, GENERAL ECONOMIC CONDITIONS, CUSTOMER
RELATIONS, RELATIONSHIPS WITH VENDORS, THE INTEREST RATE ENVIRONMENT,
GOVERNMENTAL REGULATION AND SUPERVISION, PRODUCT INTRODUCTIONS AND ACCEPTANCE,
TECHNOLOGICAL CHANGE, CHANGES IN INDUSTRY PRACTICES, ONETIME EVENTS AND OTHER
FACTORS DESCRIBED HEREIN AND IN THE COMPANY'S REGISTRATION STATEMENT ON FORM
SB-2 (FILE NO. 333-37441) AND IN THE COMPANY'S ANNUAL, QUARTERLY AND OTHER
REPORTS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION (COLLECTIVELY,
"CAUTIONARY STATEMENTS"). ALTHOUGH THE COMPANY BELIEVES THAT ITS EXPECTATIONS
ARE REASONABLE, IT CAN GIVE NO ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO BE
CORRECT. BASED UPON CHANGING CONDITIONS, SHOULD ANY ONE OR MORE OF THESE RISKS
OR UNCERTAINTIES MATERIALIZE, OR SHOULD ANY UNDERLYING ASSUMPTIONS PROVE
INCORRECT, ACTUAL RESULTS MAY VARY MATERIALLY FROM THOSE DESCRIBED HEREIN AS
ANTICIPATED, BELIEVED, ESTIMATED, EXPECTED, OR INTENDED. ALL SUBSEQUENT WRITTEN
AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO THE COMPANY OR PERSONS
ACTING ON ITS BEHALF ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY THE APPLICABLE
CAUTIONARY STATEMENTS. THE COMPANY DOES NOT INTEND TO UPDATE THESE
FORWARD-LOOKING STATEMENTS. PROSPECTIVE INVESTORS ARE ADVISED NOT TO RELY UPON
FORWARD-LOOKING STATEMENTS, BUT RATHER BASE THEIR INVESTMENT DECISION ON THE
COMPANY'S ACTUAL RESULTS TO DATE.
THE COMPANY
OVERVIEW
Medical Science Systems, Inc., a Texas corporation ("MSSI" or the
"Company") develops and commercializes genetic diagnostic tests and medical
research tools. The Company's efforts are focused on genetic factors that affect
the rate of progression of clinical disease through their influence on common
host systems. The Company's first genetic test, PST(R), a test predictive of
risk for periodontal disease, is currently marketed in the United States, France
and Israel. Products under development include tests predictive of risk for
osteoporosis, coronary artery disease, diabetic retinopathy, asthma and
meningitis/sepsis. The Company believes by combining genetic risk assessment
with specific therapeutic strategies, improved clinical outcomes and more
cost-effective management of these common diseases are achieved. MSSI also
develops and licenses its medical research tools, including BioFusion(R), to
pharmaceutical companies. BioFusion, a proprietary enabling system for
diagnostic and drug discovery and development, is a computer modeling system
that integrates genetic and other sub-cellular behavior, system functions, and
clinical symptoms to simulate complex diseases. This system allows for the
utilization of the rapidly increasing databases of gene expression, cell
biology, prognostic, pharmacogenomic and predictive medicine databases being
generated in companies and academic centers worldwide.
MSSI's executive offices are located at 100 N.E. Loop 410, Suite 820,
San Antonio, Texas 78216, and its telephone number is 210/349-6400. MSSI was
incorporated in Texas in 1986. MSSI maintains a website at www.medscience.com.
In November 1997 MSSI completed an initial public offering of 1,800,000 shares
of common stock, no par value ("Common Stock"). On March 16, 1999, the closing
bid price of the Common Stock on The Nasdaq SmallCap Market was $1.00 per share.
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CURRENT FINANCIAL CONDITION
Since its inception, the Company has incurred cumulative net losses of
approximately $14.9 million, including losses of approximately $9.5 million
during 1998 and $4.5 million during 1997. For the years ended December 31, 1998
and 1997, the Company had negative cash flows from operating activities of
approximately $8.5 million and $3.4 million respectively. As a result of these
losses, available cash resources are limited and will be depleted in July 1999
absent additional debt or equity funding. While the Company continues to pursue
sources of capital, there can be no assurance that they will be successful in
these efforts. The ability of the Company to continue as a going concern is
dependent upon the Company achieving significant revenue increases from their
existing genetic products, developing new products, successfully marketing its
products to customers at profitable prices and obtaining significant levels of
new capital. If the Company is not successful in these efforts, the Company
would likely be unable to continue operating as a going concern.
The Company has retained the services of a New York City-based
investment banking firm to assist it in raising capital pursuant to a private
placement. Management of the Company believes that this offering will be
successfully concluded during the second quarter of 1999. In addition, the
Company is in discussions with a number of potential strategic partners and, if
such discussions are successfully completed, the Company believes this will
result in the up-front funding of some of its programs. There can be no
assurance that the private placement or any of the partnering discussions will
be completed.
STRATEGY
MSSI's objective is to be a leading genetic diagnostic tests and
medical research tools development company. MSSI's strategy is to develop
products for research and clinical use that are commercialized through strategic
collaborations. These products include tests that are predictive of disease risk
and tools for use in drug development. The Company believes that it will, in the
near term, generate testing revenues, licensing fees, research and development
funding, and fee-for-service or participatory revenues pursuant to contracts
with its collaborative partners. In the long term, the Company believes it will
generate royalty payments from its corporate partners for new genetic tests and
therapeutic products. The Company believes that this strategy allows the Company
to generate near-term revenues and diversify risk, while building a proprietary
product portfolio with significant long-term potential.
DEVELOPMENT SYSTEM AND APPROACH
Many factors, both environmental and genetic, contribute to most common
diseases. Importantly, some genetic factors are sufficiently strong that they
influence the onset and progression of a disease despite many other variables.
These genetic factors control aspects of the biology that have high leverage on
the disease. The Company has focused its research and product development
efforts on genetic factors that significantly change the clinical course of
common, chronic diseases.
The Company's development program uses a proprietary enabling system
called BioFusion. BioFusion is a computer modeling system that integrates
genetic and other biological information to identify specific molecules or
biochemical pathways that have large magnitude effects on the progression of
disease and clinical outcomes. The Company then conducts clinical and basic
biological studies to test hypotheses generated by the modeling system.
Using this approach, the Company has demonstrated that certain genetic
factors are significant determinants of the clinical expression of multiple
common diseases. These factors affect the severity and the rate of progression
of clinical disease through their influence on host systems that are common to
several disease processes. Thus a genotype-positive individual translates a
disease challenge into a higher clinical disease trajectory than a
genotype-negative individual with a comparable disease challenge.
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PRODUCT PIPELINE AND PROPRIETARY POSITION
The Company has completed clinical trials and patent applications have
been filed or patents have been issued on the role of genetic factors in the
following diseases:
o Periodontitis
o Osteoporosis
o Coronary artery disease
o Diabetic retinopathy
o Meningitis/Sepsis
o Asthma
Based on these discoveries, the Company is developing a pipeline of tests that
are predictive of disease risk. Under development are tests predictive of the
disease risk for osteoporosis, coronary artery disease, diabetic retinopathy
(blindness associated with diabetes), asthma and meningitis/sepsis. PST, a test
predictive of disease risk for periodontitis (gum disease), was introduced
commercially in the U.S. in the fourth quarter of 1997.
In each clinical disease field, the Company's development program is
focused on understanding how genetic risk factors relate to overall risk for the
disease and establishing clear links to treatment. By combining genetic risk
assessment with specific therapeutic strategies, the Company believes improved
clinical outcomes and more cost-effective management of these common diseases
can be achieved. These genetic factors are also of value in both identifying
response patterns during clinical trials for the enhancement of existing
therapeutic agents and for developing new therapeutics directed at specific
immuno- inflammatory components of several common diseases.
CLINICAL UTILITY
The Company believes in the advantages a genetic approach to medicine
offers in the prevention, management and treatment of disease. The Company
believes its predictive tests and research tools are of value to:
o Pharmaceutical companies, who may use them to speed new drug
development, to improve the efficacy of their drugs, and to develop new
therapeutics.
o Payors and organizations who provide health care services, who may use
them to stratify patients by risk and more effectively allocate
resources for the greatest benefit.
o Physicians and other healthcare professionals, who may use this
information to assess the risk involved for their patients and adopt
appropriate treatments or preventive strategies.
o Patients committed to staying healthy, who may use this information to
make better choices and set priorities based on personal knowledge of
their individual risk for common diseases.
TEST PREDICTIVE OF DISEASE RISK FOR PERIODONTAL DISEASE.
The Company's first genetic susceptibility test, PST, 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.
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The PST is the result of a scientific breakthrough in which an
association was discovered between a specific IL-1 genotype and severe
periodontal disease. 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. 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. 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.
The Company has developed PST pursuant to a project agreement between
the Company and Sheffield University. In November, 1997, a patent related to the
detection of genetic predisposition to periodontal disease was issued to the
Company. The Company initiated commercial sales of PST in October 1997. In
December 1998, the Company entered into an agreement with Washington Dental
Service, a member of Delta Dental Plans Association, for the purchase of 1,200
PST tests to be used in a study sponsored by Washington Dental Service, in
collaboration with the University of Washington School of Dentistry and MSSI.
The study is designed to quantify the relationship between PST genotype status
and the utilization of dental services by patients in a dental plan.
The study, which began in early 1999, will provide scientific and
financial information about PST in a reimbursement system. If patients who are
at increased risk for periodontal disease can be identified early using PST,
services can be provided which should minimize the progression of disease and
the cost and complications of its consequences. The most costly dental
procedures are usually those associated with tooth loss due to advanced disease
(i.e., bridges, partial dentures, implants, etc.). Therefore, early
identification and intervention of high-risk patients is in the patients' and
payer's best interest. The Company believes that this study will provide
important scientific and financial data regarding the use of PST as a
treatment-planning tool to assess risk before actual damage occurs. It is
currently anticipated that the data from the study will be available for
analysis by the third quarter of 1999.
The Company has entered into agreements for PST to be marketed in North
America, France and Israel and is currently in discussions with several
prospective marketing partners for European rights.
TEST PREDICTIVE OF DISEASE RISK FOR OSTEOPOROSIS.
The Company's second genetic test 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. The Company has identified a genetic marker that in
clinical trials was associated with a more rapid loss of bone in women after
menopause.
The clinical utility of the osteoporosis susceptibility test lies in
its ability to predict a patient's future bone density trend. A genotype
positive test result is a significant risk factor for accelerated bone loss
after menopause. A positive patient is more likely to exhibit low bone mineral
density and experience severe fractures compared to a genotype negative patient.
Early patient identification and appropriate intervention can alter the rate of
the disease.
The Company's test provides data that will allow practitioners to
practice preventive medicine. Results of this test will assist women who are
approaching menopause in deciding whether to start treatment. 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.
The Company is also expecting results from a large-scale clinical trial
on its osteoporosis test during 1999.
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TEST PREDICTIVE OF DISEASE RISK FOR CORONARY ARTERY DISEASE (Patent Pending).
The Company's third genetic susceptibility test, which is currently
under development, 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. This
marker can be combined with other risk factors to identify individuals at high
risk for developing a more rapidly progressive and severe form of coronary
artery disease.
The availability of the Company's 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.
The Company is also expecting results from two large-scale clinical
trials on its coronary artery disease test during 1999.
TEST PREDICTIVE OF DISEASE RISK FOR RETINOPATHY IN DIABETICS (Patent Pending).
The Company's fourth genetic susceptibility test, which is currently
being developed, 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 Company has 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.
To date, the Company has completed an initial study involving 500
patients who demonstrated a strong association between specific genetic markers
and susceptibility to diabetic retinopathy. A confirmatory clinical trial is
presently underway. Clinical utility studies to establish links to treatment are
planned to begin when the confirmatory data are in.
TESTING PROCEDURE
Each of the Company's six genetic susceptibility tests requires, or
will require, that a single procedure be utilized. To conduct a genetic
susceptibility test, the doctor draws a blood sample and submits it to the
Company's customer service department. The customer service department then logs
in the sample and submits sample batches to the MSSI Laboratory or reference lab
for testing. The laboratory then performs the test following the Company's
specific protocol and informs the Company of the results. The Company, in turn,
advises 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,
the Company's billing service 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.
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The Company will continue to use one or more sophisticated, certified,
and fully validated laboratories capable of providing consistent and high
quality analysis. Customer service is handled via the Company's toll free "888"
numbers by the Company's own staff who are knowledgeable about its genetic
susceptibility tests, the procedural requirements of the testing system and the
related diseases.
In the future, the Company may license the right to market and perform
the testing services to collaborative partners in exchange for a royalty or
other payments.
PRE-MARKETING TRIALS/STATUS OF PREDICTIVE TESTS
As an internal procedural standard, the Company conducts three
categories of clinical trials in conjunction with its 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.
Following confirmatory studies, additional trials are completed on
larger populations to help develop broad scientific evidence supporting the
clinical utility of each of the Company's 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
The Company has ongoing research to continue to identify other genetic
factors that appear to be associated with other diseases. The Company plans on
filing additional patent applications to cover these discoveries. It is the
Company's intent to bring these discoveries to market in the form of tests
predictive of disease risk or medical research tools. The Company has also come
upon certain genetic factors that might be likely candidates to serve as
therapeutic targets, those susceptible to influence by drug agents. The Company
is considering certain collaborative long term relationships with pharmaceutical
companies as a method to provide for either the licensing of its discoveries or
to assist in the research and development of future products.
STRATEGIC ALLIANCES AND COLLABORATIONS
The Company's strategy is to develop products for research and clinical
use and commercialize such products through strategic alliances.
SHEFFIELD UNIVERSITY
In 1994 the Company 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. The Company has
followed a strategy of working with strategic partners at the fundamental
discovery stage. This strategy has given the Company access to discoveries while
reducing up-front research expenses. Since 1994, the Company has had a strategic
alliance with the Department of Molecular and Genetic Medicine at Sheffield
University in the United Kingdom ("Sheffield"). Under this alliance, Sheffield
has provided to the Company the fundamental discovery and genetic analysis from
Sheffield's research laboratories and the Company has focused on product
development, including clinical trials, and the commercialization of these
discoveries. The Company has entered into multiple joint development and
commercialization project agreements with Sheffield, and anticipates entering
into additional collaborative arrangements with Sheffield and other parties in
the future. See "Factors Affecting Future Performance - Reliance on
Collaborative Partners."
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GLAXO WELLCOME
The Company has entered into a development and license agreement with
Glaxo Wellcome to develop a computer model in support of new compound screening.
MSSI's BioFusion proprietary technology provides a means of developing
computer-based simulation models of large, complex biological systems, which can
assist in the interpretation of gene expression and molecular screening
databases. The computer models can be used for a number of purposes, including
identifying new biologic targets for drug or diagnostic discovery, understanding
how genetic discoveries influence disease, and clinical trial design. Medical
Science Systems has utilized this technology to support the development and
commercialization of its genetic tests and in support of drug development
efforts for large pharmaceutical companies.
DELTA DENTAL
The Company signed an agreement with Washington Dental Service, a
member of the Delta Dental Plans Association, for the purchase of 1,200 PST
tests. PST is the Company's test predictive of disease risk for periodontal
disease (gum disease). The tests will be used in a study, sponsored by
Washington Dental Service, in collaboration with the University of Washington
School of Dentistry and Medical Science Systems. The study is designed to
quantify the relationship between PST genotype status and the utilization of
dental services by patients in a dental plan.
The study, scheduled to begin in 1999, will provide scientific and
financial information about PST in a reimbursement system. This study is
expected to provide scientific and financial data regarding the use of PST as a
treatment-planning tool to assess risk. The data from the study should be
available for analysis during 1999. See "Factors Affecting Future Performance -
Reliance on Collaborative Partners."
PST COMMERCIAL PARTNERSHIPS
In December 1997, the Company entered into an agreement with
Medicadent, a French corporation ("Medicadent"), to market and sell PST in
France. In August 1998, the Company entered into an agreement with H.A. Systems,
Ltd. to market and sell PST in Israel. Medicadent commenced offering PST in
France in June 1998, and the Company expects H.A. Systems to commence offering
PST in Israel in early 1999. No assurances can be made regarding the commercial
acceptance of PST. The Company anticipates additional international agreements
for the distribution of PST in 1999, but no assurances can be made that such
agreements will be entered into by the Company.
In March 1999, the Company entered into an agreement with the Straumann
Company to market and sell PST in the United States and Puerto Rico.
INTELLECTUAL PROPERTY
The Company's commercial success will be dependent in part on its
ability to obtain patent protection on genes, genetic sequences and/or their
relationship to common diseases, as well as diagnostic and therapeutic products
and methods based on the association between particular genes and diseases,
discovered by the Company and Sheffield University. The Company has a total of
four issued U.S. patents and 14 pending U.S. patent applications. Of the four
issued patents, two relate to the Company's genetic tests and two relate to
BioFusion, the Company's biologic modeling software. The U.S. Patent and
Trademark Office issued patents for the Company's periodontal and osteoporosis
tests in November and December, 1997, respectively.
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The Company has been granted a number of corresponding foreign patents
and has filed foreign counterparts of its U.S. applications within the
appropriate time frames. Where the Company has originally filed in another
country, it has filed and plans to continue 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.
As provided in the applicable project agreements between the Company
and Sheffield University, the Company files and prosecutes all patents. To the
extent an invention is developed by personnel of Sheffield, the Company is
granted a worldwide license to the invention and Sheffield is obligated to
assign its patent rights to the invention, both subject to Sheffield's
continuing rights to share in the net profits as set forth in the applicable
project agreement. To the extent the invention is developed by personnel of the
Company, the Company owns the patent, subject to the right of Sheffield to share
in the net profits as set forth in the applicable project agreement. To the
extent the invention is jointly developed by personnel of the Company and
Sheffield, each party has joint ownership. However, the Company is granted a
worldwide license to the invention patent, subject to Sheffield's continuing
rights to share in the net profits as set forth in the applicable project
agreement. Such assignment agreements transferring rights to both the issued and
pending U.S. patents and patent applications have been recorded in the U.S.
Patent and Trademark Office and for corresponding foreign patents in the
relevant foreign patent offices.
The Company is continuing to identify and develop applications related
to additional genetic markers. The Company has also applied for trademark
protection for the name of its periodontal susceptibility test. The Company's
proprietary technology is subject to numerous risks. See "Factors Affecting
Future Performance."
COMPETITION
Competition in the Company's potential markets is intense. 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,
other companies do exist which have research programs seeking disease related
genes for therapeutic and susceptibility testing purposes, including some that
involve treatable/ preventable disease. The technologies for discovering genes
which predispose individuals to major diseases and approaches for
commercializing those discoveries are new and rapidly evolving. Rapid
technological developments could result in the Company's potential services,
products, or processes becoming obsolete before the Company recovers a
significant portion of its related research and development costs and capital
expenditures associated therewith.
Competitors of the Company 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. Other companies
with research programs include Myriad Genetics, Inc. ("Myriad") and Genome
Therapeutics Corp. ("GTC"). GTC has announced that it has research programs
focusing on osteoporosis. Myriad has a test for breast cancer and has announced
research programs for osteoporosis and coronary artery disease. Many of the
Company's other potential competitors have considerably greater financial,
technical, marketing and other resources than the Company, which may allow these
competitors to discover important genes in advance of the Company. If the
Company does not discover disease-predisposing genes, characterize their
functions, develop genetic tests and related information services based on such
discoveries obtain regulatory and other approvals, and launch such services or
products before competitors, the Company could be adversely affected.
Additionally, some of the Company's 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 the Company's
competitors receive data and funding from the Human Genome Project at no cost to
them, they may have a competitive advantage over the 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.
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Furthermore, 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, the Company's primary business focus is developing and
commercializing genetic susceptibility tests for common diseases, with only an
ancillary drug discovery program.
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 the Company's business. In
addition, certain billing practices of the Company required it, or a subsidiary,
to be licensed and regulated under CLIA.
In addition, while the Company's main focus is on genetic
susceptibility testing, the Company may, in the future, endeavor to partner with
pharmaceutical companies in the area of drug development. Any drug products
developed by the Company or the Company's 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 the Company or its collaborative partners, impose
costly procedures upon the Company and its collaborative partners' activities,
diminish any competitive advantages that the Company or its collaborative
partners may attain and adversely affect its 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.
EMPLOYEES
As of March 1, 1999, the Company had 18 full-time employees. Of the
Company's employees, 78% are engaged directly in the development and
commercialization of tests and 22% are engaged in administrative or managerial
activities.
The Company's employees are not covered by a collective bargaining
agreement, and the Company considers its relations with its employees to be
good.
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FACTORS AFFECTING FUTURE PERFORMANCE
NO ASSURANCE OF ADDITIONAL NECESSARY CAPITAL
The Company anticipates that its current financial resources will be
adequate to maintain its current and planned operations through July 1999. THERE
CAN BE NO ASSURANCE THAT THE COMPANY WILL BE ABLE TO RAISE ANY ADDITIONAL
NECESSARY CAPITAL. IF ADDITIONAL AMOUNTS CANNOT BE RAISED, THE COMPANY WOULD
SUFFER MATERIAL ADVERSE CONSEQUENCES TO ITS BUSINESS, FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND WOULD LIKELY BE REQUIRED TO SEEK PROTECTION UNDER THE
UNITED STATES BANKRUPTCY LAWS.
The Company's future capital requirements will depend on many factors,
including successful expansion of sales of PST(R), the Company's genetic test
for periodontal disease, and continued scientific progress with its research and
development programs. The continuation of the Company's research and development
activities may require substantial additional capital from private or public
sources. There is no assurance that such capital will be available to the
Company on acceptable terms. Furthermore, the market for publicly-traded stocks
of biotechnology companies has been depressed since 1993, and the competition
for equity capital from public and private sources has intensified among the
over 1,000 biotechnology companies in the United States that are dependent on
infusions of capital to fund their operations. The Company is also engaged from
time to time in discussions with several companies concerning the licensing of
certain of the Company's proprietary technologies or forming strategic
alliances, which could provide additional sources of funding to the Company as
well as a possible source of equity capital. The Company is unable to predict
the likelihood of completing any such arrangements. There can be no assurance
that the Company will be successful in obtaining additional capital in amounts
sufficient to continue to fund its operations and product development.
INABILITY TO FULLY USE NET OPERATING LOSS CARRYFORWARDS
As a result of the losses incurred in 1997 and 1998, the Company has
not recorded a Federal income tax provision for those years and has recorded a
valuation allowance against all future tax benefits. As of December 31, 1998,
the Company had net operating loss carryforwards of approximately $13,000,000
for federal income tax purposes, expiring in varying amounts through the year
2018, which are available to offset future taxable income. The Company also had
a research tax credit of approximately $170,129 at December 31, 1998 that
expires in varying amounts through the year 2018. The Company's ability to use
its NOL and credit carryforwards to offset future taxable income is subject to
Section 382 of the Internal Revenue Code of 1986 (the "Code"). These
restrictions provide for limitations on the Company's utilization of its NOL and
credit carryforwards following a greater than 50% ownership change during the
prescribed testing period. As of December 31, 1998 the Company has experienced
an ownership change in excess of 40% during its testing period of October 1,
1996-December 31, 1998.
UNCERTAINTY OF MARKET ACCEPTANCE FOR GENETIC SUSCEPTIBILITY TESTS
The commercial success of the Company's genetic susceptibility tests
and those that it 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. It is uncertain whether current genetic susceptibility tests or
others that the Company may develop will gain market acceptance on a timely
basis. If patients, dentists and physicians do not accept the Company's tests,
or take a longer time to accept than the Company anticipates, then the Company's
revenues and profit margins may be reduced and may result in losses.
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DIFFICULTY OF DEVELOPING GENETIC SUSCEPTIBILITY TESTS
It is uncertain whether the Company will be successful in developing
and bringing to market its current portfolio or future tests based on the
genetic discoveries made by the Company and its collaborators. Even when the
Company discovers 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
the Company to cancel a program. Such delays, reduced acceptance or
cancellations would reduce revenues and may result in losses.
HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE
PROFITABILITY
We incurred a net operating loss of $788,546 in fiscal year 1996,
$4,494,062 in 1997 and $9,508,275 in 1998. As of December 31, 1998, our
accumulated deficit was $14,790,883. 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.
UNCERTAINTY OF INSURANCE REIMBURSEMENT
The Company's ability to successfully commercialize existing genetic
susceptibility tests and others that the Company 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, the Company
initially expects 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 the Company 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 the Company
formalized its relationship by entering into a master agreement (the "Master
Agreement"). Under the terms of the Master Agreement, the Company 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 the Company and Sheffield University agreed upon
separately under project agreements related to each test (each a "Project
Agreement"). The Company's share of the net profits under such Project
Agreements ranges from 60% 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 the Company's access to future Sheffield University genetic
discoveries that fall outside of the scope of the Company's existing Project
Agreements.
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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 the 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 the Company 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, the Company would need to enter into
additional collaborative arrangements in order to continue to build a future
pipeline of products.
In the future the Company may, in order to facilitate the sale of the
Company's testing services and/or products, enter into collaborative selling
arrangements with one or more other persons. It is uncertain whether the Company
will be able to negotiate acceptable collaborative arrangements in the future or
that such collaborative arrangements will be successful. If the Company is
unable to identify collaborative partners to sell certain of its services and/or
products, the Company may be forced to develop an internal sales force to market
and sell its services and/or products in markets where it is not intending on
developing a direct selling presence. Such a process would take more time and
potentially cost more. As a result, the Company's revenues and earnings would be
reduced. If the Company does enter into collaborative selling arrangements, its
success will depend upon the efforts of others and may be beyond the Company's
control. Failure of any collaborative selling arrangement could result in
reduced revenues and possible losses.
UNCERTAIN ABILITY TO PROTECT PROPRIETARY TECHNOLOGY
The Company's success will partly depend on its ability to obtain
patent protection, both in the United States and in other countries, for its
products and services. In addition, the Company's success will also depend upon
its ability to preserve its trade secrets and to operate without infringing the
proprietary rights of third parties.
The Company has fourteen patent applications pending, including
applications covering certain of its anticipated genetic susceptibility tests.
There can be no assurance that the Company's patent applications will ever be
issued as patents or that the claims of any issued patents will afford
meaningful protection for the Company's technology or products. Further, others
may develop similar products which test for susceptibility related to some
diseases yet avoid infringing upon, or conflicting with, the Company's
anticipated patents. In addition, there can be no assurance that any patents
issued to the Company will not be challenged, and subsequently narrowed,
invalidated or circumvented.
The Company's 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
the Company's 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 the Company seeking damages or seeking to enjoin the
Company from testing, manufacturing or marketing its products. Patent litigation
is costly, and even if the Company prevails, the cost of such litigation could
have an adverse effect on the Company. If the other parties in any such actions
are successful, in addition to any liability for damages, the Company could be
required to cease the infringing activity or obtain a license. It is uncertain
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whether any license required would be available to the Company on acceptable
terms, if at all. Failure by the Company to obtain a license to any technology
that it may require to commercialize its products could have a material adverse
effect on the Company's 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 the Company's
filing of a patent application on such discovery, may compromise the Company's
ability to obtain U.S. and foreign patent protection for the discovery.
The Company also relies upon unpatented proprietary technologies. The
Company relies on confidentiality agreements with its employees, consultants and
collaborative partners to protect such proprietary technology. There can be no
assurance that the Company can adequately protect its rights in such unpatented
proprietary technologies, that others will not independently develop
substantially equivalent proprietary information or techniques, or otherwise
gain access to the Company's proprietary technologies or disclose such
technologies.
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 the Company's or the Company's 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 the Company's testing services could
also be adversely affected by technological change. It is uncertain whether the
Company's competitors will succeed in developing genetic susceptibility tests
that circumvent or are more effective than the Company's technologies or
services. Further, it is uncertain whether such developments would render the
Company's or the Company's collaborators' technology or services less
competitive or obsolete. Further, the Company's 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 the Company's ability to market its
services effectively.
POSSIBLE NASDAQ DELISTING; LIMITED PUBLIC MARKET FOR COMMON STOCK;
POSSIBLE VOLATILITY OF SECURITIES PRICES
Our Common Stock is currently listed on The Nasdaq SmallCap Market and
the Boston Stock Exchange. If the Company fails to maintain the qualification
for its Common Stock to trade on the Nasdaq SmallCap Market or the Boston Stock
Exchange, its Common Stock could be subject to delisting. The Nasdaq Stock
Market announced increases in the quantitative standards, which became effective
in February 1998, for maintenance of any of (x) $2,000,000 of net tangible
assets, (y) $35,000,000 of market capitalization or (z) $500,000 of net income
for two of the last three years and a minimum bid price per share of $1.00. On
February 3, 1999, we received notice from Nasdaq that we are in violation of
Nasdaq's minimum bid price requirement and that if our Common Stock does not
have a closing bid price of at least $1.00 for ten consecutive trading days
during the 90 day period ended May 3, 1999, our Common Stock will be subject to
delisting on May 3, 1999. The Company believes it has satisfied this requirement
by having a closing bid price of at least $1.00 for the ten consecutive trading
days ending March 29, 1999; however the Company has not yet received notice from
NASDAQ that such requirement was satisfied. Furthermore, there can be no
assurance that our stock price will maintain such $1.00 minimum bid price. If
the market price for our Common Stock does fall below the $1.00 bid price, our
Common Stock could be subject to delisting from The NASDAQ SmallCap Market.
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If our shares are not listed as intended, trading, if any, would be
conducted in the over-the-counter market in the so-called "pink sheets" or the
OTC Bulletin Board, which was established for securities that do not meet The
Nasdaq SmallCap Markets listing requirements. Consequently, selling our shares
would be more difficult because smaller quantities of shares could be bought and
sold, transactions could be delayed, and security analysts' and news media's
coverage of our company may be reduced. These factors could result in lower
prices and larger spreads in the bid and ask prices for our shares.
If our shares are not listed on The Nasdaq SmallCap Markets and/or the
Boston Stock Exchange, they may become subject to Rule 15g-9 under the Exchange
Act. That rule imposes additional sales practice requirements on broker-dealers
that sell low-priced securities to persons other than established customers and
institutional accredited investors. For transactions covered by this rule, a
broker-dealer must make a special suitability determination for the purchaser
and have received the purchaser's written consent to the transaction prior to
sale. Consequently, the rule may affect the ability of broker-dealers to sell
our shares and affect the ability of holders to sell our shares in the secondary
market.
The SEC's regulations define a "penny stock" to be any equity security
that has a market price less than $5.00 per share or with an exercise price of
less than $5.00 per share, subject to certain exceptions. The penny stock
restrictions will not apply to our shares if they are listed on The Nasdaq
SmallCap Market or the Boston Stock Exchange and we provide certain price and
volume information on a current and continuing basis, or meet required minimum
net tangible assets or average revenue criteria. We cannot assure you that our
shares will qualify for exemption from these restrictions. If our shares were
subject to the penny stock rules, the market liquidity for the shares could be
adversely affected.
Historically, the Common Stock has experienced low trading volumes. The
market price of the Common Stock also has been highly volatile and it may
continue to be highly volatile as has been the case with the securities of other
public biotechnology companies. Factors such as announcements by Medical Science
Systems or its competitors concerning technological innovations, new commercial
products or procedures, proposed government regulations and developments or
disputes relating to patents or proprietary rights may substantially affect the
market price of the Company's securities. Changes in the market price of the
Common Stock may bear no relation to the Company's actual operational or
financial results.
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 represented 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.
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.
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ETHICAL, LEGAL AND SOCIAL IMPLICATIONS OF GENETIC TESTING
The prospect of broadly available genetic 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 (Health Insurance Portability Act 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.
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 or Dr. Kornman 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
Our directors, executive officers and certain of their affiliates
beneficially own approximately 55.9% 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.
ABSENCE OF DIVIDENDS
We have never paid dividends and do not intend to pay any dividends in
the foreseeable future.
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SHARES ELIGIBLE FOR FUTURE SALE
Substantially all of the outstanding Common Stock is available for sale
in the public marketplace. There are also outstanding stock options and warrants
to purchase an aggregate of 1,174,383 shares of Common Stock at various exercise
prices per share. No prediction can be made as to the effect, if any, that sales
of shares of Common Stock or the availability of such shares for sale will have
on the market prices prevailing from time to time. The possibility that
substantial amounts of Common Stock may be sold in the public market may
adversely affect prevailing market prices for the Common Stock, and could impair
the Company's ability to raise capital through the sale of its equity
securities.
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. The issuance of Preferred Stock may 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.
ITEM 2. DESCRIPTION OF PROPERTY
The Company has two offices in the following locations: Flagstaff,
Arizona and San Antonio, Texas. Flagstaff, Arizona is the site of the Company's
global commercial operations, including its marketing, sales and customer
service organization. The San Antonio Research Center is the principal site of
its research and development and employs teams of top medical, dental and
computer scientists. San Antonio is the site of its corporate headquarters.
The Company's commercial operations office located at 3100 N. West
Street, Bldg. A, Flagstaff, Arizona, contains 6,000 square feet and is held
under a five year lease which expires in September 2002. The Company's research
and development office, located at 100 N.E. Loop 410, Suite 1350, 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 May 31, 2003 unless either
party gives a prior 30 day notice. The Company's former corporate headquarters,
located at 4400 MacArthur Boulevard, Suite 980, Newport Beach, California,
contains 1,798 usable square feet and has been subleased by the Company until
the expiration of the Company's original lease in April 2001.
ITEM 3. LEGAL PROCEEDINGS
On March 2, 1999, Entelos, Inc. filed an action against the Company in
United States District Court for the Northern District of California, alleging
that two of Entelos' principals, Samuel Holtzman and Thomas Paterson, are
co-inventors of the inventions claimed in two of the Company's patents - U.S.
Pat. Nos. 5,657,255 and 5,808,918, both of which relate to the Company's
BioFusion products. In the suit, Entelos seeks a declaratory judgment that
Entelos is the co-owner of all rights under the foregoing patents, an order
correcting the inventorship of the patents to list Holtzman and Paterson as
co-inventors, and restitution to Entelos of its share of the profits obtained
from the patents. The Company is currently investigating the claims of
co-inventorship and is engaged in settlement discussions with Entelos in an
effort to resolve the matter out of court.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of the year ended
December 31, 1998.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
MARKET INFORMATION
The Company's Common Stock began trading on The Nasdaq SmallCap Market
on November 26, 1997 under the symbol "MSSI" and on the Boston Stock Exchange
under the symbol "MSC." Prior to that date, there was no established trading
market for the Common Stock. the following table sets forth, for the periods
indicated, the high and low bid prices for the Common Stock, as reported by the
Nasdaq Small Cap market, since the Common Stock commenced public trading. The
quotations represent prices in the over-the-counter market between dealers and
securities, and do not include retail markup, markdown or commissions and may
not necessarily represent actual transactions.
1998: High Low
------ ------
First Quarter........................ $6.063 $2.938
Second Quarter ...................... $5.00 $3.50
Third Quarter........................ $4.25 $1.313
Fourth Quarter....................... $2.125 $0.469
1997:
November 26 - December 31, 1997...... $9.00 $3.875
NUMBER OF SHAREHOLDERS
As of March 23, 1999, there were approximately 475 beneficial holders
and 97 record holders of the Company's Common Stock.
DIVIDENDS
The Company has not declared any dividends to date and does not plan to
declare any dividends in the foreseeable future.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL OVERVIEW
Medical Science Systems, Inc., a Texas corporation ("MSSI" or the
"Company") develops and commercializes genetic diagnostic tests and medical
research tools. The Company's efforts are focused on genetic factors that affect
the rate of progression of clinical disease through their influence on common
host systems. The Company's first genetic test, PST(R), a test predictive of
risk for periodontal disease, is currently marketed in the United States, France
and Israel. Products under development include tests predictive of risk for
osteoporosis, coronary artery disease, diabetic retinopathy, asthma and
meningitis/sepsis.
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The Company believes by combining genetic risk assessment with specific
therapeutic strategies, improved clinical outcomes and more cost-effective
management of these common diseases are achieved. MSSI also develops and
licenses its medical research tools, including BioFusion(R), to pharmaceutical
companies. BioFusion, a proprietary enabling system for diagnostic and drug
discovery and development, is a computer modeling system that integrates genetic
and other sub-cellular behavior, system functions, and clinical symptoms to
simulate complex diseases. This system allows for the utilization of the rapidly
increasing databases of gene expression, cell biology, prognostic,
pharmacogenomic and predictive medicine databases being generated in companies
and academic centers worldwide.
The Company has followed a strategy of working with strategic partners
at the fundamental discovery stage. This strategy has given the Company access
to discoveries while reducing up-front research expenses. Since 1994, the
Company has had a strategic alliance with the Department of Molecular and
Genetic Medicine at Sheffield University in the United Kingdom ("Sheffield").
Under this alliance, Sheffield has provided to the Company the fundamental
discovery and genetic analysis from Sheffield's research laboratories and the
Company has focused on product development, including clinical trials, and the
commercialization of these discoveries. The Company has entered into multiple
joint development and commercialization project agreements with Sheffield, and
anticipates entering into additional collaborative arrangements with Sheffield
and other parties in the future.
In December 1997, the Company entered into an agreement with
Medicadent, a French corporation ("Medicadent"), to market and sell PST in
France. In August 1998, the Company entered into an agreement with H.A. Systems,
Ltd. to market and sell PST in Israel. Medicadent commenced offering PST in
France in June 1998, and the Company expects H.A. Systems to commence offering
PST in Israel in early 1999. No assurances can be made regarding the commercial
acceptance of PST. The Company anticipates additional international agreements
for the distribution of PST in 1999, but no assurances can be made that such
agreements will be entered into by the Company. In March 1999, the Company
entered into an agreement with the Straumann Company to market and sell PST in
the United States
and Puerto Rico.
The Company has been awarded four U.S. patents, and has fourteen U.S.
patent applications pending. The U.S. Patent & Trademark Office awarded patents
to the Company for its osteoporosis and periodontal disease susceptibility tests
and two patent awards for its biologic modeling technology called BioFusion(R),
which is used by the Company in the discovery, development and commercialization
process.
In November 1997, the Company completed its initial public offering of
Common Stock raising gross proceeds of $16.2 million. The Company is using the
proceeds of the offering for sales, marketing and commercial operations for its
genetic susceptibility testing business and continued research and development
of new genetic susceptibility tests.
-19-
<PAGE>
RESULTS OF OPERATIONS
COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
Gross revenue for the year ended December 31, 1998 was $412,942 as
compared to $195,928 for the year ended December 31, 1997, representing an
increase of $217,014 or 111%. The increase in revenue is primarily attributable
to sales of PST, the Company's first genetic test which was made commercially
available in the fourth quarter of 1997. Cost of sales was $216,284 for the year
ended December 31, 1998 as compared to $166,442 for the same period in 1997,
representing an increase of 30%. This increase is a result of the increase in
sales, offset by the Company's ability to take advantage of volume processing
discounts provided to it by its outside laboratory vendors.
For the year ended December 31, 1998, the Company had research and
development expenses of $2,799,220 as compared to $1,223,468 for 1997, an
increase of $1,575,752 or 129%. This increase was due to our continued
investment in genetic research projects. In addition to the full time employment
of key scientists for our coronary artery disease and osteoporosis genetic
susceptibility tests, and for new clinical trials which have commenced and are
continuing to run for the same two tests, the Company continues to perform
science enhancement studies for our PST product, as well as invest in our
previously disclosed research projects related to diabetic retinopathy and
asthma.
One additional factor in the increase of research and development
expenses, as discussed above, is the write-down of capitalized patent expenses.
The resulting charge, taken in the fourth quarter of 1998, was $866,534, or 32%,
of research and development expenses for the year. Management believes it is
appropriate to expense these costs after consideration of their current
development strategy, available capital and the requirements of statement of
Financial Accounting Standard 121.
Selling, general and administrative expenses increased for 1998 to
$7,200,444 from $2,868,057 for 1997, an increase of $4,332,387 or 151%. This
increase is primarily attributable to building the infrastructure required to
support commercial operations and the increased marketing and sales efforts
required to support the Company's genetic susceptibility testing business.
Additionally, general and administrative expenses increased to support the
research and development efforts of the Company, and due to increased legal and
accounting expenses related to complying with SEC reporting obligations.
During the second quarter of 1998, the Company consolidated its
corporate headquarters from Newport Beach, California into the Company's San
Antonio Research Facility. As a result of this relocation, the Company amended
its existing lease in San Antonio to extend the term and expand its premises.
The amended lease expires on May 31, 2003 and extends its square footage from
approximately 1,961 square feet to 8,131 square feet. Also, as a result of the
move from California, the Company has subleased its leased office space in
Newport Beach. The sublease expires on the same date of the Company's lease,
April 30, 2001.
Interest income for the year ended December 31, 1998 increased to
$379,054 from $53,889 for 1997. Such increase is attributable entirely to the
interest income generated by the unused net proceeds of the initial public
offering. Interest expense of $94,597 was incurred during the year ended
December 31, 1998, a decrease of 81% from $485,062 over the same period in 1997.
Such decrease is attributable to a decrease in the amount of the Company's debt
obligations, which were substantially reduced with the net proceeds of the
Company's initial public offering.
Net losses increased to $9,508,275 for the year ended December 31,
1998, as compared to $4,494,062 for the same period in 1997, an increase of
$5,014,213 or 112%. Such increased loss is a result of the increased expenses
set forth above.
Based on the change in late 1998 to a partnering strategy for both
development and commercialization of new products, the Company believes that its
net loss for the first quarter of 1999 will be approximately 50% of its average
quarterly loss in 1998.
-20-
<PAGE>
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31,
1996.
Revenues for the year ended December 31, 1997 decreased by $1,722,951,
from $1,918,879 for the year ended December 31, 1996 to $195,928 for the same
period in 1997, due to the decrease in contract research agreements. In the
summer of 1996, the Company changed its focus from providing pharmaceutical
companies clinical trial and research services pursuant to contract research
agreements to concentrating its resources on developing genetic susceptibility
tests. This change in focus resulted in a significant decrease in revenue for
the year ended December 31, 1997 compared to the same period for 1996. Research
and development expenses increased by $265,219 to $1,223,468 for the year ended
December 31, 1997 from $958,249 in 1996. The research and development expenses
are attributed to development expenses related to work on developing genetic
susceptibility tests for periodontitis, osteoporosis, coronary artery disease
and diabetic retinopathy. Selling, general and administrative expenses increased
by $1,705,289 from $1,162,768 for the year ended December 31, 1996 to $2,868,057
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 the periodontal susceptibility test, sales and marketing
expenses related to the launch of the periodontal susceptibility test and
salaries and benefits paid to existing and newly-hired sales and marketing
employees. In addition, the Company has incurred additional legal and accounting
expenses as a result of the reporting obligations related to being a
publicly-traded entity.
Interest income for the year ended December 31, 1997 increased by
$45,328 primarily due to the investment of unexpended public offering proceeds
in U.S. Treasury Notes. Interest expense for the year ended December 31, 1997,
amounted to $485,062, an increase of $450,833 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 year ended December 31, 1997 was $4,494,062
compared to $788,546 for the year ended December 31, 1996. 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company believes that its cash and cash equivalents are the most
significant indicators of the Company's liquidity position. As of December 31,
1998, the Company had cash and cash equivalents of $2,432,271. The cash and cash
equivalents position generated interest income of $52,584 in the fourth quarter
of 1998, and $379,054 for the year.
The Company currently does not have any commitments for material
capital expenditures. The Company's obligation at December 31, 1998 for
capitalized lease obligations totaled $261,488, of which $156,651 is classified
as long-term and $104,837 is classified as current.
During the second quarter of 1998 the Company changed the terms of its
long-term bank loan with the Bank of America NT&SA. The Company combined its two
existing loans into a single term loan which matures in June 2005, representing
a three-year extension from the previous loans. The principal balance at
December 31, 1998 was $529,288, of which $447,856 is classified long-term debt
and $81,432 is classified short-term debt. Three officers and directors of the
Company who had served as guarantors on the two previous loans were removed as
guarantors on the new loan. The Company has provided a certificate-of- deposit
as security for this loan, the balance of which at December 31, 1998 was
$530,000.
The Company anticipates that its existing cash and cash equivalents,
together with anticipated interest income and revenue, will be sufficient to
conduct its operations as planned through July 1999.
-21-
<PAGE>
However, the Company's future capital requirements are anticipated to be
substantial, and the Company does not have commitments for additional capital at
this time. Such capital requirements are expected to arise from the commercial
launch of additional genetic tests, continued marketing and sales efforts for
PST, continued research and development efforts, the protection of the Company's
intellectual property rights (including preparing and filing of patent
applications), as well as operational, administrative, legal and accounting
expenses. The Company plans to raise capital through equity and/or debt issuance
when, and if, such capital is available to it. THERE CAN BE NO ASSURANCE THAT
THE COMPANY WILL BE ABLE TO RAISE ANY ADDITIONAL NECESSARY CAPITAL. IF
ADDITIONAL AMOUNTS CANNOT BE RAISED, THE COMPANY WOULD SUFFER MATERIAL ADVERSE
CONSEQUENCES TO ITS BUSINESS, FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND
WOULD LIKELY BE REQUIRED TO SEEK PROTECTION UNDER THE UNITED STATES BANKRUPTCY
LAWS.
YEAR 2000 COMPLIANCE
The efficient operation of the Company's business is dependent on its
computer software programs and operating systems (collectively, "Programs and
Systems"). These Programs and Systems are used in several key areas of the
Company's business, including financial reporting, as well as in various
administrative functions. The Company has evaluated its Programs and Systems to
identify potential year 2000 compliance problems, as well as manual processes,
external interfaces with customers, and services supplied by vendors to
coordinate year 2000 compliance and conversion. The year 2000 problem refers to
the limitations of the programming code in certain existing software programs to
recognize date sensitive information for the year 2000 and beyond. Unless
modified prior to the year 2000, such systems may not properly recognize such
information and could generate erroneous data or cause a system to fail to
operate properly. Based on current information, the Company believes its
Programs and Systems are year 2000 compliant. However, because most computer
systems are, by their very nature, interdependent, it is possible that
non-compliant third party computers may not interface properly with the
Company's computer systems. The Company could be adversely affected by the year
2000 problem if it or unrelated parties fail to successfully address this issue.
In the event the Company's determines following the year 2000 date
change that its Programs and Systems are not year 2000 compliant, the Company
will likely experience considerable delays in compiling information required for
financial reporting and performing various administrative functions. In the
event of such occurrence, the Company's contingency plans call for it to switch
vendors to obtain hardware and/or software that is 2000 compliant, and until
such hardware and/or software can be obtained, the Company will plan to use
non-computer systems for its business, including information management services
and financial reporting, as well as its various administrative functions.
YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT
To the maximum extent permitted by applicable law, the above
information is being designated as "Year 2000 Readiness Disclosure" pursuant to
the "Year 2000 Information and Readiness Disclosure Act" which was signed into
law on October 19, 1998.
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements of the Company, together with the
Independent Auditors Report thereon of each of Arthur Andersen LLP and Singer
Lewak Greenbaum & Goldstein LLP, appears on pages F-2 through F-23 of this
report. See the Index to Financial Statements" on page F-1 of this report.
-22-
<PAGE>
ITEM 8. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Previously reported.
-23-
<PAGE>
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
Information required under this Item will be contained in the Company's
Proxy Statement for 1999 Annual Meeting, which is incorporated herein by
reference.
ITEM 10. EXECUTIVE COMPENSATION
Information required under this Item will be contained in the Company's
Proxy Statement for 1999 Annual Meeting, which is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information required under this Item will be contained in the Company's
Proxy Statement for 1999 Annual Meeting, which is incorporated herein by
reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required under this Item will be contained in the Company's
Proxy Statement for 1999 Annual Meeting, which is incorporated herein by
reference.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBIT INDEX
-------------
EXHIBIT NO. IDENTIFICATION OF EXHIBIT
- ----------- -------------------------
3.1 Amended and Restated Articles of Incorporation of the Company,
as amended (incorporated herein by reference to Exhibits 3.1
and 3.2 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
3.2 Amended and Restated Bylaws of the Company, as amended
(incorporated herein by reference to Exhibits 3.3 and 3.4 of
the Company's Registration Statement No. 333-37441 on Form
SB-2 filed October 8, 1997).
4.1 Form of Stock Certificate representing Common Stock, no par
value, of the Company (incorporated herein by reference to
Exhibit 4.1 of the Company's Registration Statement No.
333-37441 on Amendment No. 1 to Form SB-2 filed October 29,
1997).
4.2 Form of Representative's Warrant (incorporated herein by
reference to Exhibit 4.2 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
4.3 Form of Security Agreement (incorporated herein by reference
to Exhibit 4.4 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
4.4 Form of Warrant Agreement (incorporated herein by reference to
Exhibit 4.5 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
-24-
<PAGE>
4.5 Form of Warrant Certificate (incorporated herein by reference
to Exhibit 4.6 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
10.1 Loan Agreement dated June 27, 1997, between the Company and
Bank of America (incorporated herein by reference to Exhibit
4.7 of the Company's Registration Statement No. 333-37441 on
Form SB-2 filed October 8, 1997).
10.2 Loan Agreement dated March 1, 1996, between the Company and
Bank of America (incorporated herein by reference to Exhibit
4.8 of the Company's Registration Statement No. 333-37441 on
Form SB-2 filed October 8, 1997).
10.3 + Master Agreement for Technology Evaluation dated July 1, 1996,
between the Company and The University of Sheffield
(incorporated herein by reference to Exhibit 10.1 of the
Company's Registration Statement No. 333-37441 on Form SB-2
filed October 8, 1997).
10.4 + Research Support Agreement and Amendments to Various Existing
Project Agreements dated April 1, 1998, between the Company
and The University of Sheffield (incorporated herein by
reference to Exhibit 10.2 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.5 + Development and Commercialization Project Agreement dated
August 1, 1996, between the Company and The University of
Sheffield (Atherosclerosis including Coronary Artery Disease)
(incorporated herein by reference to Exhibit 10.3 of the
Company's Registration Statement No. 333-37441 on Form SB-2
filed October 8, 1997).
10.6 + Development and Commercialization Project Agreement dated
August 1, 1996, between the Company and The University of
Sheffield (Eye Disease Among Diabetics)(incorporated herein by
reference to Exhibit 10.4 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.7 + Development and Commercialization Project Agreement dated
August 1, 1996, between the Company and The University of
Sheffield (Osteoporosis) (incorporated herein by reference to
Exhibit 10.5 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
10.8 + Joint Project Agreement dated November 9, 1994, between the
Company and Gordon W. Duff, Ph.D. (incorporated herein by
reference to Exhibit 10.6 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.9 Employment Agreement dated January 1, 1996, between the
Company and Paul J. White (incorporated herein by reference to
Exhibit 10.7 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
10.10 Employment Agreement dated January 1, 1996, between the
Company and Kenneth S. Kornman (incorporated herein by
reference to Exhibit 10.9 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
-25-
<PAGE>
10.11 Employment Agreement dated January 1, 1996, between the
Company and Michael G. Newman (incorporated herein by
reference to Exhibit 10.11 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.12 Amendment to Employment Agreement dated August 1, 1997,
between the Company and Michael G. Newman (incorporated herein
by reference to Exhibit 10.12 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.13 + Laboratory Services Agreement dated December 7, 1996, between
the Company and Baylor College of Medicine (incorporated
herein by reference to Exhibit 10.13 of the Company's
Registration Statement No. 333-37441 on Form SB-2 filed
October 8, 1997).
10.14 Lease Agreement dated March 21, 1996, between the Company and
Koll Center Newport Number 9 (incorporated herein by reference
to Exhibit 10.14 of the Company's Registration Statement No.
333-37441 on Form SB-2 filed October 8, 1997).
10.15 Lease Agreement dated March 31, 1997, between the Company, Jim
Jamison and Richard Henderson (incorporated herein by
reference to Exhibit 10.15 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.16 Lease Agreement dated October 23, 1997, between the Company
and Diamond Shamrock Leasing, Inc. (incorporated herein by
reference to Exhibit 10.16 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.17 Medical Science Systems, Inc. 1996 Equity Incentive Plan
(incorporated herein by reference to Exhibit 10.17 of the
Company's Registration Statement No. 333-37441 on Form SB-2
filed October 8, 1997).
10.18 Amendment to the Medical Science Systems, Inc. 1996 Equity
Incentive Plan (incorporated herein by reference to Exhibit
10.18 of the Company's Registration Statement No. 333-37441 on
Form SB-2 filed October 8, 1997).
10.19 Form of Stock Option Agreement (incorporated herein by
reference to Exhibit 10.19 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.20 Stock Option Exercise Agreement (incorporated herein by
reference to Exhibit 10.20 of the Company's Registration
Statement No. 333-37441 on Form SB-2 filed October 8, 1997).
10.21 + Exclusive Independent Representative Agreement dated December
1, 1997, between the Company and Medicadent, a French
corporation (incorporated herein by reference to Exhibit 10.21
of the Company's annual report on Form 10-KSB filed March 31,
1998).
10.22* Consulting and Severance Agreement dated October 28, 1998,
between the Company and Michael G. Newman.
10.23* Amendment to Employment Agreement dated to be effective as of
November 17, 1998, between the Company and Paul J. White.
10.24* Amendment to Employment Agreement dated to be effective as of
November 17, 1998, between the Company an Kenneth S. Kornman.
11.1* Statement re: computation of per share earnings.
16.1 Letter from Singer Lewak Greenbaum & Goldstein LLP dated
October 26, 1998, to the Securities and Exchange Commission
pursuant to Item 304(a)(3) of Regulation S-K (incorporated
herein by reference to Exhibit 16 of the Company's current
report on Form 8-K filed November 2, 1998).
21.1 Subsidiaries of the Company
-26-
<PAGE>
Names Under Which
Name Incorporated Subsidiary Does Business
----------------------------------- ------------ ------------------------
Medical Science Systems France E.U. France N/A
Medical Science Systems Laboratory Delaware N/A
Services, Inc.
23.1* Consent of experts and counsel.
24.1 Power of attorney (included in signature page).
27.* Financial Data Schedule.
- -----------------
* Filed herewith.
+ Confidential treatment has been requested with respect to certain portions
of this exhibit. Omitted portions have been filed separately with the
Securities and Exchange Commission.
(b) REPORTS ON FORM 8-K
-------------------
The Company filed a report on Form 8-K on November 2, 1998 to report a
change in the Company's certifying accountant to Arthur Andersen LLP.
-27-
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this amended report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MEDICAL SCIENCE SYSTEMS, INC.
Date: March 31, 1999 By: /s/ U. Spencer Allen
-------------------------------------
U. Spencer Allen
Chief Financial Officer and Treasurer
In accordance with the Exchange Act, this amended report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the date indicated.
SIGNATURES TITLE DATE SIGNED
/s/ Paul J. White President, Chief Executive Officer
- ---------------------- and Director March 31, 1999
Paul J. White (PRINCIPAL EXECUTIVE OFFICER)
/s/ U. Spencer Allen Chief Financial Officer and Treasurer
- ---------------------- (PRINCIPAL FINANCIAL AND ACCOUNTING March 31, 1999
U. Spencer Allen OFFICER)
/s/ Kenneth S. Kornman Chief Scientific Officer and March 31, 1999
- ---------------------- Director
Kenneth S. Kornman
/s/ Michael G. Newman Secretary and Director March 31, 1999
- ----------------------
Michael G. Newman
/s/ Thomas A. Moore Director March 31, 1999
- ----------------------
Thomas A. Moore
/s/ Ronald L. LaRosa Director March 31, 1999
- ----------------------
Ronald L. LaRosa
/s/ Philip R. Reilly Director March 31, 1999
- ----------------------
Philip R. Reilly
-28-
<PAGE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED
DECEMBER 31, 1998 AND 1997
<PAGE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONTENTS
DECEMBER 31, 1998
________________________________________________________________________________
Page
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS F-3
REPORT OF PRIOR INDEPENDENT PUBLIC ACCOUNTANTS F-4
FINANCIAL STATEMENTS
Consolidated Balance Sheet F-5
Consolidated Statements of Operations F-7
Consolidated Statements of Shareholders' Equity F-8
Consolidated Statements of Cash Flows F-9
Notes to Consolidated Financial Statements F-11
F-2
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Medical Science Systems, Inc.:
We have audited the accompanying consolidated balance sheet of Medical Science
Systems, Inc., and subsidiaries as of December 31, 1998, and the related
statements of operations, shareholders' equity and cash flows for the year then
ended. 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 audit.
We conducted our audit 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 audit provides 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.,
and subsidiaries as of December 31, 1998, and the results of their operations
and their cash flows for the year then ended, in conformity with generally
accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has experienced recurring operating and net
losses, negative cash flows from operations, a lack of significant sales
revenues, and has an accumulated deficit, all of which raise substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 1. The financial statements do not
include any adjustments that might result from the outcome of these
uncertainties.
ARTHUR ANDERSEN LLP
San Antonio, Texas
February 19, 1999
F-3
<PAGE>
[Singer Lewak Greenbaum & Goldstein LLP letterhead]
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Medical Science Systems, Inc.
We have audited the consolidated statements of operations, shareholders' equity,
and cah flows of Medical Science Systems, Inc. and subsidiary for the year ended
December 31, 1997. 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 audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated results of Medical Science Systems, Inc.
and subsidiary's operations and their consolidated cash flows for the year ended
December 31, 1997 in conformity with generally accepted accounting principles.
/s/ Singer Lewak Greenbaum & Goldstein LLP
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
March 13, 1998
F-4
<PAGE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
________________________________________________________________________________
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 2,432,271
Accounts receivable, net of allowance for doubtful
accounts of $20,959 125,086
Prepaid expenses 127,426
-----------------
Total current assets 2,684,783
FURNITURE AND EQUIPMENT, net 458,107
OTHER ASSETS 530,000
-----------------
TOTAL ASSETS $ 3,672,890
=================
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
<PAGE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (CONTINUED)
DECEMBER 31, 1998
________________________________________________________________________________
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 278,773
Accrued expenses 433,859
Notes payable 47,813
Deferred income 275,321
Current portion of long-term debt 81,432
Current portion of capitalized lease obligations 104,837
-----------------
Total current liabilities 1,222,035
LONG-TERM DEBT, less current portion 447,856
CAPITALIZED LEASE OBLIGATIONS, less current portion 156,651
-----------------
Total liabilities 1,826,542
-----------------
COMMITMENTS AND CONTINGENCIES (Note 8)
SHAREHOLDERS' EQUITY
Preferred stock, no par value
5,000,000 shares authorized
none issued and outstanding -
Common stock, no par value
10,000,000 shares authorized
5,548,470 shares issued and outstanding 16,719,933
Accumulated deficit (14,873,585)
-----------------
Total shareholders' equity 1,846,348
-----------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 3,672,890
=================
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
<PAGE>
<TABLE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
___________________________________________________________________________________________________________________
<CAPTION>
1998 1997
---------------- ----------------
<S> <C> <C>
SALES $ 412,942 $ 195,928
COST OF SALES 216,284 166,442
---------------- ----------------
GROSS PROFIT 196,658 29,486
---------------- ----------------
EXPENSES
Research and development 2,799,220 1,223,468
Selling, general, and administrative 7,200,444 2,868,057
---------------- ----------------
Total expenses 9,999,664 4,091,525
---------------- ----------------
LOSS FROM OPERATIONS (9,803,006) (4,062,039)
---------------- ----------------
OTHER INCOME (EXPENSE)
Interest income 379,054 53,889
Interest expense (94,597) (485,062)
Other expense 11,124 -
---------------- ----------------
Total other income (expense) 295,581 (431,173)
---------------- ----------------
LOSS BEFORE PROVISION FOR INCOME TAXES (9,507,425) (4,493,212)
PROVISION FOR INCOME TAXES 850 850
---------------- ----------------
NET LOSS $ (9,508,275) $ (4,494,062)
================ ================
BASIC AND DILUTED LOSS PER COMMON SHARE $ (1.72) $ (1.19)
================ ================
WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING 5,540,895 3,773,474
================ ================
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
<PAGE>
<TABLE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,
____________________________________________________________________________________________________________________
<CAPTION>
Common Stock Accumulated
Shares Amount Deficit Total
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1996 3,295,539 171,500 (871,248) (699,748)
SALE OF COMMON STOCK THROUGH
PRIVATE PLACEMENTS 442,468 2,019,100 2,019,100
SALE OF COMMON STOCK THROUGH
INITIAL PUBLIC OFFERING 1,800,000 16,200,000 16,200,000
OFFERING COSTS (2,540,078) (2,540,078)
STOCK OPTIONS ISSUED FOR REDUCTION
IN SALARY 445,132 445,132
ISSUANCE OF WARRANTS RESULTING IN
ADDITIONAL INTEREST EXPENSE 356,545 356,545
EXERCISE OF STOCK OPTIONS 8,939 42,356 42,356
REPURCHASE OF COMMON STOCK (6,051) (42,356) (42,356)
NET LOSS (4,494,062) (4,494,062)
--------------- --------------- --------------- ---------------
BALANCE, DECEMBER 31, 1997 5,540,895 16,652,199 (5,365,310) 11,286,889
SALE OF COMMON STOCK THROUGH
EMPLOYEE STOCK PURCHASE PLAN 7,575 5,734 5,734
STOCK OPTIONS ISSUED FOR SERVICES
RENDERED 62,000 62,000
NET LOSS (9,508,275) (9,508,275)
--------------- --------------- --------------- ---------------
BALANCE, DECEMBER 31, 1998 5,548,470 $ 16,719,933 $ (14,873,585) $ 1,846,348
=============== =============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-8
<PAGE>
<TABLE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
__________________________________________________________________________________________________________________
<CAPTION>
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (9,508,275) $ (4,494,062)
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization 178,283 74,368
Accretion of investments (219,082) (7,102)
Issuance of stock options for reduction in salary - 445,132
Issuance of stock options for services rendered 62,000 -
Issuance of warrants resulting in additional
interest expense - 356,545
Write down of patents 886,534 -
Other non cash expenses 31,272 -
(Increase) decrease in
Accounts receivable (87,971) (24,756)
Inventories 50,212 (50,212)
Prepaid expenses (84,914) (42,512)
Due from shareholder - 6,565
Increase (decrease) in
Accounts payable (271,414) 330,518
Accrued expenses 306,177 70,595
Accrued officer compensation - (127,500)
Deferred income 202,320 73,001
--------------- ---------------
Net cash used in operating activities (8,454,858) (3,389,420)
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of furniture and equipment (216,597) (60,504)
Increase in patents (443,520) (307,710)
Purchase of investments - (6,000,611)
Proceeds from maturity of investments 6,226,795 -
Increase in other assets (530,000) -
--------------- ---------------
Net cash generated from investing activities 5,036,678 (6,368,825)
--------------- ---------------
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
F-9
<PAGE>
<TABLE>
MEDICAL SCIENCE SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31,
__________________________________________________________________________________________________________________
<CAPTION>
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from sale of common stock $ 5,734 $ 18,219,100
Payment of offering costs - (2,540,078)
Proceeds from note payable 570,000 -
Principal payments on long-term debt (673,012) (85,987)
Borrowings on line of credit, net - 146,277
Principal payments on capital lease obligations (105,143) (31,974)
Proceeds from notes payable 47,813
Proceeds from promissory notes - 1,780,000
Principal payments on promissory notes - (1,780,000)
--------------- ---------------
Net cash provided by (used in) financing
activities (154,608) 15,707,338
--------------- ---------------
Net increase (decrease) in cash and cash
equivalents (3,572,788) 5,949,093
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 6,005,059 55,966
--------------- ---------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,432,271 $ 6,005,059
=============== ===============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
INTEREST PAID $ 94,597 $ 126,149
=============== ===============
INCOME TAXES PAID $ 1,660 $ 800
=============== ===============
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the years ended December 31, 1998 and 1997, the Company acquired
furniture and equipment of $182,042 and $149,847, respectively, under
capitalized lease obligations.
During the year ended December 31, 1997, the Company converted its line of
credit for $500,000 into a note payable for $500,000. In addition, in a non-cash
exchange, a shareholder exchanged 6,051 shares of the Company's common stock as
consideration for the exercise price of 8,939 stock options, which resulted in a
net issuance of 2,888 shares of common stock to this shareholder.
The accompanying notes are an integral part of these
consolidated financial statements.
F-10
<PAGE>
NOTE 1 - COMPANY BACKGROUND AND UNCERTAINTIES
Organization and Line of Business
---------------------------------
Medical Science Systems, Inc., a Texas corporation, originally operated
under two separate corporations, 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 as a pooling of interests.
During the year ended December 31, 1998, a wholly-owned subsidiary,
Medical Science Systems France EU, was formed which was incorporated in
Paris, France. (The consolidated companies are hereafter referred to as
the "Company".)
The Company is currently developing genetic diagnostic tests and
medical research tools. As of December 31, 1998, the Company has
commercially introduced one such product and is in various stages of
development for several others. Additionally, the Company provides
research services under contract to pharmaceutical companies. Such
research services contributed less than 10% of net revenue to the
Company in both 1997 and 1998.
The accompanying financial statements of the Company have been prepared
on the basis of accounting principles applicable to a going concern.
Since its inception, the Company has incurred cumulative net losses of
approximately $14.5 million, including losses of approximately $9.5
million during 1998 and $4.5 million during 1997. For the years ended
December 31, 1998 and 1997, the Company had negative cash flows from
operating activities of approximately $8.5 million and $3.4 million
respectively. As a result of these losses, available cash resources are
limited and will be depleted in 1999 absent additional debt or equity
funding. While the Company continues to pursue sources of capital,
there can be no assurance that they will be successful in these
efforts. These matters raise substantial doubt about the Company's
ability to continue as a going concern. The financial statements do not
include any adjustments, that might result from the outcome of these
uncertainties. The ability of the Company to continue as a going
concern is dependent upon the Company achieving significant revenue
increases from their existing genetic products, developing new
products, successfully marketing its products to customers at
profitable prices and obtaining significant levels of new capital. If
the Company is not successful in these efforts, the Company would
likely be unable to continue operating as a going concern.
The company has retained the services of a New York City-based
investment banking firm to raise additional equity capital via a
private placement. A private placement memorandum has been prepared for
this offering and is currently being circulated to potential investors.
Management of the company believes this offering can be successfully
concluded during the second quarter of 1999. In addition, management is
in discussions with a number of potential strategic partners and, if
discussions are successfully completed, believes there should be
up-front funding of some of the Company's development programs.
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. It is uncertain whether current
genetic susceptibility tests or others that the Company may develop
will gain commercial acceptance on a timely basis.
F-11
<PAGE>
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 revenues may 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 payers. If both
third-party payers 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 certain discoveries resulting from Sheffield
University's research. The agreement is non-cancellable for discoveries
on which the parties have reached a specific agreement, but may be
terminated with or without cause by either party upon six-months notice
with respect to new discoveries on which the parties have not yet
reached agreement. If Sheffield University terminated the agreement,
such termination could make the discovery and commercial introduction
of new products more difficult or unlikely.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
---------------------------
The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All material intercompany
accounts and transactions have been eliminated.
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 and cash equivalents,
accounts receivable, accounts payable, and accrued expenses, the
carrying amounts approximate fair value due to their short maturities.
The amounts shown for long-term debt, notes payable 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.
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. The Company maintains cash
deposits at one bank. Deposits at this bank are insured by the Federal
Deposit Insurance Corporation up to $100,000. As of December 31, 1998,
uninsured portions of balances held at this financial institution
totaled $2,290,372. 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.
F-12
<PAGE>
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.
Leasehold improvements are amortized over the life of the lease or the
life of the improvement, whichever is shorter. See Note 3.
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
-------
During 1998 the Company expensed approximately $886,534 of unamortized
patent costs incurred for existing products or those which may be
developed in the future. Management believes it is appropriate to
expense these costs after consideration of their current development
strategy, available capital and the requirements of Statement of
Financial Accounting Standards 121.
Revenue Recognition
-------------------
Revenue from genetic susceptibility tests is recognized when the tests
have been completed and the results reported to the doctors. Contract
revenues are recognized ratably as services are provided based on a
fixed contract price or on negotiated hourly rates. Provision for
anticipated losses on fixed-price contracts is made in the period such
losses are identified.
Research and Development
------------------------
Research and development costs related to the development of new
products are expensed as incurred.
Income Taxes
------------
The company files consolidated U.S. Federal income tax returns which
include all of its U.S. subsidiaries and a separate French federal
income tax return for the French subsidiary. Deferred income taxes are
provided when certain revenues and expenses are reported in periods
which are different for financial reporting purposes than for income
tax reporting purposes.
Deferred tax liabilities and assets are recorded based on the enacted
income tax rates which are expected to be in effect in the periods in
which the deferred tax liability or asset is expected to be settled or
realized. A change in the tax laws or rates results in adjustments to
the deferred tax liabilities and assets. The effect of such adjustments
is included in income in the period in which the tax laws or rates are
changed. Valuation allowances are established, when necessary, to
reduce deferred tax assets to the amount expected to be realized.
Net Income (Loss) Per Share
---------------------------
In 1997, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share" ("SFAS 128"), which was
effective for fiscal years ending after December 15, 1997. Basic
earnings per share is determined by dividing net income by the weighted
average number of shares of common stock outstanding during the period.
Diluted earnings per share is determined by dividing net income by the
weighted average number of shares of common stock and common stock
equivalents outstanding during the period. Stock options with an
exercise price below fair market value for any of the periods presented
are considered common stock equivalents.
F-13
<PAGE>
There is no reconciliation of the numerators and the denominators of
the basic and diluted earnings per share computations, as the effect is
antidilutive based on losses for both years presented.
Various stock options granted to vendors and employees in connection
with the Company's stock compensation plans were outstanding during the
year ended December 31, 1998 but were not included in the computation
of diluted earnings per share from continuing operations for such
period because the effect would have been antidilutive. Options to
purchase approximately 1.1 million shares of common stock were
outstanding at December 31, 1998.
Recently Issued Accounting Pronouncements
-----------------------------------------
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Post-retirement Benefits". The Company does not provide post-retirement
or post-employment benefits to its employees.
SFAS No. 130, "Reporting Comprehensive Income," was issued by the FASB
in June 1997 and became effective for the Company's financial
statements beginning in 1998. SFAS No. 130 establishes standards for
reporting and display of comprehensive income and its components in a
full set of general-purpose financial statements and requires that all
items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement
that is displayed with the same prominence as other financial
statements. The Company had no items of other comprehensive income
during the years ended December 31, 1998 and 1997.
Reclassifications
-----------------
Certain reclassifications have been made in the prior period financial
statements to conform with the current period presentation.
NOTE 3 - FURNITURE AND EQUIPMENT
Furniture and equipment useful lives and balances at December 31, 1998
consisted of the following:
Computer equipment 3 years $ 289,772
Furniture and fixtures 5 years 32,304
Office equipment 3 years 37,769
Leasehold Improvements 5 years 60,310
Equipment under capitalized leases 3 to 5 years 372,452
--------------
792,607
Less accumulated depreciation and amortization 334,500
--------------
TOTAL $ 458,107
==============
NOTE 4 - NOTES PAYABLE AND LONG TERM DEBT
The Company has a note payable to an insurance company for current
policies in place, with a balance at December 31, 1998 of $47,813, at
an interest rate of 9.3%, which is due in monthly payments of $7,234,
until August, 1999.
F-14
<PAGE>
In May 1998, prior notes payable were combined into a single term loan
which matures in June 2005. The Company has provided a certificate of
deposit as security for this note. The original principal balance of
$570,000 is due in monthly installments of $6,786, plus interest. The
note bears interest at the bank's prime rate (7.75% at December 31,
1998). At December 31, 1998, the Company had outstanding borrowings of
$529,288 under this note. At December 31, 1998, the Company had a
$530,000 certificate of deposit (classified on the Consolidated Balance
Sheet in Other assets) on deposit with the bank as security for the
note.
Required principal payments under the long term debt are as follows:
Year Ending
December 31,
------------
1999 $ 81,432
2000 $ 81,432
2001 $ 81,432
2002 $ 81,432
2003 $ 81,432
Beyond 2003 $ 122,128
--------------
529,288
Less current portion 81,432
--------------
LONG-TERM PORTION $ 447,856
==============
NOTE 5 - INCOME TAXES
As a result of the losses incurred in 1997 and 1998, the Company has
not recorded a Federal income tax provision for those years and has
recorded a valuation allowance against all future tax benefits. As of
December 31, 1998, the Company had net operating loss carryforwards of
approximately $13,000,000 for federal income tax purposes, expiring in
varying amounts through the year 2018, which are available to offset
future taxable income. The Company also had a research tax credit of
approximately $170,000 at December 31, 1998 that expires in varying
amounts through the year 2018. The Company's ability to use its NOL and
credit carryforwards to offset future taxable income is subject to
Section 382 of the Internal Revenue Code of 1986 (the "Code"). These
restrictions provide for limitations on the Company's utilization of
its NOL and credit carryforwards following a greater than 50% ownership
change during the prescribed testing period. As of December 31, 1998
the Company has experienced an ownership change in excess of 40% during
its testing period of October 1, 1996-December 31, 1998.
F-15
<PAGE>
Deferred tax assets (liabilities) consisted of the following:
Year Ended
December 31,
1998
-------------
Deferred tax assets
Net operating loss carryforwards $ 4,432,995
Research tax credit carryforwards 170,129
Accrual to cash adjustments 242,924
Charitable Contributions 7,293
Patents 83,265
-------------
Total deferred tax assets 4,936,606
Valuation allowance for deferred tax assets 4,925,390
-------------
11,216
Deferred tax liabilities
Depreciation and Amortization 11,216
------------
NET DEFERRED TAX ASSETS $ -
============
As there is no assurance of future income, a 100% valuation reserve has
been established against the Company's deferred tax assets.
NOTE 6 - CAPITAL STOCK
Private Placements of Common Stock
----------------------------------
During the year ended December 31, 1997, the Company had two private
placements. The first sold 148,648 shares of its common stock at a
price of $3.70 per share, with gross proceeds of $550,000. The second
sold 293,820 shares of its common stock at $5.00 per share, with gross
proceeds of $1,469,100. The offering costs for the above private
placements of common stock amounted to $136,975.
Initial Public Offering
-----------------------
In November 1997, the Company completed an IPO in which it sold
1,800,000 shares of common stock at $9.00 per share. Gross proceeds
from the sale were $16,200,000, and the offering costs were $2,403,103.
Warrants
--------
In August and September 1997, the Company entered into several
subscription agreements to sell subordinated Promissory Notes
("Notes"). (These notes were repaid in December 1997 with proceeds from
the IPO.) 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 $1,780,000 and issued
356,545 warrants to purchase the Company's common stock of which
$425,000 of notes and 85,000 warrants were issued to officers of the
Company. The Notes accrued interest at 10% per annum. The warrants
expire five years from the date of issuance and are callable by the
Company upon the occurrence of the Company's common stock being traded
on a national or regional stock exchange and the closing price of the
common stock equalling or exceeding or exceeds $12.00 per share for
thirty consecutive trading days. In connection with the issuance of
such warrants, the Company recognized additional interest expense of
$356,545 for the year ended December 31, 1997.
F-16
<PAGE>
Employee Stock Purchase Plan
----------------------------
Effective October 14, 1998, the Company's Board of Directors approved
an Employee Stock Purchase Plan for qualified employees of the Company.
Under the terms of the Employee Stock Purchase Plan, an employee may
purchase up to $25,000 per calendar year of the Company's stock at a
price of 85% of the fair market value of the stock (as quoted on the
NASDAQ national quotation system) on the date of the purchase. The
purchases are limited to either the first or last day of a calendar
quarter. There have been 500,000 shares of the Company's stock set
aside for purchases to be made under the Employee Stock Purchase Plan.
During the quarter ended December 31, 1998, 7,575 shares were purchased
under the Employee Stock Purchase Plan at a price of approximately
$0.757 per share.
NOTE 7 - 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. In September
1998, the Company amended and restated the profit sharing plan to
include provisions for section 401(k) of the Internal Revenue Code.
Under the amended and restated plan, the Company may, at the discretion
of the Board of Directors, "match" a portion of the participant
contributions. Company contributions, if any, are credited to the
participant's account and vest over a period of four years based on the
participant's initial service date with the Company. During the years
ended December 31, 1998 and 1997, no contributions were made to the
amended and restated profit sharing plan or the original profit sharing
plan, respectively.
NOTE 8 - STOCK OPTION PLAN
In October 1995, SFAS No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123), was issued. SFAS 123 defines a fair value
based method of accounting for employee stock options or similar equity
instruments and encourages all entities to adopt that method of
accounting for all of their employee stock compensation plans. Under
the fair value based method, compensation cost is measured at the grant
date based on the value of the award and is recognized over the service
period of the award, which is usually the vesting period. However, SFAS
123 also allows entities to continue to measure compensation costs for
employee stock compensation plans using the intrinsic value method of
accounting prescribed in APB Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB 25). The Company has adopted SFAS 123
effective January 1, 1996, and has elected to remain with the
accounting prescribed by APB 25. The Company has made the required
disclosures prescribed by SFAS 123.
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 1,300,000 shares of
the Company's common stock have been reserved for award under the
amended Plan.
Nonqualified and incentive stock options with a life of ten years are
granted at exercise prices equal to the fair market value of the common
stock on the date of grant. Options granted before December 31, 1997
vest as follows: one-sixth of the options are generally available for
exercise at the end of six months and the remainder of the grant is
exercisable ratably over the next 30-month period provided the optionee
remains in service to the Company. Options granted after January 1,
1998 vest ratably over four years after each anniversary date provided
the optionee remains in service to the Company. The Company may also
award share appreciation rights ("SARs") either in tandem with stock
options or independently. At December 31, 1998 and 1997, no SARs have
been awarded under the Plan.
F-17
<PAGE>
On October 14, 1998, the Company's Board of Directors voted to reduce
the exercise price for all outstanding options granted under the 1996
Equity Incentive Plan to one half of the previous price per share, but
not to a price below $1.85 per share. The close of the Company's common
stock on the previous day was $1.25 per share.
Had compensation cost for these plans been determined consistent with
SFAS 123, the Company's net loss and net loss per share (EPS) would
have been changed to the following pro forma amounts at December 31:
1997 1998
------------ ------------
Net Loss As Reported $(4,494,062) $(9,508,275)
Pro Forma $(4,796,791) $(9,855,915)
EPS As Reported $(1.19) $(1.72)
Pro Forma $(1.27) $(1.78)
Because the SFAS 123 method of accounting has not been applied to
options granted prior to January 1, 1995, the resulting pro forma
compensation cost may not be representative of that to be expected in
future years.
A summary of the status of the Company's stock options at December 31,
1997 and 1998, and changes during the years then ended is presented in
the table and narrative below:
<TABLE>
<CAPTION>
1997 1998
------------------------ -------------------------
Weighted Weighted
Average Average
Exercise Exercise
Price Price
Shares Per Share Shares Per Share
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Outstanding, beginning of year 142,500 $3.70 792,640 $4.37
Granted 659,079 $4.46 1,088,783 $2.23
Exercised (8,939) $4.74 - -
Canceled - - (807,040) $4.37
Outstanding, end of year 792,640 $4.37 1,074,383 $2.11
Options exercisable, end of year 212,543 387,502
Weighted average fair value of options
granted $2.55 $1.39
</TABLE>
F-18
<PAGE>
The following table summarizes the information about options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Weighted Average
Remaining Number
Exercise Prices Number Contractual Exercisable at
Per Share Outstanding Life (Years) December 31, 1998
------------ --------------- -------------- -----------------
<S> <C> <C> <C>
$1.25 54,350 9.90 2,083
$1.50 39,283 9.92 818
$1.69 5,000 9.79 313
$1.85 373,701 8.00 186,851
$1.94 47,000 9.20 9,792
$2.04 30,000 8.00 15,000
$2.07 10,000 9.29 1,875
$2.13 40,000 9.37 6,667
$2.19 130,500 9.13 29,906
$2.38 15,000 9.04 3,750
$2.50 277,424 8.41 109,814
$2.75 52,125 8.41 20,633
--------------- ------------------
1,074,383 387,502
</TABLE>
The fair value of each option grant is estimated on the date of grant
using an option pricing model, which approximates the Black-Scholes
option pricing model, for a stock that does not pay dividends with the
following weighted average assumptions used for grants in 1997 and
1998, respectively: risk-free interest rates of 6.4 percent and 5.5
percent; expected lives of 7 years and 7 years; and expected volatility
of 61 percent and 143 percent.
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. As of December 31, 1998, 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 in salary.
Employees elected to reduce their salaries up to 100% 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 recorded an expense relating to the issuance of these stock
options in the amount of $74,189 per month for each of the six months
from May 1997 to October 1997.
F-19
<PAGE>
During 1998, the Company awarded nonqualified stock options to outside
consultants for services rendered. As a result, the Company recognized
$62,000 in selling, general and administrative expense for the issue of
these options. This amount represents the then fair market value of the
services rendered to the Company based on the consultants' usual and
customary charges for the services rendered.
NOTE 9 - COMMITMENTS AND CONTINGENCIES
The Company leases its office space under non-cancelable operating
leases expiring through May 2003. In June 1998, the Company
consolidated its corporate offices into its San Antonio Research and
Development facility. As a result of this move, the Company subleased
its leased space in Newport Beach, CA. The sublease expires on the same
date of the Company's lease in April 2001. The sublease income is
aggregated with the net rent expense and included in Other income and
expense in the Consolidated Statements of Operations.
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, 1998 are as follows:
Year Ending Operating Capital
December 31, Leases Leases
------------ ------------ ------------
1999 $ 282,184 $ 145,209
2000 267,894 92,097
2001 174,833 60,938
2002 166,046 36,926
2003 69,641 12,119
------------ ------------
$ 960,598 347,289
============
Less amount representing interest 85,801
------------
261,488
Less current portion 104,837
------------
LONG-TERM PORTION $ 156,651
============
Included in furniture and equipment is capitalized leased equipment of
$372,452 with accumulated depreciation of $125,303 at December 31,
1998.
Rent expense was $230,780 and $102,815 for the years ended December 31,
1998 and 1997, respectively. The net sublease income for the year ended
December 31, 1998 was $10,193.
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.
F-20
<PAGE>
NOTE 10 - SEGMENT INFORMATION
During 1998, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
establishes new standards for reporting information about operating
segments in annual and interim financial statements, requiring that
public business enterprises report financial and descriptive
information about its reportable segments based on a management
approach. SFAS No. 131 also establishes standards for related
disclosures about products and services, geographic areas and major
customers. In applying the requirements of this statement, each of the
Company's geographic areas described below were determined to be an
operating segment as defined by the statement, but have been aggregated
as allowed by the statement for reporting purposes. As a result, the
Company continues to have one reportable segment, which is the
development of genetic susceptibility tests and therapeutic targets for
common diseases.
The following table presents information about the Company by
geographic area.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
1998 1997
------------ ------------
<S> <C> <C>
Total Revenues:
United States....................................... $ 319,145 $ 171,358
France.............................................. 23,730 1,370
Other foreign....................................... 70,067 23,200
------------ ------------
Total.......................................... $ 412,942 $ 195,928
============ ============
Operating Income:
United States....................................... $(7,576,319) $(3,552,646)
France.............................................. (563,337) (28,403)
Other foreign....................................... (1,663,350) (480,990)
------------ ------------
Total.......................................... $(9,803,006) $(4,062,039)
============ ============
Assets:
United States....................................... $ 3,672,890 $12,823,376
France.............................................. 0 0
Other foreign....................................... 0 0
------------ ------------
Total.......................................... $ 3,672,890 $12,823,376
============ ============
</TABLE>
Concentrations of Risk
----------------------
The Company sells products and provides contract services for customers
primarily in the United States and France and extends credit based on
an evaluation of the customer's financial condition, generally without
requiring collateral. The Company monitors its exposure for credit
losses and maintains allowances for anticipated losses.
During the year ended December 31, 1998, no one customer accounted for
more than 10% of total revenues. During the year ended December 31,
1998, the company obtained lab services for its genetic susceptibility
tests from two companies whose services comprised approximately 50% and
30% of cost of sales, respectively.
NOTE 11 - SUBSEQUENT EVENTS (UNAUDITED)
In March 1999 the Company was served with a lawsuit which alleges
co-ownership of one of the Company's software patents. The Company is
pursuing settlement discussions and management does not believe that
the outcome will have a material adverse effect on the Company's
financial position or results of operations.
F-21
<PAGE>
Exhibit 10.22
CONSULTING AND SEVERANCE AGREEMENT
This Consulting and Severance Agreement is entered into this ___ day of
November, 1998 by and between Michael Gary Newman ("Dr. Newman") and Medical
Science Systems, Inc. ("MSS").
W I T N E S S E T H:
- - - - - - - - - -
WHEREAS, Dr. Newman is presently employed as the Executive Vice
President of MSS pursuant to the Employment Agreement dated January 1, 1996, as
amended, between MSS and Dr. Newman (the "Employment Agreement").
WHEREAS, the Company and Dr. Newman wish to discontinue their
employment relationship and, in lieu thereof, enter into this Consulting and
Severance Agreement (the "Agreement");
NOW, THEREFORE, in consideration of the premises, the agreements herein
contained and for other good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the Company and Dr. Newman agree
as follows:
1. This Agreement embodies the full and final settlement of all rights
and obligations of the Company and Dr. Newman under the Employment Agreement and
the Employment Agreement shall be terminated in all respects except for the
terms thereof that specifically survive as set forth in this Agreement. Each
party hereto acknowledges that the Employment Agreement is being terminated
without cause by mutual agreement of the parties hereto pursuant to Section
12.1.1 of the Employment Agreement. MSS and Dr. Newman acknowledge and agree
that Dr. Newman is not owed any amounts under the Employment Agreement resulting
from this mutual agreement to terminate, and that no compensation or payment of
monies how so ever characterized is due to Dr. Newman upon or subsequent to such
termination of the Employment Agreement or termination of his employment.
2. Dr. Newman acknowledges that, effective as of October 27, 1998, in
lieu of being employed by the Company and holding the position of Executive Vice
President of MSS, Dr. Newman will provide consulting services to MSS on an "as
available" and "as needed" basis and without additional compensation through
November 30, 1999, except as provided in paragraphs 3 and 4 below. MSS hereby
acknowledges and agrees that Dr. Newman shall be entitled to retain the
computer, facsimile machine, photocopier, desktop computer and printer that Dr.
Newman currently has in his possession. Dr. Newman also agrees that he will
return his corporate American Express card on December 1, 1998, and MSS will
continue to pay for the telephone line to his home office until February 1,
1999.
3. In consideration for the release contained herein and for such
consulting services and accrued but untaken vacation pay, MSS agrees to pay Dr.
Newman, by MSS check on the eighth day following Dr. Newman's execution of this
Agreement and provided Dr. Newman has not revoked this Agreement in the
-1-
<PAGE>
seven-day period following his execution of this Agreement, a lump sum payment
equal to $200,900 (less standard legal deductions). Dr. Newman releases the
Company from all liabilities under, and all obligations to perform or observe
any term or provision of, the Employment Agreement.
4. MSS shall pay Dr. Newman his full salary through October 31, 1998
and no other compensation or benefits shall be paid to Dr. Newman under the
Employment Agreement or otherwise. Effective November 30, 1998, Dr. Newman shall
not be entitled to any benefits (including medical and other insurance) from MSS
and shall not be a participant in MSS's 401(k) Plan or the MSS Profit Sharing
Plan; provided, however, nothing herein shall effect Dr. Newman's eligibility to
elect the continuation of health care coverage pursuant to Title X of the
Consolidated Omnibus Budget Reconciliation Act of 1985, as amended ("COBRA"), or
Dr. Newman's vested rights under the MSS Profit Sharing Plan.
5. Each of Dr. Newman and the Company releases, remises, acquits and
discharges the other party and their predecessors and affiliates, and their
divisions, officers, directors, agents, employees, consultants, independent
contractors, attorneys, advisers, successors and assigns, jointly and severally,
from any and all claims, known or unknown, which releasing party, their heirs,
successors or assigns have or may have against any of such parties and any and
all liability that any of such parties may have to the released party whether
denominated claims, demands, causes of action, obligations, damages or
liabilities arising from any and all bases, however denominated, including but
not limited to claims of discrimination under the Age Discrimination in
Employment Act, as amended, Title VII of the Civil Rights Act of 1964, as
amended, the Civil Rights Act of 1991, the Americans with Disabilities Act, the
Employee Retirement Income Security Act of 1974, 42 U.S.C. ss. 1981, the Texas
Commission on Human Rights Act, or any other U.S. federal, state or local law or
any other law, rule or regulation or workers' compensation or disability claims
under any such laws. This release relates to claims arising from and during Dr.
Newman's relationship with MSS and its predecessors and affiliates or as a
result of the termination of such relationship. This release is for any relief,
no matter how denominated, including but not limited to wages, back pay, front
pay, compensatory damages or punitive damages. Each party further agrees that
they will not file or permit to be filed on their behalf any such claim. This
release shall not apply to (i) the obligations set forth in this Agreement or
those under the Confidentiality Agreement (as defined hereafter), or (ii) any
other claims based on acts or omissions of any released party first occurring
after the date on which he signs this Agreement.
6. This Agreement does not affect Dr. Newman's obligations or MSS's
rights under the Confidentiality and Invention Assignment Agreement
("Confidentiality Agreement") dated as of January 1, 1996, by and between MSS
and Dr. Newman; or any other confidentiality, secrecy or proprietary information
or intellectual property agreement; or any laws governing such matters. In
addition, this Agreement shall not affect Dr. Newman's status as a current
member of the Board of Directors of MSS.
7. Dr. Newman acknowledges he received a copy of this Agreement on
October 28, 1998. Dr. Newman shall have until and including November 19, 1998,
to accept and consider this Agreement, a period Dr. Newman acknowledges to be
twenty-one (21) days following receipt of this Agreement.
-2-
<PAGE>
This Agreement shall not become effective and enforceable until seven (7) days
following its execution. Dr. Newman may revoke this Agreement in a writing
delivered to and received by U. Spencer Allen, CFO, Medical Science Systems,
Inc., 100 N.E. Loop 410, #820, San Antonio, Texas 78216, within said seven (7)
days.
8. This Agreement is personal to Dr. Newman and, without the prior
written consent of the Board of Directors of MSS, shall not be assignable by Dr.
Newman otherwise than by will or the laws of descent and distribution. The terms
of this Agreement shall be binding and inure to the benefit of the parties
hereto and their affiliates and their respective successors and assigns. The
terms of this Agreement may be changed, modified or discharged only by an
instrument in writing signed by the parties hereto. This Agreement shall be
construed, enforced and interpreted in accordance with applicable federal law
and the laws of the State of Texas without reference to its principles of
conflicts of law, and venue for any action arising in connection herewith shall
be proper in Bexar County, Texas. This Agreement may be executed in any number
of counterparts, each of which shall be deemed to be original.
9. The parties each agree that Dr. Newman is engaged as an independent
contractor of MSS. Dr. Newman shall take no unilateral action or incur any
expense, and has no express or implied authority to do either, on behalf of MSS,
as an independent contractor, a consultant or otherwise, unless he has received
written instructions from MSS' President to so proceed. Dr. Newman further
represents that he maintains a separate place of business, serves customers
other than MSS, has all necessary permits and licenses to conduct the services
under this Agreement, withholds and pays all state and federal income, social
security, disability and insurance taxes and maintains adequate insurance. The
parties further agree that nothing contained in this Agreement shall be
construed to place them in the relationship of partners, principal and agent,
employer/employee or joint venturers.
10. The failure of either party at any time to enforce any of the
provisions of this Agreement or to require performance by the other party of any
provision hereof shall not be construed to be a waiver of such provisions or to
affect the validity of this Agreement, or of any part hereof, or of the right of
either party thereafter to enforce each and every provision of this Agreement in
accordance with its terms.
11. Written notices required or furnished under this Agreement shall be
sent to the following addresses:
to MSS: U. Spencer Allen
Medical Science Systems, Inc.
100 N.E. Loop 410, #820
San Antonio, Texas 78216
-3-
<PAGE>
to Dr. Newman: Michael Gary Newman
16682 Calle de Nancy
Pacific Palisades, CA 90272
Notices shall be effective on the first business day following receipt thereof.
Notices sent by mail shall be deemed received on the date of delivery shown on
the return receipt.
12. This Agreement represents and contains the entire agreement between
the parties hereto with respect to the subject matter hereof, and the terms of
this Agreement are contractual and not a mere recital. Further, this Agreement
supersedes any and all prior oral and written agreements and understandings, and
no representation, warranty, condition, understanding, or agreement of any kind
with respect to the subject matter hereof shall be relied upon by the
undersigned unless incorporated herein.
13. Except for the provisions of Paragraph 6 regarding the
Confidentiality Agreement, with respect to which the Company expressly reserves
the right to petition a court directly for injunctive and other relief, any
claim, dispute or controversy of any nature whatsoever, including but not
limited to tort claims or contract disputes, between the parties to this
Agreement or their respective heirs, executors, administrators, legal
representatives, successors and assigns, as applicable, arising out of or
relating to the terms or conditions of this Agreement or the Employment
Agreement hereby terminated, including the implementation, applicability and
interpretation thereof, shall be resolved exclusively as follows: Upon the
written request of one party served upon the other, any such claim, dispute or
controversy shall be submitted to and settled by arbitration in accordance with
the provisions of the Federal Arbitration Act, 9 U.S.C. ss.ss. 1-14, as amended.
If arbitration is requested, each of the parties to this Agreement shall appoint
one person as an arbitrator to hear and determine any such disputes. The two
arbitrators shall then choose a third arbitrator from a panel made up of
experienced arbitrators selected pursuant to the procedures of the American
Arbitration Association (the "AAA"). The majority decision of the three
arbitrators shall be final, binding and conclusive upon the parties to this
Agreement. Each party shall be responsible for the fees and expenses of its
arbitrator and the fees and expenses of the third arbitrator shall be shared
equally by the parties; provided, however, to the extent possible, the
arbitrators shall, as part of their decision, provide that the non-prevailing
party shall pay all costs incurred by the prevailing party (including fees and
costs of the arbitrators and the prevailing party's legal counsel). The terms of
the commercial arbitration rules of AAA shall apply except to the extent they
conflict with the provisions of this paragraph. Arbitration shall take place in
Los Angeles, California. It is further agreed that any of the parties hereto may
petition the United States District Court for the Central District of California
for a judgment to be entered upon any award entered through such arbitration
proceedings.
14. (a) The parties hereto acknowledge that their legal counsel has
advised them, and that they are familiar with, the provision of Section 1542 of
the California Civil Code, which provides as follows:
-4-
<PAGE>
"A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE
CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE
TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE
MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR."
(b) Being aware of said Civil Code Section 1542, the parties
hereto expressly waive and relinquish any rights or benefits they may have
thereunder, as well as under any other state or federal statutes or common law
principles of similar effect.
IN WITNESS WHEREOF, MSS has caused this Agreement to be executed by its
duly authorized officer, and Dr. Newman has executed this Agreement, in each
case as of the date first above written.
MEDICAL SCIENCE SYSTEMS, INC.
By:
-----------------------------------
Name:
---------------------------------
Title:
--------------------------------
Dr. Newman acknowledges that he has read the foregoing Agreement and knows its
contents and fully understands it. Dr. Newman acknowledges that he has been
advised to consult with an attorney prior to executing this Agreement, has had
such opportunity, and he is executing the Agreement voluntarily, fully
understanding the significance and consequences of this Agreement.
DR. NEWMAN
---------------------------------------
Michael Gary Newman
-5-
AMENDMENT TO EMPLOYMENT AGREEMENT
THIS AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment"), by and
between Medical Science Systems, Inc., a Texas Corporation (the "Corporation"),
and Paul J. White ("Employee"), is effective this 17th day of November, 1998.
The Corporation and Employee are hereinafter sometimes referred to, individually
and collectively, as a "Party" or the "Parties."
WHEREAS, the Corporation and Employee have previously entered into that
certain employment agreement dated January 1, 1996, as amended on August 1, 1997
and January 1, 1997 (the "Agreement"); and
WHEREAS, the Corporation and Employee desire to amend the terms and
conditions of the Employee's employment with the Corporation.
NOW THEREFORE, in consideration of the promises and of the mutual
covenants and agreements set forth below, the Parties hereto agree to delete the
first paragraph of section three (COMPENSATION) of the Employment Agreement in
its entirety and replace it with the following paragraph:
"In consideration of the performance by Employee of
Employee's obligations during the Employment Term (including any
services as an officer, director, employee, member of any committee of
the Corporation or any of its subsidiaries, or otherwise), the
Corporation will pay Employee a salary (the "Salary") at an annual rate
of $148,750 per year during the seven (7) month period of December 1
1998 to June 30, 1999 and at an annual rate of $170,000 per year
thereafter."
This amendment is intended to and shall only effect the changes set
forth in the preceding paragraph. No other change, amendment, waiver, discharge,
or termination shall be effected except by a subsequent written instrument.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment on
the day and year first above written.
DATED: December 14, 1998.
Medical Science Systems, Inc.,
A Texas Corporation
By:
-----------------------
U. Spencer Allen
Chief Financial Officer
EMPLOYEE
By:
-----------------------
Paul J. White
AMENDMENT TO EMPLOYMENT AGREEMENT
THIS AMENDMENT TO EMPLOYMENT AGREEMENT (the "Amendment"), by and
between Medical Science Systems, Inc., a Texas Corporation (the "Corporation"),
and Dr. Kenneth S. Kornman ("Employee"), is effective this 17th day of November,
1998. The Corporation and Employee are hereinafter sometimes referred to,
individually and collectively, as a "Party" or the "Parties."
WHEREAS, the Corporation and Employee have previously entered into that
certain employment agreement dated January 1, 1996, as amended on August 1, 1997
and January 1, 1997 (the "Agreement"); and
WHEREAS, the Corporation and Employee desire to amend the terms and
conditions of the Employee's employment with the Corporation.
NOW THEREFORE, in consideration of the promises and of the mutual
covenants and agreements set forth below, the Parties hereto agree to delete the
first paragraph of section three (COMPENSATION) of the Employment Agreement in
its entirety and replace it with the following paragraph:
"In consideration of the performance by Employee of
Employee's obligations during the Employment Term (including any
services as an officer, director, employee, member of any committee of
the Corporation or any of its subsidiaries, or otherwise), the
Corporation will pay Employee a salary (the "Salary") at an annual rate
of $144,375 per year during the seven (7) month period of December 1,
1998 to June 30, 1999 and at an annual rate of $165,000 per year
thereafter."
This amendment is intended to and shall only effect the changes set
forth in the preceding paragraph. No other change, amendment, waiver, discharge,
or termination shall be effected except by a subsequent written instrument.
IN WITNESS WHEREOF, the parties hereto have executed this Amendment on
the day and year first above written.
DATED: December 14, 1998.
Medical Science Systems, Inc.,
A Texas Corporation
By:
-----------------------
Paul J. White
President
EMPLOYEE
By:
-----------------------
Dr. Kenneth S. Kornman
January 6, 1997
Mr. U. Spencer Allen
29672 Avante
Laguna Niguel, California 92677
Re: Employment with Medical Science Systems, Inc.
---------------------------------------------
Dear Spence:
It was nice speaking with you. As we agreed, Medical Science Systems, Inc.
(the "Company") is willing to engage your services on the following terms and
conditions:
1. COMPENSATION. The Company will compensate you at an annual compensation
rate of Eighty Thousand Dollars ($80,000) per year. This compensation
will be paid to you on a monthly basis, pursuant to the Company's
regular pay periods.
2. DUTIES. The job will require your ful time commitment, and we would
expect that you would not perform services for any other person or
entity. You shall serve as Chief Financial Officer of the Company, or
such other position as may be agreed between you and the Company, and
shall perform such duties, services and responsibilities as are
consistent with such position. Your duties, services and
responsibilities will be performed under the overall supervision of the
President of the Company.
3. EXPENSES. The Company shall reimburse you for all normal and reasonable
business expenses upon presentation of an approved expense report. You
agree to timely prepare and submit said expense report on a monthly
basis. Company agrees that the accumulation of frequent flyer mileage
benefits will be credited to you personally.
4. HEALTH BENEFITS. The Company agrees to contribute to its group Accident
and Health Plan for you.
5. STOCK OPTION. In consideration for your agreeing to join, you shall be
granted an Incentive Stock Option of 50,000 common shares, pursuant to
the terms and conditions of the Company's 1996 Equity Incentive Plan.
<PAGE>
Mr. U. Spencer Allen
Page 2
January 6, 1997
6. VACATION. You shall be entitled to an annual vacation of two (2) weeks
during each year of this Agreement, without loss of compensation. You
shall not accrue more than four (4) weeks vacation at any time, and all
future vacation accrual shall cease once the ceiling is reached. If you
later use enough vacation pay to fall below the maximum, you will
resume earning vacation pay from that date forward. Upon termination of
this Agreement, you shall be paid vacation accrued but not taken and
all further vacation accrual shall cease. The times for these vacation
periods shall be most convenient to the Company's business, as may be
orally agreed on by the Company.
7. HOLIDAYS. You shall be entitled to all holidays designated by the
Company, without loss of compensation, so long as said holidays occur
on the day you would normally be performing your duties pursuant to the
terms of this Agreement.
8. OTHER BENEFITS. You shall be entitled to participate in any employee
benefit plans then in effect for similarly situated employees to the
extent you meet the eligibility requirements for any such plan,
including group insurance, retirement, supplemental pension, bonus
plan, stock option or award plans.
9. TAX WITHHOLDING. All compensation shall be subject to the customary
withholding tax and other employment taxes as required with respect to
compensation paid by a corporation to an employee.
10. TERM AND TERMINATION. This Agreement shall become effective January 6,
1997, and shall continue thereafter for successive periods of one year
unless terminated as provided herein. Your engagement with the Company
shall immediately be deemed terminated upon the occurrence of the
following:
a. MUTUAL CONSENT. Upon mutual agreement of all parties.
b. DEATH. Upon your death.
c. DISABILITY. If a disability (whether mental or physical)
serves to impair your ability to adequately render services to the Company, for
a period of thirty (30) consecutive days.
d. CAUSE. You shall have (a) committed an act of theft or
embezzlement from or fraud on the Company; (b) shall have willfully neglected
your duties under the terms of this Agreement; or (c) should you materially
breach your obligations under this Agreement.
Either party may terminate this Agreement, with or without cause,
by giving the other party one (1) months written notice of intention to do so.
It is the intention of the parties hereto that this provision shall not relieve
either party of their respective duties, obligations and responsibilities to the
other party during the one (1) month notice period that this Agreement is to be
terminated.
<PAGE>
Mr. U. Spencer Allen
Page 3
January 6, 1997
e. CONTINUING OBLIGATIONS. You shall be only entitled to a
pro-rata share of compensation, up to the effective date of termination, based
on the ratio of the number of days that you have performed in accordance with
the terms and provisions of this Agreement in the relevant term year that bears
to 365.
11. YOUR DUTIES ON TERMINATION. In the event of termination of working
relationship with Company, you agree to deliver promptly to Company all
property, keys, credit cards, manuals, models, notes, logs, technical
data, equipment, notebooks, documents, memoranda, reports, files,
hardware and software, samples, books, correspondence, lists, or other
written or graphic records, and the like, relating to Company's
business, which are or have been in your possession or under your
control.
12. ENTIRE AGREEMENT. This Agreement constitutes the entire understanding
between the parties with respect to the subject matter hereof,
superseding all negotiations, prior discussions and preliminary
agreements, if any.
13. IN WRITING. This Agreement shall not be modified or amended except in
writing signed by you and a duly empowered officer of the Company.
14. CHOICE OF LAW. This Agreement shall be construed under and governed in
accordance with, the laws of the State of California. Venue shall be
Orange County, California.
15. SUCCESSORS AND ASSIGNS. Except as otherwise provided in this Agreement,
the provisions hereof shall be binding upon and shall inure to the
benefit of the parties hereto, their personal representatives, heirs,
executives, administrators, successors and/or permitted assigns.
16. ASSIGNMENT. Neither this Agreement nor the rights, duties or
obligations arising hereunder shall be assignable by you.
17. CONFIDENTIALITY AND INVENTION ASSIGNMENT AGREEMENT. You will be
required to sign and abide by the standard Company Confidentiality and
Invention Assignment Agreement that the Company requires all of its
employees to sign.
If the above terms and conditions of this Letter Agreement are
acceptable, please execute below and forward to my attention. We are excited
about having you aboard our team and want you to feel free to call me regarding
any questions or comments you may have regarding this letter or otherwise.
Sincerely,
<PAGE>
Mr. U. Spencer Allen
Page 4
January 6, 1997
MEDICAL SCIENCE SYSTEMS, INC.
Paul J. White
President
IN WITNESS WHEREOF, the parties hereto agree and accept the terms and
conditions set forth in the above Letter Agreement as of the date first above
written.
MEDICAL SCIENCE SYSTEMS, INC.
By:
------------------------------
Paul J. White, President
------------------------------
U. SPENCER ALLEN
November 12, 1998
Spencer Allen
11020 Huebner Oaks #2328
San Antonio, TX 78230
Dear Spencer:
On October 14, 1998, the Board of Directors (the "Board") of Medical Science
Systems, Inc., a Texas corporation (the "Company"), approved the following
amendment to the Letter Agreement with the effective date of January 6, 1997
between you and the Company. This letter amends the first sentence of Paragraph
1, COMPENSATION, to read as follows:
<PAGE>
Mr. U. Spencer Allen
Page 5
January 6, 1997
"Effective December 1, 1998, the Company will compensate you at an
annual compensation rate of Ninety-Six Thousand Two Hundred and Fifty
Dollars ($96,250.00) per year."
Additionally, as you and I have discussed, the following shall be inserted at
the end of the second subparagraph of Paragraph 10.d., TERM AND TERMINATION:
"Notwithstanding the above, to the extent the Company is acquired and
terminates this agreement, the Company shall provide six (6) months
written notice. The Company shall have the right to pay you in lieu of
continuing your employment at any time during the six (6) month notice
period."
All other terms of the aforementioned Letter Agreement remain the same. If the
above amendment to the Letter Agreement is acceptable, please execute below and
forward to my attention.
Additionally, the Board has approved a grant of Incentive Stock Options
("ISO's") equivalent to one (1) option for each dollar of compensation reduction
for the three month period beginning December 1, 1998. Therefore, the number of
options granted to you will be 3,437 options. These options will be priced at
$1.50 per share, which was the fair market value of the Company's stock at the
close of trading on October 14, 1998. Additional information about this ISO
grant will be forthcoming soon.
Finally, the Board has also approved a reduction in the price of your
outstanding ISO's. Please find attached a letter with further information
regarding this re-price of your options.
If you have any questions or comments, regarding this letter or otherwise,
please do not hesitate to contact me.
Sincerely,
MEDICAL SCIENCE SYSTEMS, INC.
Paul J. White
President
<PAGE>
Mr. U. Spencer Allen
Page 6
January 6, 1997
IN WITNESS WHEREOF, the parties hereto agree and accept the terms set forth in
this amendment to the Letter Agreement with the effective date of January 6,
1997 effective December 1, 1998.
MEDICAL SCIENCE SYSTEMS, INC.
By:
------------------------
Paul J. White, President
By:
------------------------
Spencer Allen
Date:
------------------------
MEDICAL SCIENCE SYSTEMS, INC.
-----------------------------
COMPUTATION OF NET LOSS PER SHARE
---------------------------------
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Years Ended December 31
---------------------------------
1997 1998
--------------- ---------------
<S> <C> <C>
COMPUTATION OF BASIC NET LOSS PER SHARE:
Net Loss $ (4,494,062) $ (9,508,275)
=============== ===============
Weighted average number of shares of common stock and common
stock equivalents outstanding-
Weighted average shares of common stock outstanding 3,773,474 5,540,895
Common stock equivalents applicable to convertible
preferred stock
Weighted average number of common stock equivalents
applicable to stock options and warrants
Basic net loss per share (1.19) (1.72)
COMPUTATION OF DILUTED NET LOSS PER SHARE:
Net loss $ (4,494,062) $ (9,508,275)
=============== ===============
Weighted average number of shares of common stock and common
stock equivalents outstanding-
Weighted average shares of common stock outstanding 3,773,474 5,540,895
Common stock equivalents applicable to convertible
preferred stock
Weighted average number of common stock equivalents
applicable to stock options and warrants
Diluted net loss per common share and common share
equivalents (1.19) (1.72)
</TABLE>
<PAGE>
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We hereby consent to the incorporation of our report, dated March 13,
1998, included in this Form 10-K in the previously filed Registration
Statements of Medical Science Systems, Inc. and subsidiary on Form S-8
(No. 333-47343 and 333-67147).
SINGER LEEWAK, GREENBAUM & GOLDSTEIN
San Antonio, Texas
March 30, 1999
<PAGE>
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation of our reports included in this Form 10-K, into the
Company's previously filed Registration Statements on Form S-8 (SEC
File Nos. 333-47343 and 333-67147).
ARTHUR ANDERSEN LLP
San Antonio, Texas
March 30, 1999
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