SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
(Mark One)
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: DECEMBER 31, 1998
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[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number: 0-13092
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SPECTRASCIENCE, INC.
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(Name of small business issuer in its charter)
MINNESOTA 41-1448837
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(State of incorporation) (I.RS. Employer Identification No.)
3650 ANNAPOLIS LANE, SUITE 101, MINNEAPOLIS, MINNESOTA 55447-5434
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: (612) 509-9999
Securities registered under Section 12(b) of the Exchange Act:
NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK, $.25 PAR VALUE
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(Title of Class)
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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 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. [ ]
Issuer's revenues for its fiscal year ended December 31, 1998 were: $0
As of March 26, 1999, the number of outstanding shares of the Registrant's
Common Stock, par value $.25 per share, was 5,261,720. The aggregate market
value of the voting stock held by non-affiliates of the registrant was
approximately $26,308,600 based on the last reported closing price of $5.00 on
March 26, 1999.
Transitional Small Business Disclosure Format (Check one): Yes _____ No __X__
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SPECTRASCIENCE, INC.
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FORM 10-KSB
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
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PART I 3
ITEM 1. BUSINESS 3
ITEM 2. DESCRIPTION OF PROPERTY 14
ITEM 3. LEGAL PROCEEDINGS. 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. 14
PART II 15
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS. 15
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 17
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA 22
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. 22
PART III 22
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE
EXCHANGE ACT. 22
ITEM 10. EXECUTIVE COMPENSATION. 24
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT. 28
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. 29
ITEM 13. EXHIBITS, FINANCIAL STATEMENTS, AND REPORTS ON FORM 8-K. 29
SIGNATURES 31
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SPECTRASCIENCE, INC.
FORM 10-KSB
For the fiscal year ended December 31, 1998
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain statements in this Form 10-KSB constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Words or phrases such as "may," "expects," "will continue," "is
anticipated," "management believes," "estimate," "projects," "hope" or similar
expressions or the negatives thereof identify forward-looking statements. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical, currently
anticipated or projected results. We caution you not to place undue reliance on
forward-looking statements. Please refer to Exhibit 99 of our Quarterly Report
on Form 10-QSB for the quarter ended March 31, 1998, for important cautionary
factors, risks and uncertainties related to forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL
SPECTRASCIENCE, Inc. (the "Company" or "we") was incorporated in the
state of Minnesota on May 4, 1983 as GV Medical, Inc., is located at 3650
Annapolis Lane, Suite 101, Minneapolis, Minnesota 55447-5434. Our telephone
number is (612) 509-9999, and our fax number is (612) 509-9805. Our web-site can
be accessed at http://www.spectrascience.com, and our e-mail address is
[email protected].
Portions of this Annual Report on Form 10-KSB include information and
disclosures relating to persons who are executive officers, directors or more
than 5% shareholders of the Company, and as such, include information relating
to Mr. Brian T. McMahon. Mr. McMahon was our Chairman and Chief Executive
Officer until December 9, 1998, when he died suddenly. Mr. Chester E. Sievert,
Jr. has since been appointed our Chief Executive Officer.
DEVELOPMENT OF THE BUSINESS
From incorporation until October 1992, we developed, manufactured and
sold laser-enhanced angioplasty catheter systems for the treatment of heart and
blood vessel disease. The two products developed during this time were the
LASTAC(R) system and the Laser Angiosurgery System. In 1992, due to changes in
medical practices and market conditions, we changed our name to SPECTRASCIENCE,
Inc. and refocused our development efforts on developing diagnostic products
that use spectroscopic techniques. Since 1996 we have focused on developing the
Optical Biopsy(TM) System, which is based on spectroscopic techniques and
technology.
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PRODUCTS AND MARKETS
INDUSTRY OVERVIEW
* COLORECTAL CANCER
According to the American Cancer Society, colorectal cancer is the
second leading cause of cancer deaths in the United States. In 1998,
approximately 56,500 deaths in the United States were attributed to colorectal
cancer. There were approximately 165,000 new cases of gastrointestinal cancer
detected in 1998, of which an estimated 131,600 were cancer of the colon and
rectum. Five-year survival rates using current techniques to detect and treat
colorectal cancer are as follows:
* 92% if detected and treated at an early stage
* 64% if the cancer spreads outside the colon to the lymph nodes
* 7% if the cancer has spread further to the liver or other organs
As the above statistics demonstrate, early detection is essential and critical
for long-term survival. Unfortunately, only 37% of colorectal cancers are
detected at an early stage. Studies indicate that screening can prevent 20%-40%
of potential colorectal cancers and up to 30%-50% of colorectal cancer deaths.
Recent government studies indicate that the cost per year of life saved by
colorectal cancer screening is about $15,000-$20,000 -- compared to the $40,000
average cost of cancer care per patient.
An endoscopic examination is currently the best method for detecting
colorectal cancer. Polyps are small, pronounced masses of tissue found in the
colon and are known to be the precursor for cancer. During an endoscopic
examination, the endoscopist typically does a visual assessment of the polyp for
size, color, texture and location and, based upon the assessment, chooses a
course of treatment. Large polyps are generally removed immediately and sent to
pathology for identification. Small polyps require a further subjective
determination as to whether the polyp is benign or potentially malignant, and
accordingly, random representative biopsies are often taken to determine what
course of treatment should be pursued.
The endoscopist can err in visually determining the size of the polyp
or in visually assessing whether the polyp is benign or malignant. Certain
medical literature reports that accuracy rates in visually determining polyp
size can range from 6%-80%, and accuracy rates in determining the potential
malignancy of polyps can range from 50%-80%, depending on the skill of the
endoscopist. Our clinical studies revealed that the endoscopist's accuracy in
visually assessing the malignancy of polyps is approximately 88%. Accurate
characterization is critical because recent data has shown that 40%-60% of small
polyps are either malignant or potentially malignant.
It is estimated that 3.5 million colon endoscopies were performed in
the United States in 1998, and endoscopic procedures are growing at an estimated
rate of 5%-6% per year. Based upon current reimbursement fees, which currently
permit reimbursement for biopsy and pathology of $100 per procedure, we believe
the potential colorectal cancer market in the
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United States is approximately $350 million. In addition, the United States
market represents only a fraction of the worldwide market for colorectal
endoscopies.
* BARRETT'S ESOPHAGUS
Barrett's esophagus is considered a pre-cancerous condition that is
normally found in the lower esophagus. Barrett's patients suffer from chronic
acid reflux, which causes stomach cells to eventually migrate into the lower
esophagus. The cells that line the esophagus have a distinctly different
appearance from those that line the stomach, and therefore can easily be
identified during an endoscopic examination. Biopsies are taken during the
examination, and are examined for abnormal changes in size, appearance or
cancerous cell growth. These tissue changes are considered to be the precursor
of cancer of the lower esophagus.
OPTICAL BIOPSY(TM) SYSTEM
Our principal product, the Optical Biopsy(TM) System ("OBS"), is a
minimally-invasive diagnostic tool used to detect and differentiate among
normal, pre-cancerous, and cancerous tissues without physically removing tissue
from the body. We are initially focusing on the gastrointestinal tract,
specifically colorectal cancer. We believe that use of the OBS will
significantly improve the diagnostic accuracy of the physician, provide earlier
detection, improve patient survival rates, and lead to a cost-effective outcome.
The OBS, an endoscopic biopsy forceps system, directs light at tissue
through an optical fiber and obtains and interprets, in real-time, a spectral
analysis. It is composed of three components:
* a biopsy forceps, which may be reusable or disposable, that
incorporates an optical fiber to excite tissue and collect light
energy from the excited tissue;
* a spectrophotometric console that produces the light, and then
measures and records the intensity of the excited tissue; and
* proprietary software and algorithm that analyze the recorded data
The OBS optical fiber and biopsy forceps are used through the endoscope
to make contact with a polyp, optically scan its tissue and give an instant
analysis. The OBS is intended to be used by physicians to assist them when they
make diagnostic decisions as to whether a polyp should be biopsied, removed or
left for further surveillance. Based on our clinical study results, we believe
that the OBS offers the following advantages:
* Significantly improves the diagnostic accuracy of the physician in
determining whether tissue is normal, pre-cancerous or cancerous.
The improved diagnostic accuracy in identifying polyps the physician
may misdiagnose should translate into earlier detection of cancers
and, perhaps more importantly, pre-cancerous polyps.
* Provides an instant diagnostic analysis that may reduce patient
waiting time for obtaining pathology results, or rescheduling an
additional procedure after pathology results are known.
* Is cost-effective because it allows the physician to combine a
diagnostic and therapeutic procedure in the same visit and with the
same instrument. This may reduce the need for re-scheduling
additional and/or unnecessary procedures.
We believe that once the OBS is commercialized, our core technologies
can be applied to other medical specialties, including the detection of normal,
pre-cancerous or cancerous
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tissues in the esophagus, lungs, urinary tract, prostrate, cervix and other
minimally-invasive endoscopic and laparoscopic applications. We are currently
conducting clinical feasibility studies with the OBS to determine the viability
of our technology as it applies to Barrett's esophagus and the changes that
esophageal tissue undergoes as it becomes a cancerous condition. These
additional applications could potentially represent large market opportunities
for us in the future.
We can provide no assurance that the OBS will be commercialized, that
we will capture the market share we anticipate, or that we will successfully
adapt the OBS for use in other medical specialties.
CLINICAL STUDIES
In 1998 we conducted multi-center clinical studies using the OBS for
detection of colorectal cancer at the following sites:
* Mayo Clinic, Rochester, Minnesota
* The Massachusetts General Hospital, Boston, Massachusetts
* Hennepin County Medical Center, Minneapolis, Minnesota
* Minnesota Gastroenterology PA through clinics located at:
-- United Hospital, St. Paul, Minnesota
-- Abbott Northwestern Hospital, Minneapolis, Minnesota
We have attempted to demonstrate through our clinical studies that the
OBS is a valuable adjunctive tool for use during colorectal endoscopies to
improve the physician's ability to identify and distinguish among normal,
pre-cancerous, and cancerous tissue during a colorectal examination.
In early 1998, we had obtained clinical data on a sufficient number of
patients to support a pre-market approval ("PMA") application to the United
States Food and Drug Administration ("FDA"). We requested and were granted a
pre-PMA submission meeting with the Gastroenterology/Urology branch of the FDA
to review data, clinical protocols and clinical results of our multi-center
clinical trials using the OBS in April 1998. We presented our clinical study
results demonstrating that use of the OBS improves the diagnostic accuracy of
the endoscopist in detecting colorectal cancer. At the pre-PMA submission
meeting, the FDA indicated that they wanted us to demonstrate we could reproduce
the results presented from our clinical studies by obtaining data on 144 more
patients. We completed these additional clinical trials in August 1998 and
submitted a Modular PMA application in September 1998. See "Government
Regulations." Our clinical studies revealed the endoscopists' diagnostic
accuracy in correctly identifying cancer or pre-cancerous polyps using current
methodology to be 88%. The use of OBS technology increased the endoscopists'
diagnostic accuracy in correctly identifying pre-cancerous or cancerous polyps
to 97.2%. More importantly, during these clinical studies the endoscopist
misdiagnosed 12 cancers as normal; however, the endoscopist was able to
correctly diagnose 9 of those 12 cancers when using the OBS.
Based on the results of our clinical studies and the Modular PMA
application process, we expect to receive FDA clearance to market in the first
half of 1999. Additionally, we plan to conduct post-approval clinical outcome
studies to initially market to managed health care
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organizations ("HMOs") as well as secure third-party reimbursement codes
necessary to market to non-HMO physicians. We can provide no assurance that our
PMA application will be approved in the time frame we expect or at all, or that
the FDA will not request additional data or require us to conduct further
clinical trials. See also "Government Regulations."
We also commenced a multi-center clinical trial for the detection of
esophageal cancer at the Mayo Clinic and the University of California at San
Francisco (UCSF) in 1998. In general, Barrett's Esophagus is a known risk factor
for esophageal cancer. This clinical trial is designed to determine the
viability of using spectroscopic techniques to detect esophageal cancer in
Barrett's patients and to develop and demonstrate the feasibility of the OBS. We
plan to expand our Barrett's Esophagus clinical trials in mid-1999.
PRODUCT RESEARCH AND DEVELOPMENT
Our research and development expenditures were $1,719,171 in 1998,
$1,095,281 in 1997 and $998,137 in 1996. Research and development activities are
performed by our employees and outside consultants. Our research and development
efforts during the past two years have been focused primarily on designing and
developing our biopsy forceps, designing and developing the OBS for the
detection of colorectal cancer, and conducting and monitoring clinical trials at
multiple sites. In addition, clinical feasibility studies to detect esophageal
cancer have begun at two sites. See "Clinical Studies" above.
We expect that our research and development efforts will now be focused
on conducting post-FDA clearance outcome-based clinical studies to market the
OBS to HMOs, as well as support and establish reimbursement codes for the OBS,
and expanding the gastrointestinal applications for the OBS to patients with
Barrett's esophagus.
There can be no assurance that we will receive FDA clearance to market
the OBS, be successful in establishing third-party reimbursement for the OBS, or
be able to develop other applications for the OBS.
GOVERNMENT REGULATIONS
Medical device development, manufacturing and marketing activities are
heavily regulated in the United States and other countries by numerous
governmental agencies, especially for product safety and effectiveness. In the
United States, the FDA reviews and grants approval to distribute medical device
products. The Food, Drug and Cosmetic Act, the Public Health Service Act, the
Safe Medical Devices Act of 1990 and other federal statutes and regulations also
govern or influence the testing, manufacture, safety, labeling, storage,
record-keeping, clearance, advertising and promotion of such products.
Noncompliance with applicable governmental requirements can result in, among
other things, fines, injunctions, civil penalties, recall or seizure of
products, failure of the government to grant pre-market clearance or pre-market
approval for devices, withdrawal of marketing approvals and criminal
prosecution.
In the United States, medical devices are classified into one of three
classes on the basis of the controls deemed necessary by the FDA to reasonably
ensure their safety and efficacy. Class I devices are subject to general
controls, Class II devices are subject to general
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and special controls, and Class III devices generally must receive pre-market
approval by the FDA after evaluation of their safety and efficacy. The OBS is a
Class III device that will require pre-market approval by the FDA prior to
commercialization.
FDA clearance to distribute a new device can be obtained two ways. If a
new device is "substantially equivalent" to an existing legally marketed device,
it can be commercially distributed after filing a 510(k) pre-market notification
with, and receiving an order permitting commercial distribution from, the FDA.
When submitting a 510(k) pre-market notification or a PMA application for a
"significant risk" device, an investigational device exemption ("IDE")
application must be submitted to the FDA before clinical testing is done. An IDE
application is not required for a "non-significant risk" device. The OBS is
considered a non-significant risk device. While an IDE application is not
required in this case, the FDA may still require us to submit one. If the FDA
requires us to submit an IDE application, we may be required to repeat all or
part of the clinical testing conducted prior to obtaining an IDE. This would
delay approval of the OBS.
A more comprehensive approval process applies to a Class III device.
First, clinical trials must be conducted. These trials must comply with testing
protocols approved by an internal board of the participating research
institution that oversees and approves all clinical studies for that
institution. Second, a PMA application must be submitted to the FDA. The PMA
application describes the results of the clinical trials, the device and its
components, the methods, facilities and controls used for its manufacture,
proposed labeling, and the demonstration that the product is safe and effective.
Finally, the manufacturing site for the product under submission must pass FDA
pre-approval inspection.
PMA applications can be submitted using two different methods. The
first method involves submitting the complete PMA document, which often takes
several months to a year to prepare. The FDA review process starts only after
all PMA components are submitted. Finally, the submission is discussed at an FDA
panel meeting. Any comments received back from the FDA must be resolved before
market clearance is granted. Generally, FDA market clearance for medical device
submissions averages 6-8 months from the date the application is accepted.
The second method is called a Modular PMA application and is available
for those companies that apply for and are granted permission to use it. The
modular approach is designed to expedite and streamline the review process. With
this approach, modules are submitted as they are completed, and the FDA begins
the review process as the modules are received. The distinct advantage to this
process is that additional modules can be completed while already submitted
modules are being reviewed by the FDA. Comments from the FDA may be received
throughout the process. Once all modules have been reviewed, the submission is
then discussed at a FDA panel meeting. At this meeting, the FDA panel may
recommend approval of the application, with or without additional conditions, or
reject the application. See "Clinical Studies" for a discussion of the status of
our PMA application.
We can provide no assurance that our Modular PMA application will be
approved, that we will not be required to submit an IDE application, that FDA
clearance for the OBS or any future products will be granted, or that the
process will not be unduly lengthy. Failure to
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comply with these requirements could adversely affect our financial condition
and results of operations.
Medical device manufacturers and/or contract manufacturers of medical
devices are also required to register with the FDA and are subject to periodic
inspections. These inspections are to determine if the manufacturer is in
compliance with the FDA's Quality Systems Regulations ("QSR") requirements and
various FDA labeling requirements. These regulations require manufacturers to
manufacture their products and maintain their documents for manufacturing,
testing and control activities in a prescribed manner. We believe we are
complying in all material respects with such applicable regulations. Failure to
comply with such applicable regulations could subject us to fines and other
enforcement actions.
There are additional issues such as import tariffs, duties and taxes,
and additional laws and regulations that must be addressed when selling in
foreign markets. These barriers could impact our ability to compete with other
larger companies and technologies, as well as our ability to enter those foreign
markets. In July 1998, the European Union adopted a new Medical Device
Directive, 93/42/EEC, that requires companies to have the CE mark on their
medical device products before the device can be sold to countries in the
European Union. We can receive the CE mark on our product by having it tested
specifically for the purpose of obtaining the mark, or by receiving ISO 9001
certification. We are currently in the process of having our product tested for
the CE mark and expect to receive the CE mark in 1999. We also anticipate
receiving ISO 9001 certification in late 1999. We can provide no assurance,
however, that we will receive ISO 9001 certification in the time frame
anticipated or at all, or that our product will receive the CE mark in the time
frame anticipated or at all.
We are also subject to other federal, state and local regulations
regarding environmental protection and hazardous substance controls. To date,
the costs we have incurred or the effects of complying with federal, state and
local environmental laws have been routine and customary. Although we are not
aware of any manufacturing methods for the OBS that will require extensive or
costly compliance with environmental regulations, we can provide no assurance
that we will not incur substantial costs to comply with these laws.
DISTRIBUTION, MARKETING AND CUSTOMERS
At this time, we have limited marketing and sales capabilities. We will
need to strengthen our marketing capabilities and, pending FDA clearance to
market for the OBS, we plan to focus our initial marketing efforts on the
following areas:
* establishing a limited in-house sales and marketing group to market
initially to HMOs
* launching the OBS initially in the United States to HMOs by
performing clinical outcome-based studies to demonstrate efficacy
and cost effectiveness
* using the results of the HMO clinical outcome-based studies to
obtain reimbursement codes which are necessary for third-party
reimbursement
* identifying major cancer and endoscopy centers in the United States
and leading endoscopists and other physicians at those institutions
to leverage their reputation in the medical community to generate
demand for the OBS
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* conducting physician-training seminars as necessary to educate
physicians about the OBS
Although we intend to establish a small in-house marketing group to
assist in commercializing our products, initially to HMOs, and to provide
clinical education to physicians, our future success may depend, in part, on our
ability to enter into and successfully develop strategic partnerships and
relationships with distributors to market and distribute our products to non-HMO
physicians. We plan to explore relationships with potential strategic partners
having strong market positions in the field of gastrointestinal medicine in the
United States and internationally. We have not entered into any strategic
partnership agreements at this time. We believe that distributing our products
through strategic partners may be more cost-effective and less time-consuming
than establishing an in-house sales group and will enable us to capitalize on
the marketing expertise of the strategic partner(s). We also believe that
distribution or marketing agreements with well-established, reputable strategic
partners might enable us to leverage our products into other market niches. We
can provide no assurance that we will be able to enter into such strategic
partnerships on favorable terms or at all.
THIRD-PARTY REIMBURSEMENT
Medical institutions are the primary non-HMO market for the OBS. These
institutions generally rely on third-party payors to reimburse all or part of
the costs and fees associated with the procedures performed using products such
as the OBS. Health care services provided by such institutions are reimbursed by
various third-party payors, such as Medicare, Medicaid, other government
programs and private insurance plans.
Funding for Medicare and Medicaid is subject to limits set by Congress.
Congress approved Medicare coverage for preventive colorectal cancer screening
tests as part of the Balanced Budget Act of 1997. This new benefit went into
effect in January 1998 for the 37.3 million Americans covered by Medicare. We
believe that this funding could lead to greater awareness of colorectal cancer
among the general populace, larger screening budgets, higher reimbursement
levels and potentially the establishment of new reimbursement codes for
technologies like the OBS.
Hospitals are reimbursed for medical procedures at a fixed rate
according to Diagnosis Related Groups ("DRGs") established by the Health Care
Financing Administration ("HCFA"), a federal government agency. It is unlikely
that HCFA would approve a new technology that has not received clearance from
the FDA. Normally, the fixed rate of reimbursement is based on the procedure
performed, not the specific device(s) used in that procedure. If a procedure is
not covered by a DRG, third-party payors may deny reimbursement. Payors may also
deny reimbursement if they determine the device used in a treatment was
unnecessary, inappropriate, experimental, used for a non-approved indication, or
not cost-effective. Medicare and Medicaid provide reimbursement based on whether
they cover a particular procedure. Our success will be dependent, in part, on
the ability of these institutions to obtain satisfactory reimbursement from
third-party payors for medical procedures in which our products are used.
Currently, there are no established DRGs covering spectroscopic
diagnostic procedures for cancer detection. DRG reimbursement is available for
non-spectroscopic, endoscopic
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procedures such as flexible sigmoidoscopies, colonoscopies and polypectomies,
including fees for biopsies. Prospective governmental reimbursement programs
provide financial incentives for health care institutions to become more
efficient and productive by reimbursing these institutions at a fixed rate based
on DRGs. For each illness treated or procedure performed, the fixed
reimbursement rate is based on an average rate. Therefore, the more cases that
can be treated below the fixed rate, the higher the level of profitability.
Capital costs incurred by hospitals for medical equipment purchases are
reimbursed separately from DRG payments. Changes in federal legislation or the
policies of governmental or private third-party payors that reduce reimbursement
under capital cost pass-through systems could adversely affect the market for
the OBS.
Even though reimbursement for spectroscopic procedures using the OBS is
not currently available, we anticipate that reimbursement for spectroscopic
procedures using the OBS will eventually become available. We believe that once
FDA clearance is obtained, outcome-based studies will prove the clinical utility
of the OBS as well as its ability to reduce cost and save time. The clinical
utility, cost reduction and time-savings recognized through use of the OBS will
stem from the ability of the endoscopist to combine a diagnostic and therapeutic
procedure in one visit using the same instrument. However, there can be no
assurance that reimbursement for procedures using the OBS will become available
or that it will become available within a time frame that will benefit us.
We believe that there will be continued pressure on cost containment
throughout the health care system. Cost reduction, cost containment, managed
care, capitation pricing (i.e., fixed price reimbursement based on the procedure
rather than the number of disposable products or supplies used), and consignment
sales are becoming increasingly common measures, not only in the United States
but also in Japan and many European countries. Emphasis on cost containment and
cost reduction has led to an increase in managed care participants as companies
seek to reduce the cost of providing health care benefits to employees.
Third-party reimbursement limits have led to cuts in reimbursements for new or
experimental procedures.
With the strong emphasis on cost containment, many vendors have merged
or acquired other suppliers in order to achieve economies of scale, to be price
competitive, and to be the dominant vendor for a range of products which would
allow them to bundle products or product lines together. We can provide no
assurance, given our limited size and resources, that we will be able to achieve
the economies of scale necessary to successfully commercialize products such as
the OBS while obtaining third-party reimbursement for such products.
MANUFACTURING AND SOURCES OF SUPPLY
To date, our manufacturing activities have consisted primarily of
assembling a limited number of our OBS's for use in our clinical studies. We
have not yet commercialized any of our products, and do not have experience in
manufacturing our products in commercial quantities.
Pending United States FDA clearance to market, we plan to assemble the
OBS console in-house. Our OBS console has both standard "off-the-shelf"
components and components that
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are built to our specifications. We also use third parties to perform certain
manufacturing processes, including the manufacture of our OBS forceps. Our
proprietary software was developed in-house in conjunction with outside
consultants. We then assemble, inspect and test the completed OBS at our
facility.
Any of our products requiring FDA clearance must be manufactured in
accordance with current QSR requirements. Most of the purchased components and
processes are available from more than one vendor; however, certain components
used in the OBS have sole or limited sources of supply. The performance of these
sole or limited source manufacturers has been satisfactory to date, but there
can be no assurance that they will continue to perform up to our standards, meet
government regulations or handle labor unrest, if any. The inability of these
sole or limited source manufacturers to meet standards and regulations could
severely impact our ability to test, manufacture and sell our products. The
process of qualifying additional or replacement vendors in the heavily regulated
medical device industry can be expensive and time-consuming, and any supply
interruption could have a material adverse effect on the Company's business,
financial condition and results of operations.
COMPETITION
The medical device industry is highly competitive. We believe that our
success will depend upon our ability to create and deliver innovative, minimally
invasive spectroscopic diagnostic products and systems on a timely basis and at
competitive prices, effectively create market awareness and acceptance of our
products, and maintain the proprietary nature of our technologies and processes.
We believe we have few direct competitors in applying spectroscopy to the
detection of colorectal cancer; however, the development of products using
spectroscopic diagnostics for various medical specialties is rapidly growing.
Currently, there are several ongoing spectroscopic diagnostic research projects
employing humans. To the best of our knowledge, no other competitors have
completed FDA clinical studies or submitted a PMA application to the FDA for a
colorectal cancer application. The companies that follow have developed or are
in the process of developing products that use spectroscopic technology that
could potentially compete with our products or technologies.
Xillix Technologies (Richmond, British Columbia, Canada) began to
commercialize its LIFE-Lung system in 1998. This product uses light-based
spectroscopy to detect and localize lung cancer and costs approximately $200,000
per system. Xillix also formed a strategic alliance with Miravant Medical
Imaging in 1998 to co-develop a product that will integrate Xillix's technology
with Miravant's PhotoPoint Drug technology. Xillix is also developing a system
to detect gastrointestinal cancers of the esophagus, stomach, intestines and
colon and has completed some feasibility clinical testing in this area. Xillix
also has a strategic alliance with Olympus (Japan). Olympus supplies endoscopic
equipment to approximately 70% of the market. The second largest endoscopic
equipment supplier is Pentax (Japan) with about 25% of the market.
SpectRx (Norcross, GA) has developed spectroscopy systems that offer
less invasive and painless alternatives to blood tests currently used for
glucose monitoring, diabetes screening and infant jaundice. Their products are
in various stages of development. Their glucose monitoring product is furthest
along the development path, and SpectRx has indicated
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<PAGE>
they expect to submit the glucose monitoring device for FDA approval in 1999.
FluorRx, a sister company to SpectRx, is also developing spectroscopy systems
for other clinical chemistry diagnostics.
Mediscience Technology (Cherry Hill, New Jersey) has conducted clinical
studies for oral leukopakia, a pre-cancerous condition of the mouth, with a
prototype product called CD SCAN. They also plan to conduct clinical studies in
the areas of breast cancer and Barrett's Esophagus with products using
spectroscopic technology.
Lasertec International, Inc. (Stamford, Connecticut) expects to have
results from ongoing human trials of its Photo Therapic Resonancy System in
several months. Their technology is currently focused on the diagnosis and
treatment of bladder cancer, but they plan to expand their technology to the
diagnosis of laryngeal cancer. Their product differs from other cancer
diagnostic products because it is designed to eliminate the cancer by causing
the cancer cell to destroy itself.
Lifespex (Kirkland, Washington) is a development stage company that has
successfully completed clinical studies with its cervical cancer detection
device called CERVISCAN. Lifespex is also conducting initial testing for its
skin cancer detection device.
PATENTS
Our success depends in part on our ability to obtain and maintain
patent protection for our products, to preserve our trade secrets and to operate
without infringing the proprietary rights of third parties. Some of the
technology used in, and that is important to, our products is not covered by any
patents or patent applications. We seek to protect our trade secrets and
proprietary know-how through proprietary information agreements with employees,
consultants and other parties.
We currently own exclusive rights to five issued, allowed and pending
U.S. patents and applications for the OBS, two of which were filed in March
1999. The patents and patent applications include but are not limited to the
following areas: types of forceps having an optical fiber and biopsy jaws;
methods of tissue diagnosis using these forceps; various improvements in the
OBS; apparatus and method for diagnosing tissue using the OBS; and providing the
physician with additional information regarding whether it is necessary to take
a biopsy sample. As of March 1999, there were three patents pending in the
United States, and four patents pending in various foreign countries. We are
also the exclusive licensee through the Massachusetts General Hospital of
another U.S. patent for the OBS, which was issued in December 1998, and three
related pending patents. We believe our patents, in addition to the licensed
patents described below, provide for a strong intellectual property position. We
can provide no assurance that any additional patents will be filed or issued, or
if issued, that such patents will afford us any competitive advantage.
In addition to the above, we also have an exclusive licensing agreement
with the Massachusetts Institute of Technology for seventeen issued patents and
pending applications, relative to the use of spectroscopy for the diagnosis of
atherosclerotic cardiovascular disease. This licensing agreement runs for the
life of the patents and includes technology developed
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under National Institute of Health funding. We also have a licensing arrangement
with the Massachusetts General Hospital's Wellman Laboratories of Photomedicine
which provides that certain patents that result from the Wellman Lab's research
on cancer detection will be licensed exclusively to us.
EMPLOYEES
As of March 26, 1999, we had nine employees, all of whom were full-time
employees. Eight employees were engaged in product engineering, manufacturing,
and regulatory affairs, and one employee was engaged in finance and
administration. We had 11 full-time employees at December 31, 1997, and nine
full-time employees at December 31, 1996. We are not subject to any collective
bargaining agreement and believe that our employee relations are generally
satisfactory.
We also rely heavily on external consultants in the financial,
regulatory, software development and design engineering areas. To date, we have
been successful in attracting and retaining qualified technical personnel. We
can provide no assurance, however, that we will be able to continue to attract
or retain the skilled employees we need for profitable operations.
ITEM 2. DESCRIPTION OF PROPERTY
Our offices are located at 3650 Annapolis Lane, Suite 101, Minneapolis,
Minnesota 55447-5434. Our leased facility consists of approximately 5,530 square
feet of office, laboratory, quality testing, and warehouse space. The five-year
lease, which expires on October 31, 2001, provides for monthly rental payments
of approximately $4,500 per month. Our current rental payments, including a PRO
RATA share of operating expenses and real estate taxes, are $5,915 per month. We
maintain standard property and casualty insurance coverage at levels that we
deem appropriate. We also believe that our current facility will be sufficient
for our operations, including manufacturing, for the next year.
ITEM 3. LEGAL PROCEEDINGS
On or about September 4, 1998, we were served with a Complaint in the
case of Paul Gibson v. SpectraScience, Inc. (Minn. 4th Jud. Dist.), claiming
that the plaintiff, who was at one time a financial consultant to the Company,
was entitled to receive options for 50,000 shares of our Common Stock at an
exercise price of $2.50 per share. Mr. Gibson was retained to successfully
complete a proposed private placement financing. The stock options were to vest
upon the successful closing of the proposed financing on or before December 31,
1994. The proposed financing did not occur. The parties are in the process of
exchanging information in the case. The Company believes the claim to lack merit
and intends to defend itself vigorously.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There have been no matters submitted to a vote of the security holders
since the 1998 annual shareholders' meeting.
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
MARKET INFORMATION
During the year ended December 31, 1998, our Common Stock, par value
$.25 per share (the "Common Stock") traded on the Nasdaq SmallCap Market under
the symbol "SPSI." The following table sets forth, for the periods indicated,
the high and low sales prices for our Common Stock as reported by the Nasdaq
SmallCap Market.
<TABLE>
<CAPTION>
1998 Stock Prices 1997 Stock Prices
--------------- --------------- ---------------- ---------------
QUARTER ENDED High Sales Low Sales High Sales Low Sales
---------------------------- --------------- --------------- ---------------- ---------------
<S> <C> <C> <C> <C>
March 31 $8.000 $3.690 $5.125 $3.6250
June 30 $7.625 $4.000 $4.500 $2.4375
September 30 $5.500 $2.875 $4.750 $3.6250
December 31 $8.000 $3.625 $9.125 $4.5625
</TABLE>
Our Common Stock was delisted from the Nasdaq SmallCap Market at the
close of business on March 17, 1999, and since March 18, 1999, has been trading
on the Over-The-Counter Bulletin Board under the symbol "SPSI." On March 26,
1999, the closing price quoted for our Common Stock was $5.00 per share.
NASDAQ DELISTING
Our Common Stock traded on the Nasdaq SmallCap Market from May 15, 1996
until March 17, 1999. The process that led to delisting of the Company's Common
Stock from the Nasdaq SmallCap Market is described below.
On February 9, 1999, The Nasdaq Stock Market notified us that in order
to continue to have our Common Stock listed on The Nasdaq SmallCap Market we
must demonstrate by March 12, 1999, based on a pro forma balance sheet as of
January 31, 1999, that we had a minimum of $4,000,000 in net tangible assets. On
March 12, 1999, we notified The Nasdaq Stock Market that our net tangible assets
were in excess of $2,000,000 and requested an extension of time to demonstrate
compliance with Nasdaq's requested $4,000,000 net tangible asset threshold. On
March 17, 1999, The Nasdaq Stock Market rejected our request for an extension
and notified us that our securities would be delisted from The Nasdaq Stock
Market effective with the close of business on March 17, 1999.
HOLDERS
On March 26, 1999, we had 983 registered shareholders of record of
5,261,720 shares of our Common Stock, excluding shareholders that are registered
in "street-names." We estimate that there are approximately 5,000 beneficial
shareholders of our Common Stock.
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DIVIDENDS
Since our incorporation, we have not paid any dividends, and no
dividend payments are contemplated in the foreseeable future. We will retain any
earnings we may generate to provide for the operation and expansion of our
business.
OTHER SECURITIES
We did not raise any additional funds in 1998 through any public or
private offerings. A secondary public offering was initiated but did not close
due to market conditions. A total of $1,024,187 was raised in fiscal 1998
through the exercise of stock options for 82,800 shares of Common Stock and the
exercise of warrants for 148,445 shares of Common Stock that were issued to
investors in connection with our 1995 private placement of Series A Preferred
Stock.
Warrants to purchase 174,998 shares of Common Stock were issued to
lenders in connection with our $525,000 bridge loan transaction in 1994 and
1995. These warrants were exercised in March 1999, raising an additional
$525,000 for the Company.
As of March 26, 1999, all warrants issued in connection with the bridge
loan transaction had been exercised, 184,556 warrants issued to investors in
Series A Preferred Stock had been exercised and 40,444 warrants issued to
investors in Series A Preferred Stock had expired. Additionally, warrants issued
to the selling agent to purchase 3,334 shares of Common Stock had expired,
13,333 warrants had been exercised and 10,000 warrants are still outstanding.
The Company received a total of $742,225 from the exercise of warrants issued to
investors in Series A Preferred Stock during 1998.
Investors in our 1995 private placement of Series B Preferred Stock
were issued three-year warrants to buy one-third of a share of Common Stock at a
price of $9.50 per share. The terms of these warrants were modified on December
28, 1998, by reducing the warrant exercise price to $6.00 per share, and
extending the expiration date to January 26, 1999. As of March 26, 1999, 87,668
warrants (as modified) issued in connection with the private placement of Series
B Preferred Stock had been exercised, and 176,507 warrants had expired. As of
March 26, 1999, 79,250 warrants issued to the selling agent were still
outstanding. The Company received a net amount of $485,407 from the exercise of
the modified warrants held by investors in Series B Preferred Stock, during the
first quarter of 1999.
In March 1999, the Company sold 258,750 shares of its Common Stock at
$4.00 per share to various accredited investors in a private placement.
Investors also received a warrant to purchase one-half share of Common Stock for
each share purchased in the private placement. As a result of the funding
secured during the first quarter of 1999 we are no longer pursuing a bridge loan
transaction.
STOCK OPTIONS
The Company had 949,931 stock options outstanding as of March 26, 1999.
Current employees hold 42.9% of the outstanding stock options, which represents
a substantial decrease from last year and is due primarily to the fact that Mr.
McMahon's options are no longer included as employee options.
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<PAGE>
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
The following discussion and analysis provides information that
management believes is relevant to assess and understand our results of
operations and financial condition. This discussion should be read in
conjunction with the financial statements and footnotes that follow.
PLAN OF OPERATION
The Company had cash and cash equivalents of $301,970 on December 31,
1998. Our foremost concern as we entered the first quarter of 1999 was to raise
sufficient funds to continue operations and to maintain our listing on The
Nasdaq SmallCap Market. We raised $2,057,313 through the exercise of warrants,
stock options and a private placement during the first quarter of 1999. Although
this amount was not sufficient to meet Nasdaq's requirements to remain listed,
we believe it will be sufficient to carry us beyond anticipated FDA clearance
and through the remainder of fiscal year 1999. We expect that we will need to
raise an additional $3-$5 million from such sources as, but not limited to,
strategic partners, private placements or public offerings to fully implement
the various strategies outlined below.
We intend to use our current funds to continue our clinical studies,
begin ramping-up for production of the OBS and start implementing our marketing
plan on a limited basis. Additional funding would be used to:
o work with HMOs to conduct outcome-based clinical studies which would
be conducted to collect clinical data to support and establish
reimbursement codes
o commercialize the OBS following the receipt of FDA clearance
o obtain ISO 9001 certification
o expand our manufacturing capabilities
o provide education and training to physicians and other health-care
providers
o fund the development of future products, for applications such as
Barrett's esophagus
o strengthen our intellectual property position with additional
patents and licensing
We believe we will be able to implement the above strategies without
the need to purchase or lease significant pieces of equipment or a large amount
of additional plant space. We believe we will need to hire additional employees
in 1999 to support manufacturing after we receive FDA clearance for the OBS, as
well as additional administrative and in-house marketing and research and
development personnel.
We will probably be forced to adjust our strategies and pursue other
courses of action if we are not able to raise all or any of the additional funds
we believe we will require to fully implement the various strategies and plans
outlined above. We can provide no assurance that we will be successful in
raising any or all of the additional funds that will probably be required, or
that any such funds will be raised on a timely basis.
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<PAGE>
RESULTS OF OPERATIONS
FISCAL YEARS ENDED DECEMBER 31, 1998 AND 1997
REVENUE
We recorded no revenue for the years ended December 31, 1998 and 1997.
We do not expect to begin generating revenue until after FDA clearance has been
obtained for the OBS.
RESEARCH AND DEVELOPMENT
Research and development expenses for the year ended December 31, 1998
totaled $1,719,171, compared to $1,095,281 for the year ended December 31, 1997.
This represented an increase of $623,890, or 57.0%. The increase was primarily
due to (a) increased salary expense related to the hiring of two additional
personnel during the first half of 1998, (b) increased expenses related to the
multi-center clinical trials on the OBS for colorectal cancer and feasibility
studies for esophageal cancer, (c) an inventory revaluation associated with a
change in product design, (d) increased consulting and product testing expenses
relating to the submission of the Modular PMA application to the FDA, and (e)
increased design engineering expenses.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1998 totaled $746,953, compared to $679,809 for the year ended
December 31, 1997. This represented an increase of $67,144, or 9.9%. This
increase was primarily due to increased investor relations expenses and legal
expenses. We used the services of our investor relations consultant for the
entire year in 1998 compared to only four months in 1997 to assist in the
process of informing brokers and analysts throughout the United States about the
Company and its technologies. We also incurred increased legal and other
professional service expenses in connection with the filing of a registration
statement relating to a public offering of our Common Stock, which was later
discontinued due to unfavorable market conditions.
INTEREST AND OTHER INCOME
Interest and other income for the year ended December 31, 1998 totaled
$51,982, compared to $131,299 for the year ended December 31, 1997. This
represented a decrease of $79,317, or 60.4%, and was due to lower average cash
balances during 1998 compared to 1997.
NET LOSSES
As a result of the above factors, we reported a net loss of $2,414,142
for the year ended December 31, 1998, compared to a net loss of $1,643,791 for
the year ended December 31, 1997. This represented an increase of $770,351, or
46.9%, and was primarily due to increased research and development costs and
lower interest and other income. The net loss was $.52 per share for the year
ended December 31, 1998, compared to a net loss of $.37 per share for the year
ended December 31, 1997. We anticipate that our net loss will increase at least
through fiscal year 1999 as we begin to commercialize the OBS, continue our
research and development efforts to develop applications for the OBS in other
medical specialties and investigate other potential opportunities for our
technologies.
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<PAGE>
FISCAL YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUE
We recorded no revenue for the years ended December 31, 1997 and 1996.
Even though we have 510(k) clearance from the FDA for the disposable biopsy
forceps and the reusable biopsy forceps, we decided to commercialize the forceps
only as part of the OBS. As such, we do not expect to generate any significant
revenue until FDA clearance has been obtained for the OBS.
RESEARCH AND DEVELOPMENT
Research and development expenses for the year ended December 31, 1997
totaled $1,095,281, compared to $998,137 for the year ended December 31, 1996.
This represented an increase of $97,144, or 9.7%, and was primarily due to (a)
increased expenses related to the multi-center clinical trials on the OBS, (b)
two additional personnel hired in 1997 for product research and development, (c)
increased legal fees associated with intellectual property protection and (d)
increased consulting costs for the development, data analysis and regulatory
filings relating to the OBS.
SELLING, GENERAL & ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses for the year ended
December 31, 1997 totaled $679,809, compared to $723,825 for the year ended
December 31, 1996. This represented a decrease of $44,016, or 6%, and was
primarily due to elimination of an office administrator and other cost reduction
measures. The reduction in expenses was offset partially by increased expenses
in investor relations costs. In the third quarter of 1997, we hired a consultant
who assisted us in investor relations with brokers and analysts in major cities
in the United States in order to provide better and wider dissemination of
knowledge regarding the Company and its technologies.
INTEREST AND OTHER INCOME
Interest and other income was $131,299 for the year ended December 31,
1997, compared to $176,043 for the year ended December 31, 1996. This
represented a decrease of $44,744, or 25.4%, and was due to lower average cash
balances during 1997 compared to 1996.
NET LOSSES
As a result of the above factors, we reported a net loss of $1,643,791
for the year ended December 31, 1997, compared to a net loss of $1,545,919 for
the year ended December 31, 1996. This represented an increase of $97,872, or
6.3%, and was primarily due to increased research and development costs and
lower interest and other income. The net loss per share was $.37 for the year
ended December 31, 1997, compared to a net loss per share of $.47 in for the
year ended December 31, 1996. The lower net loss per share was due to higher
weighted average shares outstanding in 1997, which resulted from the conversion
of outstanding shares of Series A and Series B Preferred Stock into an
equivalent number of shares of Common Stock.
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<PAGE>
LIQUIDITY AND SOURCES OF CAPITAL
On December 31, 1998, our working capital was ($27,791) compared to
$1,454,649 on December 31, 1997. The decrease in working capital was the result
of cash being used to fund normal business operations.
Net cash used in operating activities in 1998 was $2,341,207, compared
to $1,492,331 in 1997 and $1,379,498 in 1996. The increase was primarily due to
the higher net losses each year. The higher net losses were caused by higher
research and development costs relating to the development and clinical testing
of the OBS and the preparation and filing of the Modular PMA application with
the FDA.
Net cash used by investing activities was $19,183 in 1998, compared to
$12,192 in 1997 and 10,936 in 1996. The increase in each year was primarily due
to additional purchases of fixed assets.
Net cash provided by financing activities in 1998 was $1,024,187,
compared to $95,514 in 1997 and $314,290 in 1996. The cash provided by financing
activities each year was primarily due to the exercise of warrants and stock
options throughout each year.
Cash and cash equivalents on December 31, 1998 were $301,970, compared
to $1,638,173 on December 31, 1997 and $3,047,182 on December 31, 1996. During
the first quarter of 1999, we raised $2,057,313 through several means including
but not limited to warrant and stock option exercises and a private placement.
We estimate that this amount of cash and cash equivalents will be sufficient to
last through fiscal 1999.
Our future liquidity and capital requirements will depend upon a number
of factors, including the progress and expense of clinical trials, the potential
requirements and related costs for product modifications, the timing and expense
of various U.S. and foreign regulatory filings, the timing of receipt of various
U.S. and foreign government approvals for our products, the timing and extent to
which our products gain market acceptance, the timing and expense of product
introduction, and the expense of developing marketing and distribution
capabilities for our products. We may be required to seek additional funds
through debt or equity financing, arrangements with corporate partners or from
other sources. Issuance of additional equity securities could result in
substantial dilution in ownership and control to the then-existing shareholders.
There can be no assurance that any such funds will be available on terms
acceptable to us, or at all. Our inability to fund our capital requirements
would have a material adverse effect on our business, financial condition and
results of operations.
YEAR 2000 ISSUE
Many currently installed computer systems and software are coded to
accept only two-digit entries in the date code fields. These date code fields
will need to accept four-digit entries to distinguish 21st century dates from
20th century dates. This problem could result in system failures or
miscalculations causing disruptions of business operations. As a result, many
companies' computer systems and software will need to be upgraded or replaced in
order to comply with Year 2000 ("Y2K") requirements. The potential global impact
of the Y2K
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problem is not known, and if not corrected in a timely manner, could affect the
Company in particular and the U.S. and world economy generally.
Our product development process currently contains steps to include Y2K
compliance verification for all current and future products. Our existing
products are Y2K compliant. In addition, we are requesting assurances from our
major and sole or limited source suppliers that they are addressing the Y2K
issue. These actions are intended to help mitigate the possible external impact
of the Y2K problem. The Y2K efforts of third parties are not within our control;
however, their failure to resolve Y2K issues successfully could result in
business disruption and increased costs to the Company. At the present time, it
is not possible to determine whether any such events are likely to occur, or
quantify any potential negative impact they may have on our future results of
operations and financial condition.
We are currently analyzing internal and external Y2K issues. Our
internal and other computer systems are being reviewed to assess and minimize
Y2K issues; this assessment includes our information technology ("IT") and
non-IT systems. Our Y2K compliance program includes the following phases:
identifying systems that may need to be modified or replaced; carrying out
modifications to existing systems or converting to new systems; and conducting
validation testing of various systems and applications to determine their
readiness. All internal IT computer systems and software have been assessed and
appear to be Y2K compliant. Computer equipment that we purchased in 1997 for the
purpose of satisfying operational needs is Y2K compliant, and final testing of
our accounting software will be completed during the second quarter of 1999. To
date, the assessment of our external IT systems has not revealed any Y2K
compliance issues. The assessment of our non-IT systems should be completed by
the third quarter of 1999. We estimate that we will complete our Y2K compliance
program for all of our significant internal systems by September 30, 1999.
We estimate the total cost for resolving our Y2K issues will probably
be less than $5,000, of which approximately $1,000 has been spent through March
26, 1999. The estimate of Y2K costs is based on numerous assumptions, and there
can be no assurance that the estimate is correct or that actual costs will not
be materially greater than anticipated.
Although we use computer software and hardware for various operations,
including financial reporting, certain manufacturing and assembly functions, and
in our products, we believe that the Y2K issue will not cause any material
disruptions to our operations. However, if certain critical third-party
providers, such as those that supply electricity, water or telephone service,
experience difficulties resulting in disruption of the services they provide us,
a shutdown of our facility could occur for the duration of the disruption. We
plan to continuously monitor the status of completion of our Y2K plan and, based
upon such information, will develop a contingency plan as necessary.
The most reasonably likely worst-case scenario of failure by the
Company or our suppliers or customers to resolve Y2K issues could potentially be
a temporary slowdown or cessation of operations at our facility, and/or a
temporary inability on our part to timely process orders and to deliver finished
products to customers. Unresolved Y2K issues by the Company, suppliers or
customers could potentially delay the timing of payments from or to the Company.
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ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
Audited financial statements for each of the three years ended December
31, 1998, 1997 and 1996 are filed as part of this Form 10-KSB. See Index to
Financial Statements on Page F.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
Listed below are our directors, executive officers and key employees,
their ages, positions and year in which each first became a director, executive
officer or key employee.
<TABLE>
<CAPTION>
NAME AGE POSITION DIRECTOR/OFFICER SINCE
- ---- --- -------- ----------------------
<S> <C> <C> <C>
Chester E. Sievert, Jr. 47 President & Chief Executive Officer 1998
Henry M. Holterman(1) (2) 44 Director 1992
Nathaniel S. Thayer(1) (2) 74 Director 1992
</TABLE>
- -------------------
(1) Member of the Audit Committee of the Board of Directors
(2) Member of the Compensation Committee of the Board of Directors
CHESTER E. SIEVERT, JR. was appointed Chief Executive Officer on
January 5, 1999, after the sudden death of Mr. Brian McMahon, our former
Chairman and Chief Executive Officer, in December 1998. Mr. Sievert joined the
Company in June 1996 as a consultant, and began serving as Vice President of
Development in November 1996. He was appointed Executive President of
Development and Operations in July 1997, and was appointed President and Chief
Operating Officer in March 1998. Prior to joining us, Mr. Sievert founded and
was the president of two medical product companies, ReTech, Inc. from 1980 to
1986, and FlexMedics Corporation from 1986 to 1995. As a former academic
scientist on staff at the University of Minnesota College of Medicine and the
Veterans Administration Medical Center, Mr. Sievert published extensively in the
fields of gastroenterology, urology and fiber optics. Mr. Sievert has a Bachelor
of Science Degree in Comparative Physiology from the University of Minnesota.
HENRY M. HOLTERMAN has served as a director for the Company since March
1992. Mr. Holterman has been the Managing Director of Reggeborgh Beheer BV, a
company located in The Netherlands that invests in companies and owns property
projects generally located in The Netherlands, since 1991. Mr. Holterman is a
chartered accountant and, from 1987 to 1991, was group controller for Transport
Development Group PLC and the Dutch Holding Company
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<PAGE>
ETOM NV. From 1984 to 1988, Mr. Holterman was the President of the Board of
Directors of LETO Recycling, a Swedish-Dutch company involved in recycling
chemical waste.
NATHANIEL S. THAYER has served as a director for the Company since May
1993. Mr. Thayer has been a partner in the law firm of Blais Cunningham & Crowe
Chester, located in Pawtucket, Rhode Island, since 1969.
Our Bylaws authorize the Board of Directors to fix the number of
directors from time to time, and the number is currently set at five directors.
There are currently three vacancies on the Board, one of which was previously
held by Mr. McMahon, who was our Chief Executive Officer and Chairman of the
Board at the time of his death. All directors hold office until the next annual
meeting of the shareholders or until their successors have been elected and
qualified. Officers serve at the discretion of the Board of Directors. We intend
to nominate additional individuals to serve as directors in connection with the
1999 annual shareholders' meeting. There are no family relationships between any
of the directors or executive officers of the Company.
BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires our directors, executive
officers and persons who are beneficial owners of more than 10% of the Common
Stock to file initial reports of ownership and reports of changes in ownership
of Common Stock and any other equity securities of the Company with the
Securities and Exchange Commission, and to furnish us with copies of all Section
16(a) reports they file. To the best of our knowledge, based upon a review of
the copies of such reports furnished to us and written representations that no
other reports were required, during the year ended December 31, 1998, all
Section 16(a) filing requirements applicable to our officers, directors, and 10%
shareholders were satisfied with the exception of one late filing of a Form 4
for each of Mr. Henry Holterman, Mr. Nathaniel Thayer, and Mr. Chester Sievert.
Each of the late Form 4s were related to grants of stock options that were
pending compensation committee approval at the time of Mr. McMahon's death.
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ITEM 10. EXECUTIVE COMPENSATION.
SUMMARY COMPENSATION
The following table shows, for the fiscal year ending December 31,
1998, compensation awarded, paid to, or earned by our Chief Executive Officer
and for all executive officers whose salary and bonuses exceeded $100,000 for
that year (the "Named Executive Officers"):
<TABLE>
<CAPTION>
Annual Compensation Awards
------------------- ------
Other Securities
Annual Restricted Underlying All Other
Name and Principal Compen- Stock Option/s LTIP Compen
Position Year Salary Bonus sation(1) Award(s) SARs Payouts sation(11)
- ------------------------- ------- ---------- ---------- ---------- ----------- ------------ -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Chester E. Sievert, Jr. 1998 $110,000 $ -- $6,000 - 145,000(2) - $3,300
President and Chief 1997 92,500 15,000 6,000 - 85,000(3) - 1,712
Executive Officer 1996 11,987 -- 1,000 - 17,079(4) - -
Brian T. McMahon (5) 1998 131,855 - 6,005 - 206,667(2) - 30,000
1997 137,496 34,374 6,307 - 289,605(6) - 2,062
1996 137,496 27,500 8,279 - 50,000(7) - 1,317
Ching-Meng Chew (8) 1998 62,006 14,250 4,175 - 37,500(2) - 33,175
1997 95,000 16,500 6,575 - 25,000(9) - 2,850
1996 82,500 3,822 6,585 - 15,000(10) - 1,157
</TABLE>
(1) Other Annual Compensation primarily involves a car allowance of $500 per
month for each of the Named Executive Officers. Mr. McMahon received
$2,129 in medical benefits in 1996, but did not receive paid medical
benefits in 1997 or 1998.
(2) Details of these option grants are provided in the following table
entitled "Option Grants in Last Fiscal Year."
(3) Includes a ten-year stock option for 50,000 shares, which will vest in its
entirety upon the successful completion of the clinical studies on the OBS
and the filing with the FDA of a pre-market notification package and final
FDA product approval; and a ten-year stock option for 35,000 shares,
vesting one-third per year over three years. Both options have an exercise
price of $3.9125 per share. On March 26, 1999, Mr. Sievert held total
stock options for 247,079 shares.
(4) Includes a ten-year stock option for 15,000 shares, vesting one-third per
year over three years at an exercise price of $4.9875 per share, and a
ten-year option for 2,079 shares at an exercise price of $7.75 per share,
which is fully vested.
(5) Mr. McMahon held the titles of Chairman and Chief Executive Officer until
his sudden death in December 1998. A total of 289,379 unvested options
were forfeited at the time of his death. On March 26, 1999, Mr. McMahon's
estate held total stock options for 406,353 shares, all of which will
expire on or before December 9, 2000.
(6) Mr. McMahon previously held two fully-vested five-year stock options, one
for 50,000 shares exercisable at $2.50 per share and one for 150,000
shares exercisable at $3.00 per share. Both options expired unexercised in
1997. Mr. McMahon was granted new ten-year options, each vesting one-third
per year over three years as follows: (a) 50,000 shares at $3.7625 per
share, (b) 189,065 shares at $3.7813 per share, and (c) 50,000 shares at
$4.7625 per share.
(7) Represents a ten-year stock option for 50,000 shares, vesting one-third
per year over three years, at an exercise price of $7.00 per share.
(8) Mr. Chew resigned as Vice President Finance and Administration, Chief
Financial Officer, Secretary and Treasurer of the Company as of July 31,
1998. A total of 27,800 vested options were exercised in October 1998
prior to their expiration. A total of 71,387 options were forfeited as a
result of his resignation. On March 26, 1999, Mr. Chew held total stock
options for 23,333 shares.
(9) Represents a ten-year stock option for 25,000 shares, vesting one-third
per year over three years, at an exercise price of $4.7625 per share.
(10) Represents a ten-year stock option for 15,000 shares, vesting one-third
per year over three years, at an exercise price of $7.00 per share.
(11) All Other Compensation includes amounts contributed to the SPECTRASCIENCE
Savings and Retirement Plan, which qualifies as a 401(k) Plan under the
Internal Revenue Code of 1986, as amended.
Page 24
<PAGE>
OPTION GRANTS
The following table sets forth information concerning individual grants
of stock options under the Company's 1991 Stock Plan (the "1991 Plan") made to
each of the Named Executive Officers. No stock appreciation rights ("SARs") were
granted or exercised for the year ended December 31, 1998.
<TABLE>
<CAPTION>
OPTION GRANTS IN LAST FISCAL YEAR
Individual Grants
---------------------------------------------------- Potential Realizable
% of Total Value at Assumed
Number of Options Exercise Annual Rates of Stock
Securities Granted to or Base Price Appreciation for
Underlying Employees Price Option Term (9)
Options in Fiscal ($/Sh) Expiration ------------------------
Name Granted # Year (8) Date 5% 10%
---- --------- ---- --- ---- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
Chester E. Sievert, Jr. 45,000 (1) 9.0% $4.0833 01/23/2000 $398,121 $1,008,916
50,000 (2) 10.0% $4.4930 08/04/2000
50,000 (2) 10.0% $4.4930 08/04/2000
Brian T. McMahon (3) 100,000 (4) 20.1% $4.0833 05/28/2000 $626,796 $1,588,423
106,667 (5) 21.4% $5.5156 01/23/2000
Ching-Meng Chew (6) 37,500 (7) 7.5% $4.0833 01/23/2000 $ 96,299 $ 244,040
</TABLE>
(1) Represents a ten-year stock option for 45,000 shares granted pursuant to
the 1991 Plan. Six thousand shares vest immediately, with the remainder
vesting one-third per year over three years.
(2) Mr. Sievert was granted two ten-year options, each for 50,000 shares,
which will vest in their entirety upon the following milestones: (i)
50,000 shares upon the successful filing with the FDA of a pre-market
approval notification submission relating to the OBS, and (ii) 50,000
shares upon the written conditional approval by the FDA of the pre-market
approval application to market the OBS.
(3) Mr. McMahon died suddenly in December 1998. A total of 289,379 unvested
options were forfeited at the time of his death, including 80,000 of the
options listed herein. As of December 31, 1998, Mr. McMahon's estate held
total stock options for 406,353 shares, all of which will expire on or
before December 9, 2000.
(4) Represents a ten-year stock option for 100,000 shares, of which 20,000
shares vest immediately and the remainder vest one-third per year over
three years.
(5) Mr. McMahon previously held a fully-vested five-year stock option for
116,667 shares exercisable at $3.00 per share. A total of 10,000 shares
were exercised in May 1998, and the remainder expired unexercised in May
1998. Mr. McMahon was granted a ten-year option in May 1998 for 106,667
shares at $5.5156 per share, vesting immediately.
(6) Mr. Chew resigned from the Company as of July 31, 1998. A total of 71,387
options, including 32,500 of the options listed herein, were forfeited as
a result of his resignation. As of December 31, 1998, Mr. Chew held total
stock options for 23,333 shares.
(7) Represents a ten-year stock option for 37,500 shares, of which 5,000
shares vest immediately and the remainder vest one-third per year over
three years.
(8) The exercise price was determined based on the greater of (a) the
prevailing market price (defined as the closing price) of the Common Stock
on the date of grant or (b) the average of the closing prices of the
Common Stock for the ten trading days immediately prior to the date of
grant.
(9) Potential realizable value is net of the exercise price, but before taxes
associated with exercise. Potential realizable value is based on an
assumption that the market price of the stock appreciates at the stated
rate, compounded annually, from the date of grant until the end of the
ten-year option term, multiplied by the number of options granted. These
values are calculated based on regulations promulgated by the Securities
and Exchange Commission and do not reflect the Company's estimate of
future stock price appreciation. There can be no assurance that the actual
stock price appreciation over the ten-year option term will be at the
assumed 5% or 10% levels, or at any other defined level.
Page 25
<PAGE>
OPTION VALUES
The following table sets forth certain information concerning
individual exercises of stock options during the year ended December 31, 1998
and the value of unexercised stock options as of December 31, 1998 for each of
the Named Executive Officers.
<TABLE>
<CAPTION>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION/SAR VALUES
Number of Securities Value of unexercised
Shares Underlying In-the-Money
acquired Vaule Unexercised Options/SARs Options/SARs
on exercise realized at FY-end At FY-end (1)(2)
------------ ----------- ----------------------------- ---------------------------
Exercisable Unexercisable Exercisable Unexercisable
------------- -------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C>
Chester E. Sievert, Jr. (3) -- -- 29,745 217,334 $45,978 $383,474
Brian T. McMahon (4) 43,333 $129,999 406,353 -- $737,743 --
Ching-Meng Chew (5) 27,800 $109,463 23,333 -- $19,896 --
</TABLE>
- ---------------
(1) Upon the exercise of an option, the optionee must pay the exercise price
in cash or stock. Stock options are "in-the-money" if the closing bid
price for the Common Stock is greater than the exercise price of the stock
options. The closing bid price for the Common Stock on December 31, 1998
was $6.00 per share. The value of the options is calculated by taking the
difference between the exercise price and the closing bid price on
December 31, 1998, and multiplying this difference by the number of option
shares. When the exercise price was higher than the market value of the
Common Stock, the option was not "in-the-money."
(2) Does not include the number or value of unexercisable options granted
subsequent to December 31, 1998. No SARs were held by any of the Named
Executive Officers on December 31, 1998.
(3) "In-the-money" options include 27,666 shares which are exercisable and
217,334 shares which are unexercisable.
(4) "In-the-money" options include 373,020 which are exercisable and no shares
which are unexercisable.
(5) "In-the-money" options include 13,333 shares which are exercisable and no
shares which are unexercisable
COMPENSATION OF DIRECTORS
We pay each non-employee director $500 for each Board of Directors'
meeting and committee meeting attended and reimburse each such director for
reasonable travel and out-of-pocket expenses for attendance at these meetings.
Employee directors are not entitled to any compensation for attendance at Board
of Directors' and committee meetings.
Pursuant to the 1991 Plan, each non-employee director is entitled to
receive an option to purchase 10,000 shares of Common Stock when first elected
to the Board of Directors. Prior to October 1996, non-employee directors were
entitled to receive an initial option grant of 25,000 shares of Common Stock. In
addition, each non-employee director is entitled to receive an automatic grant
of options to purchase 5,000 shares of Common Stock upon re-election to the
Board for each year in which the 1991 Plan is in effect. The exercise price of
the option is based on the greater of the prevailing market price (defined as
the closing bid price) of the Common Stock on the date of grant, or the average
of the closing bid prices of the Common Stock for the ten trading days
immediately prior to the date of grant.
The options granted to non-employee directors under our 1991 Plan
expire ten years from the date of grant (subject to earlier termination in the
event of death), are not transferable
Page 26
<PAGE>
(except by will or the laws of descent and distribution), and become fully
exercisable one year after the date of grant.
EMPLOYMENT AGREEMENTS AND CHANGE-IN-CONTROL AGREEMENTS
The Company entered into a Severance Agreement with each of Messrs.
McMahon and Chew on November 26, 1996 and with Mr. Sievert on May 21, 1997,
providing for severance pay in the event of a "Change in Control" as defined in
each Severance Agreement. The Severance Agreements for Messrs. Chew and McMahon
are no longer in effect. Each Severance Agreement provides for severance pay if
their employment is terminated, either voluntarily or involuntarily, during the
three-year period following a Change in Control. The severance payment is to be
equal to full compensation for one year for Messrs. Sievert and Chew, and two
years for Mr. McMahon; and payment will be made in a lump sum upon termination.
In addition to the severance payment, each Severance Agreement provides for the
following benefits upon a Change in Control:
o 18 months of life, accident and health and dental insurance benefits
o 12 months of out-placement services
o complete coverage for fiduciary liability and directors' and
officers' insurance for a period of six years after a Change in
Control
o indemnification for any losses that might result from actions taken
in good faith before the "Date of Termination" as defined in the
Severance Agreement
o reimbursement for all legal fees and expenses incurred as a result
of termination, except to the extent such payment would constitute
an excess "parachute payment" within the meaning of Section 280G of
the Internal Revenue Code of 1986
o all benefits under the SPECTRASCIENCE Savings and Retirement Plan,
or any successor to such plan and any other plan or arrangement
relating to retirement benefits
o all benefits and rights under any and all of our stock purchase,
restricted stock grant and stock option plans or programs, or any
successor to any such plans or programs, which shall be in addition
to, and not reduced by, any other amounts payable under the
Severance Agreement
o immediate vesting of all outstanding but unvested options
If there had been a Change in Control for the fiscal year ended
December 31, 1998, and the employment of Mr. Sievert had been immediately
terminated, Mr. Sievert would have been entitled to receive, pursuant to the
terms of the Severance Agreement, a lump sum payment upon termination of
$162,000. Mr. Chew would have been entitled to a lump sum payment of $136,000
prior to his resignation in July 1998, and Mr. McMahon would have been entitled
to a lump sum payment of $396,989 prior to his death in December 1998.
All stock option agreements outstanding under the 1991 Plan provide for
the accelerated vesting of options immediately prior to a Change in Control,
except in certain cases where the optionee is terminated for "cause" or resigns
without "good reason."
Page 27
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT.
OWNERSHIP OF VOTING SECURITIES BY PRINCIPAL HOLDERS AND MANAGEMENT
The following table sets forth certain information regarding the
beneficial ownership of the Common Stock as of March 26, 1999, by each of our
directors, each Named Executive Officer, each person or entity known by us to
own beneficially more than five percent of the Common Stock, and all of our
directors and executive officers as a group.
<TABLE>
<CAPTION>
Percent of Class
Amount and Nature of Beneficially
Name and Address of Beneficial Owner Beneficial Ownership Owned (9)
- ------------------------------------------ ----------------------- -------------------
<S> <C> <C>
Perkins Capital Management, Inc. and
The Perkins Opportunity Fund (1) 594,087 11.2%
Reggeborgh Beheer BV (2) 559,000 10.4%
Nathaniel S. Thayer (3) 497,438 9.4%
Brian T. McMahon (4) 461,086 8.1%
Chester E. Sievert, Jr. (5) 54,412 1.0%
Ching-Meng Chew (6) 23,333 0.5%
Henry M. Holterman (7) 21,000 0.4%
Officers and Directors as a Group (8) 1,057,269 18.2%
</TABLE>
- -----------------
(1) Includes 394,087 shares owned by Perkins Capital Management, Inc. and
200,000 shares owned by The Perkins Opportunity Fund (collectively,
"Perkins"). The shares beneficially owned by Perkins Capital Mangement,
Inc. also include 35,000 shares issuable upon exercise of warrants
held by Perkins or their clients. The address of Perkins is 730 East
Lake Street, Wayzata, MN 55391-1769.
(2) Includes 434,000 shares held by Reggeborgh Beheer BV and 125,000 shares
issuable upon the exercise of warrants that are exercisable within 60
days of March 26, 1999. The address of Reggeborgh Beheer BV is Postbox
319, Industrieweg 12, 7460 AH Rijssen, The Netherlands.
(3) Includes (a) 454,238 shares owned by Mr. Thayer, (b) 43,000 shares
issuable upon exercise of options that are exercisable within 60 days
of March 26, 1999 and (c) 200 shares held in a joint account in which
Mr. Thayer has a 50% beneficial interest. Mr. Thayer, a non-employee
director of the Company, is a partner of the law firm of Blais
Cunningham & Crowe Chester, and his address is 150 Main Street, P.O.
Box 1325, Pawtucket, RI 02862.
(4) Includes (a) 54,733 shares owned by Mr. McMahon's estate, and (b)
406,353 shares issuable upon exercise of options that are exercisable
within 60 days of March 26, 1999. Mr. McMahon was Chairman of the Board
and Chief Executive Officer of the Company at the time of his death in
December 1998, and his address is 3650 Annapolis Lane, Suite 101,
Minneapolis, MN 55447-5434.
(5) Includes 54,412 shares issuable upon exercise of options that are
exercisable within 60 days of March 26, 1999. Excludes 150,000 shares
issuable upon exercise of options that will vest upon the successful
completion of various milestones related to the clinical studies on the
OBS, the filing of a PMA application with the FDA and final FDA product
approval. Mr. Sievert is the President and Chief Executive Officer of
the Company, and his address is 3650 Annapolis Lane, Suite 101,
Minneapolis, Minnesota 55447-5434.
(6) Includes 23,333 shares issuable upon exercise of options that are
exercisable within 60 days of March 26, 1999. Mr. Chew resigned from
his position with the Company in July 1998, and his address is 3650
Annapolis Lane, Suite 101, Minneapolis, Minnesota 55447-5434.
(7) Includes 21,000 shares issuable upon exercise of options that are
exercisable within 60 days of March 26, 1999. Mr. Holterman is a
non-employee director of the Company, and his address is the same as
the address of Reggeborgh Beheer BV (included in footnote (2) above),
where he is the Managing Director.
(8) Includes 509,171 shares owned by all directors and executive officers
(5 persons) and 548,098 shares issuable upon exercise of options held
by all directors and executive officers (5 persons) that are
exercisable within 60 days of March 26, 1999. Excludes 150,000 shares
issuable upon exercise of options held by Mr. Sievert upon the
successful completion of various milestones as described in footnote
(5) above.
(9) Based upon 4,737,804 share of common stock outstanding on December 31,
1998, as adjusted for the issuance of 87,668 shares issued upon the
exercise of warrants in January 1999, 2,500 shares issued upon the
exercise of
Page 28
<PAGE>
options in February 1999, and 433,748 shares issued in March 1999, in
connection with warrant exercises and a private placement.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
There were no material transactions between the Company and its
directors or executive officers for the fiscal year ended December 31, 1998.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
REPORTS ON FORM 8-K.
None.
EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-B:
Exhibit
Number Description
- ------ -----------
3.1 Articles of Incorporation, as amended. (Incorporated by reference to
the Company's Annual Report on Form 10-KSB, Exhibit 3.1, for the
year ended December 31, 1996.)
3.2 Bylaws, as amended. (Incorporated by reference to the Company's
Annual Report on Form 10-KSB, Exhibit 3.2, for the year ended
December 31, 1995.)
10.1 1991 Stock Plan adopted by the Company's Board of Directors on July
11, 1991 and shareholders on January 30, 1992. (Incorporated by
reference to the Company's Annual Report on Form 10-K, Exhibit
10.12, for the year ended December 31, 1991.)
10.2 Amendment to 1991 Stock Plan adopted by the Company's Board of
Directors on July 11, 1991 and shareholders on January 30, 1992.
(Incorporated by reference to the Company's Form 8-K Report filed
with the Securities and Exchange Commission on or about February 3,
1992.)
10.3 Amendment to 1991 Stock Plan adopted by the Company's shareholders
on June 28, 1995. (Incorporated by reference to the Company's
Registration Statement on Form S-8, Commission File No. 033-63047,
as filed on September 28, 1995.)
10.4 Amendment to 1991 Stock Plan adopted by the Company's Board of
Directors on October 4, 1995. (Incorporated by reference to the
Company's definitive Proxy Statement for its 1996 Annual Meeting of
Shareholders.)
10.5 Amendment to 1991 Stock Plan adopted by the Company's shareholders
on March 28, 1996. (Incorporated by reference to the Company's
Registration Statement on Form S-8, Commission File No. 333-4393, as
filed on May 23, 1996.)
10.6 Amendment to 1991 Stock Plan as it pertains to Section 5(k) of the
Plan regarding Directors options, adopted by the Company's Board of
Directors on October 9, 1996. (Incorporated by reference to the
Company's Annual Report on Form 10-KSB, Exhibit 10.10, for the year
ended December 31, 1996.)
10.7 Amendment to 1991 Stock Plan as it pertains to Section 3 of the
Plan, adopted by the Company's Board of Directors on March 9, 1998.
(Incorporated by reference to the Company's Annual Report of Form
10-K for the year ended December 31, 1997.)
10.8 Self-Insurance Trust Agreement between the Company and Richfield
Bank and Trust Co., as trustee dated March 5, 1987. (Incorporated by
reference to the Company's Annual Report on Form 10-K for the year
ended December 31, 1986.)
10.9 Form of Indemnification Agreement for all officers and directors.
(Incorporated by reference to the Company's Annual Report on Form
10-K for the year ended December 31, 1986.)
10.10 Employment Agreement and Severance Agreement between the Company and
Brian T. McMahon dated September 30, 1992. (Incorporated by
reference to the Company's Annual Report on Form 10-KSB, Exhibit
10.23, for the year ended December 31, 1993.)
Page 29
<PAGE>
10.11 Severance (Change in Control) Agreement between the Company and
Brian T. McMahon dated November 26, 1996. (Incorporated by reference
to the Company's Annual Report on Form 10-KSB, Exhibit 10.15, for
the year ended December 31, 1996.)
10.12 Severance (Change in Control) Agreement between the Company and
Ching-Meng Chew dated November 26, 1996. (Incorporated by reference
to the Company's Annual Report on Form 10-KSB, Exhibit 10.16, for
the year ended December 31, 1996.)
10.13 Severance (Change in Control) Agreement between the Company and
Chester E. Sievert, Jr. dated May 21, 1997. (Incorporated by
reference to the Company's Annual Report of Form 10-K for the year
ended December 31, 1997.)
10.14 Five-Year Lease Agreement between the Company and St. Paul
Properties, Inc. dated October 10, 1996 (Incorporated by reference
to the Company's Annual Report on Form 10-KSB, Exhibit 10.17, for
the year ended December 31, 1996.)
10.15 Clinical Research Agreement between The General Hospital
Corporation, doing business as Massachusetts General Hospital, and
the Company dated June 1, 1995. (Incorporated by reference to the
Company's Annual Report on Form 10-KSB, Exhibit 10.15, for the year
ended December 31, 1995.)
10.16 Bridge Loan Agreement, including form of Promissory Note and form of
Warrant by and between the Company and Qualified Lenders, dated
September 30, 1994. (Incorporated by reference to the Company's
Annual Report on Form 10-KSB, Exhibit 10.28, for the year ended
December 31, 1994.)
10.17 Form of Promissory Note that was issued in conjunction with the
Bridge Loan Agreement by and between the Company and Qualified
Lenders, dated September 30, 1994. (Incorporated by reference to the
Company's Annual Report on Form 10-KSB, Exhibit 10.28, page 45, for
the year ended December 31, 1994.)
10.18 Form of Promissory Note that was issued in conjunction with the
Bridge Loan Agreement by and between the Company and Qualified
Lenders, dated September 30, 1994. (Incorporated by reference to the
Company's Annual Report on Form 10-KSB, Exhibit 10.28, page 45, for
the year ended December 31, 1994.)
10.19 Form of Warrant. (Incorporated by reference to the Company's Annual
Report on Form 10-KSB, Exhibit 10.28, for the year ended December
31, 1994.)
10.20 List of Lenders in the Bridge Loans, and Investors in the Company's
Preferred Stock. (Incorporated by reference to the Company's Form
S-3 Registration Statement under The Securities Act of 1933 as filed
with the Securities and Exchange Commission and declared effective
on June 7, 1996, Commission File No. 333-1149.)
10.21 Form of Subscription Agreement that was used in conjunction with the
private placements of the Company's Preferred Stock. (Incorporated
by reference to the Company's Annual Report on Form 10-KSB, Exhibit
10.20, for the year ended December 31, 1995.)
10.22 Manufacturing and Sales Agreement, dated June 23, 1997, between
Portlyn Corporation and the Company. (Incorporated by reference to
Exhibit 10.28 to Amendment No. 1 to the Company's Registration
Statement on Form SB-2, dated October 7, 1998, Commission File No.
333-59395.)
23.1 Consent of Independent Auditors, filed herewith.
27 Financial Data Schedule, filed herewith.
99 Cautionary Statement Identifying Important Factors that Could Cause
the Company's Actual Results to Differ from Those Projected in
Forward-Looking Statements. (Incorporated by reference to the
Company's Quarterly Report on Form 10-QSB, Exhibit 99, for the
quarter ended March 31, 1998.)
Page 30
<PAGE>
SIGNATURES
Pursuant to the requirements of Sections 13 and 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
SPECTRASCIENCE, INC.
(Registrant)
Date: March 31, 1999 By: /S/ CHESTER E. SIEVERT, JR.
----------------------------
CHESTER E. SIEVERT, JR.
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Exchange Act of 1934,
as amended, this report has been signed below by the following persons on behalf
of the Registrant and in the capacities and on the dates indicated.
/S/ CHESTER E. SIEVERT, JR. March 31, 1999
- --------------------------------------------
Chester E. Sievert, Jr.
President and Chief Executive Officer
(Principal Executive Officer)
/S/ HENRY M. HOLTERMAN March 31, 1999
- ---------------------------
Henry Holterman
Director
/S/ NATHANIEL S. THAYER March 31, 1999
- ---------------------------
Nathaniel S. Thayer
Director
Page 31
<PAGE>
SPECTRASCIENCE, Inc.
Audited Financial Statements
Years ended December 31, 1998 and 1997
CONTENTS
Report of Independent Auditors...............................................F-1
Audited Financial Statements
Balance Sheets...............................................................F-2
Statements of Operations.....................................................F-3
Statement of Changes in Stockholders' Equity.................................F-4
Statements of Cash Flows.....................................................F-5
Notes to Financial Statements................................................F-6
Page F
<PAGE>
Report of Independent Auditors
Board of Directors
SpectraScience, Inc.
We have audited the accompanying balance sheets of SpectraScience, Inc. as of
December 31, 1998 and 1997, and the related statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of SpectraScience, Inc. at
December 31, 1998 and 1997, and the results of its operations and its cash flows
for each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles.
As discussed in Note 11 to the financial statements, the Company's deficit
accumulated since its inception during the development stage raises substantial
doubt about its ability to continue as a going concern. The Company intends to
obtain additional capital financing to permit it to continue its operations.
The financial statements do not include any adjustments that might result from
this uncertainty.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
February 5, 1999
Page F-1
<PAGE>
SPECTRASCIENCE, Inc.
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
-------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 301,970 $ 1,638,173
Inventory 185,625 180,474
Note receivable from related party 24,030 --
Prepaid expenses 50,638 57,935
Other current assets 10,585 40,484
-------------------------------
Total current assets 572,848 1,917,066
Fixed assets:
Office furniture and equipment 266,400 249,935
Machinery and equipment 562,919 560,201
-------------------------------
829,319 810,136
Less accumulated depreciation (581,788) (655,090)
-------------------------------
247,531 155,046
-------------------------------
Total assets $ 820,379 $ 2,072,112
===============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 236,769 $ 104,687
Note payable 45,217 36,122
Accrued compensation and taxes 99,263 100,690
Accrued expenses 56,990 61,019
Accrued clinical research fees 162,400 159,899
-------------------------------
Total current liabilities 600,639 462,417
Commitments
Stockholders' equity:
Common stock, $.25 par value:
Authorized shares--10,000,000
Issued and outstanding shares--4,737,804 in 1998
and 4,506,559 in 1997 1,184,451 1,126,640
Additional paid-in capital 45,586,659 44,620,283
Accumulated deficit (46,551,370) (44,137,228)
-------------------------------
Total stockholders' equity 219,740 1,609,695
-------------------------------
Total liabilities and stockholders' equity $ 820,379 $ 2,072,112
===============================
</TABLE>
SEE ACCOMPANYING NOTES.
Page F-2
<PAGE>
SPECTRASCIENCE, Inc.
Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------------------------
<S> <C> <C> <C>
EXPENSES
Research and development $ 1,719,171 $ 1,095,281 $ 998,137
Selling, general and administrative 746,953 679,809 723,825
-----------------------------------------------------------------
Net loss from operations (2,466,124) (1,775,090) (1,721,962)
OTHER (INCOME) EXPENSE
Interest and other (income) expense (51,982) (131,299) (176,043)
-----------------------------------------------------------------
Net loss $(2,414,142) $(1,643,791) $(1,545,919)
=================================================================
Net loss per share $(.52) $(.37) $(.47)
Weighted average common shares outstanding 4,663,559 4,467,233 3,276,193
</TABLE>
SEE ACCOMPANYING NOTES.
Page F-3
<PAGE>
SPECTRASCIENCE, Inc.
Statement of Changes in Stockholders' Equity
<TABLE>
<CAPTION>
SERIES A
CONVERTIBLE
COMMON STOCK PREFERRED STOCK
-----------------------------------------------------------
SHARES AMOUNT SHARES AMOUNT
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Balance December 31, 1995 2,933,348 $ 733,337 674,998 $ 674,998
Conversion of Series A preferred stock
into common shares 608,331 152,083 (608,331) (608,331)
Exercise of Series A preferred stock
detachable warrants into common shares 33,333 8,333 -- --
Exercise of stock options 46,200 11,550 -- --
Net loss -- -- -- --
-----------------------------------------------------------
Balance December 31, 1996 3,621,212 905,303 66,667 66,667
Conversion of Series A preferred stock
into common shares 66,667 16,667 (66,667) (66,667)
Conversion of Series B preferred stock
into common shares 792,500 198,125 -- --
Exercise of Series A preferred stock
detachable warrants into common stock 16,111 4,028 -- --
Exercise of stock options 10,069 2,517 -- --
Net loss -- -- -- --
-----------------------------------------------------------
Balance December 31, 1997 4,506,559 1,126,640 -- --
Exercise of Series A preferred stock
detachable warrants
into common stock 148,445 37,111 -- --
Exercise of stock options 82,800 20,700 -- --
Net loss -- -- -- --
-----------------------------------------------------------
Balance December 31, 1998 4,737,804 $1,184,451 -- $ --
===========================================================
</TABLE>
[WIDE TABLE CONTINUED FROM ABOVE]
<TABLE>
<CAPTION>
SERIES B
CONVERTIBLE
PREFERRED STOCK ADDITIONAL
--------------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance December 31, 1995 792,500 $ 792,500 $43,136,284 $(40,947,518) $ 4,389,601
Conversion of Series A preferred stock
into common shares -- -- 456,248 -- --
Exercise of Series A preferred stock
detachable warrants into common shares -- -- 158,332 -- 166,665
Exercise of stock options -- -- 136,075 -- 147,625
Net loss -- -- -- (1,545,919) (1,545,919)
--------------------------------------------------------------------------------
Balance December 31, 1996 792,500 792,500 43,886,939 (42,493,437) 3,157,972
Conversion of Series A preferred stock
into common shares -- -- 50,000 -- --
Conversion of Series B preferred stock
into common shares (792,500) (792,500) 594,375 -- --
Exercise of Series A preferred stock
detachable warrants into common stock -- -- 56,527 -- 60,555
Exercise of stock options -- -- 32,442 -- 34,959
Net loss -- -- -- (1,643,791) (1,643,791)
--------------------------------------------------------------------------------
Balance December 31, 1997 -- -- 44,620,283 (44,137,228) 1,609,695
Exercise of Series A preferred stock
detachable warrants
into common stock -- -- 705,114 -- 742,225
Exercise of stock options -- -- 261,262 -- 281,962
Net loss -- -- -- (2,414,142) (2,414,142)
--------------------------------------------------------------------------------
Balance December 31, 1998 -- $ -- $45,586,659 $(46,551,370) $ 219,740
===============================================================================
</TABLE>
SEE ACCOMPANYING NOTES
Page F-4
<PAGE>
SPECTRASCIENCE, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-----------------------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net loss $(2,414,142) $(1,643,791) $(1,545,919)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation 141,083 64,666 72,418
Gain on sale of fixed assets -- -- (387)
Changes in operating assets and liabilities:
Accounts receivable -- -- 100,641
Inventory (219,536) 11,677 (120,665)
Note receivable from related party (24,030) -- --
Prepaid expenses 7,297 10,470 (31,686)
Other current assets 29,899 (5,153) 8,147
Accounts payable and accrued expenses 138,222 69,800 137,953
-----------------------------------------------
Net cash used in operating activities (2,341,207) (1,492,331) (1,379,498)
INVESTING ACTIVITIES
Purchases of fixed assets (19,183) (12,192) (13,418)
Proceeds from sale of fixed assets -- -- 2,482
-----------------------------------------------
Net cash used in investing activities (19,183) (12,192) (10,936)
FINANCING ACTIVITIES
Proceeds from issuance of common stock 1,024,187 95,514 314,290
-----------------------------------------------
Net cash provided by financing activities 1,024,187 95,514 314,290
-----------------------------------------------
Net decrease in cash and cash equivalents (1,336,203) (1,409,009) (1,076,144)
Cash and cash equivalents at beginning of year 1,638,173 3,047,182 4,123,326
-----------------------------------------------
Cash and cash equivalents at end of year $ 301,970 $ 1,638,173 $ 3,047,182
===============================================
SUPPLEMENTAL SCHEDULE OF NONCASH TRANSACTIONS
Series A preferred stock converted into common stock $ -- $ 66,667 $ 608,331
Series B preferred stock converted into common stock -- 792,500 --
Transfer of inventory to equipment 214,385 -- 110,385
</TABLE>
SEE ACCOMPANYING NOTES.
Page F-5
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements
1. BUSINESS
The Company was incorporated on May 4, 1983 as GV Medical, Inc. and was engaged
in the development of laser angioplasty catheter systems. Subsequently, the
Company changed its name to SpectraScience, Inc. on October 16, 1992, which was
approved by the shareholders on May 13, 1993. The Company is now focused
primarily on developing and manufacturing innovative, minimally-invasive
spectroscopic systems to facilitate detection and differentiation among normal,
pre-cancerous and cancerous tissues by utilizing advanced spectroscopy, fiber
optics, and computer hardware and software.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH EQUIVALENTS
The Company considers highly liquid investments with a maturity of three months
or less when purchased to be cash equivalents.
FIXED ASSETS
Fixed assets are stated at cost. The Company depreciates the cost of the
property over its estimated useful life of five years using the straight-line
method.
LONG-LIVED ASSETS
Impairment losses are recorded on long-lived assets when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by the assets are less than the carrying amount of such assets.
INVENTORY
Inventories are stated at the lower of cost or market. Cost is determined on a
first-in, first-out basis.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from the estimates.
Page F-6
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
The Company follows Accounting Principles Board Opinion No. 25, ACCOUNTING FOR
STOCK ISSUED TO EMPLOYEES ("APB 25"), and related interpretations in accounting
for its stock options. Under APB 25, when the exercise price of stock options
equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION
("Statement 123"). The Company adopted the disclosure only provisions of
Statement 123. Accordingly, the Company has made pro forma disclosures of what
net loss and loss per share would have been had the provisions of Statement 123
been applied to the Company's stock options.
INCOME TAXES
The Company accounts for income taxes under the liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to temporary differences between the financial statement carrying
amount of assets and liabilities and their respective tax bases.
NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
EARNINGS PER SHARE (Statement 128). Statement 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share. Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants, and convertible securities. Diluted
earnings per share is very similar to fully diluted earnings per share under the
previous rules. All earnings per share amounts for all periods have been
presented and, where necessary, restated to conform to the Statement 128
requirements. Diluted earnings per share is not presented separately as the
effect of outstanding options and warrants is antidilutive.
RECLASSIFICATIONS
Certain amounts presented in the 1997 financial statements have been
reclassified to conform with the 1998 presentation.
3. INVENTORY
Page F-7
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
Inventory consists of the following:
DECEMBER 31
1998 1997
------------------------------------------
Raw materials $176,625 $ 17,560
Finished goods 9,000 162,914
==========================================
$185,625 $180,474
==========================================
During 1998, the Company wrote down a significant amount of older finished goods
inventories. This resulted from the Company's shift in product development to
the Optical Biopsy System, of which its 1998 raw materials are composed.
4. CAPITAL STOCK AND WARRANTS
During 1994, the Company granted warrants to the participants in the bridge
financing agreements it had entered into, to purchase 100,000 shares of the
Company's common stock at $3.00 per share. The warrants are exercisable for five
years from the date of the grant.
During 1995, the Company, in connection with additional bridge financing,
granted warrants to the participants to purchase 74,998 shares of the Company's
common stock at $3.00 per share. The warrants are exercisable for five years
from the date of grant.
From March 1995 to June 1995, the Company sold 500,000 shares of convertible
preferred stock, Series A at $3.00 per share in a private placement for
$1,500,000 less related costs of $60,000. Upon completion of the sale of Series
A convertible preferred stock, bridge loans of $525,000 were converted into
174,998 shares of Series A convertible preferred stock at a price of $3.00 per
share. In addition, the Company issued warrants to the investors to purchase
58,335 shares of the Company's common stock at $5.00 per share. The warrants are
exercisable for three years from the date of grant. In March 1996, the
nondividend yielding shares of Series A convertible preferred stock were
converted into an equivalent number of shares of common stock. Holders of the
shares of the Series A convertible preferred stock also received warrants to
purchase 166,665 shares of the Company's common stock at $5.00 per share. The
warrants are exercisable for three years from date of grant. During 1996, Series
A preferred stock detachable warrants to purchase 33,333 shares of common stock
were exercised at $5.00 per share. In addition, the Company issued warrants to
the placement agent to purchase 20,000 shares of the Company's common stock at
$3.00 per share. The warrants are exercisable for five
4. CAPITAL STOCK AND WARRANTS (CONTINUED)
Page F-8
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
years from the date of grant. The Company issued additional warrants to the
underwriter to purchase 6,667 shares of the Company's common stock at $5.00 per
share. The warrants are exercisable for three years from the date of grant.
During 1997, Series A convertible preferred stock detachable warrants to
purchase 6,111 and 10,000 shares of common stock were exercised at $5.00 and
$3.00, respectively. In 1998, Series A convertible preferred stock detachable
warrants to purchase 148,445 shares of common stock were exercised at $5.00 per
share.
In December 1995, the Company sold 792,500 shares of convertible preferred
stock, Series B at $5.00 per share in a private placement for $3,962,500 less
related costs of $435,875. Holders of shares of the Series B convertible
preferred stock also received warrants to purchase 264,175 shares of the Series
B Company's common stock at $9.50 per share. The warrants are exercisable for
three years from the date of grant. In addition, the Company issued warrants to
the placement agent to purchase 79,250 shares of the Company's common stock at
$5.00 per share. The warrants are exercisable for five years from the date of
grant. The Company issued additional warrants to the placement agent to purchase
26,418 shares of the Company's common stock at $9.50 per share, conditional upon
exercise of the previous warrant issued to the placement agent. The warrants are
exercisable for five years from the date of grant.
In January 1997, the Company converted all of its outstanding Series A and
Series B preferred stock into an equivalent number of shares of issued and
outstanding common stock.
In January 1999, several Series B preferred stock detachable warrants were
exercised to purchase 87,668 shares of common stock at $6.00 per share. This
resulted in net proceeds to the Company of $485,407.
5. STOCK OPTIONS
The Company has one stock option plan, the 1991 Stock Plan, under which selected
employees and non-employees may be granted incentive and non-qualified options
to purchase common stock of the Company. The options granted are exercisable
over a period of no longer than ten years and are granted at 100% of the fair
market value of the common stock as of the date of grant.
5. STOCK OPTIONS (CONTINUED)
Page F-9
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
The following table summarizes the stock option activity for the plan:
<TABLE>
<CAPTION>
STOCK OPTIONS WEIGHTED AVERAGE
SHARES OUTSTANDING UNDER EXERCISE
AVAILABLE FOR GRANT THE PLAN PRICE PER SHARE
-----------------------------------------------------------------
<S> <C> <C> <C>
Balance December 31, 1995 59,928 762,272 $3.37
Amendment to plan 500,000 --
Options exercised -- (46,200) 3.20
Options forfeited 35,493 (35,493) 5.00
Options granted (145,000) 145,000 6.73
-----------------------------------------
Balance December 31, 1996 450,421 825,579 3.95
Options granted (461,065) 461,065 4.07
Options exercised -- (10,069) 3.47
Options canceled 249,931 (249,931) 3.13
-----------------------------------------
Balance December 31, 1997 239,287 1,026,644 4.19
Amendment to Plan 140,000 -- --
Options granted (508,167) 508,167 4.53
Options exercised -- (82,800) 3.41
Options canceled 499,580 (499,580) 3.94
-----------------------------------------
Balance December 31, 1998 370,700 952,431 $4.54
=========================================
</TABLE>
The weighted average fair value of options granted in 1998 and 1997 was $3.79
and $2.84, respectively. The exercise price of options outstanding at December
31, 1998 ranged from $3.00 to $11.25 per share, as summarized in the following
table:
<TABLE>
<CAPTION>
SHARES OUTSTANDING SHARES EXERCISABLE
---------------------------------------------- ------------------------------------
WEIGHTED WEIGHTED WEIGHTED
SHARES AVERAGE AVERAGE AVERAGE
OUTSTANDING AT REMAINING EXERCISE NUMBER OF EXERCISE
RANGE OF DECEMBER 31, CONTRACTUAL PRICE PER SHARES PRICE
EXERCISE PRICE 1998 LIFE SHARE EXERCISABLE PER SHARE
<S> <C> <C> <C> <C> <C>
$3.00 to $5.00 712,186 7.7 years $ 3.91 405,685 $ 3.67
5.01 to 8.00 212,745 9.1 years 6.01 191,411 6.65
8.01 to 11.25 27,500 3.8 years 10.35 27,500 10.35
--------- --- ------- --------- -------
Total 952,431 7.9 years $ 4.54 624,596 $ 4.88
========= === ======= ========= =======
</TABLE>
5. STOCK OPTIONS (CONTINUED)
Page F-10
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
The Company has elected to follow Accounting Principles Board Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES ("APB 25") and related Interpretations
in accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
ACCOUNTING FOR STOCK-BASED COMPENSATION ("Statement 123"), requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of Statement 123. The fair
value for these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for 1998 and 1997, respectively: risk-free interest rates ranging
from 5.38% to 6.30%; volatility factor of the expected market price of the
Company's common stock of .851 and a weighted-average expected life of the
option of five to seven years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which vest by one-third each year from the date of
the grant and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions. Because the Company's
employee stock options have characteristics significantly different from those
of traded options, and because changes in the subjective input assumptions can
materially affect the fair value estimate, in management's opinion, the existing
models do not necessarily provide a reliable single measure of the fair value of
its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information is as follows:
1998 1997 1996
---------------------------------------------
Pro forma net loss $(3,079,739) $(2,258,579) $(1,846,282)
Pro forma net loss per share $(.66) $(.51) $(.56)
These pro forma amounts may not be indicative of future years' amounts since the
Statement provides for a phase-in of option values beginning with those
granted in 1995.
6. COMMITMENTS
Page F-11
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
The Company moved to a new location in Minneapolis during 1996 and entered into
a new building lease agreement that has a term extending through October 2001.
This lease requires annual base rent of approximately $53,000 plus a sharing of
certain expenses. Various other equipment operating leases were also entered
into during 1996 expiring during future years.
Future lease commitments are as follows:
1999 $ 62,000
2000 58,000
2001 49,000
Thereafter --
---------------
Total $169,000
===============
The Company incurred total lease and rental expenses of $74,000, $67,000 and
$45,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The Company has a license agreement with Massachusetts Institute of Technology
(MIT) for the use of certain patents. Under terms of the agreement, the Company
has agreed to pay $50,000 a year through October 2003 and $30,000 a year
thereafter until the expiration of the patent rights. The agreement can be
terminated by MIT if the monthly payments are not made within thirty days.
7. ACCRUED CLINICAL RESEARCH FEES
The Company is conducting ongoing multi-center clinical studies using the
Optical Biopsy(TM) System (OBS) in an attempt to show that the OBS is a
minimally-invasive diagnostic tool used to detect and differentiate among
normal, pre-cancerous and cancerous tissues without physically removing tissue
from the body. During 1995-1998, the Company entered into various clinical
testing agreements with domestic hospitals to conduct research using the OBS
system. Under the terms of these one-year agreements the Company had a maximum
commitment of $374,000 for clinical research testing related project costs as of
December 31, 1998. Some of these costs have already been paid by the Company and
will continue to be paid as testing continues in 1999. As of December 31, 1998
and 1997, the Company had accrued for $162,400 and $159,899 of these clinical
research fees, respectively.
8. INCOME TAXES
Page F-12
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
The tax effect of the Company's deferred tax assets is as follows:
DECEMBER 31
1998 1997
-----------------------------------------
Net operating loss carryforward $ 16,761,000 $ 15,955,000
Accrued liabilities 106,000 101,000
Inventory reserve -- 39,000
Tax credits 872,000 788,000
-----------------------------------------
17,739,000 16,883,000
Valuation allowance (17,739,000) (16,883,000)
-----------------------------------------
$ -- $ --
=========================================
At December 31, 1998, the Company had net operating loss carryforwards of
approximately $46,557,000 that expire at various times through the year 2013. In
addition, the Company has research and development tax credits that expire at
various times through 2013. As a result of previous stock transactions, the
Company is limited as to the amount of net operating loss and tax credit
carryforwards which may be utilized in any one year. The annual limitation is
approximately $1,000,000.
9. EMPLOYEE BENEFIT PLAN
The Company has a 401(k) profit sharing and savings plan covering substantially
all employees. The plan allows employees to defer up to 15% of their annual
earnings. The Company will match 50% of the first 6% of the employee
contributions. The contributions by the Company totaled approximately $21,000,
$17,000 and $5,000 for 1998, 1997 and 1996, respectively.
10. NOTE RECEIVABLE FROM RELATED PARTY
In May 1998, the Company loaned its prior Chief Executive Officer, Brian
McMahon, $24,030 through a promissory note agreement. Due to the untimely death
of Mr. McMahon, the Company expects reimbursement of the loan from Mr. McMahon's
estate when it is finalized.
11. GOING CONCERN
Page F-13
<PAGE>
SPECTRASCIENCE, Inc.
Notes to Financial Statements (continued)
Net losses since the Company's inception have resulted in an accumulated deficit
balance of $46,551,370 at December 31, 1998. The Company's ability to continue
as a going concern and the realization of its assets and orderly satisfaction of
its liabilities are dependent on obtaining additional funds from outside sources
and generating sufficient working capital for operations. The Company is
currently exploring a proposed Bridge Loan Agreement and a Private Placement
Offering of common stock. This financing is anticipated to be completed by the
end of the first quarter 1999. The Company believes that if successful either
event will satisfy its cash requirements for at least the next twelve months.
However, there can be no assurance that the Company will be successful in
completing a financing transaction.
Page F-14
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
- ------- -----------
23.1 Consent of Independent Auditors, filed herewith.
27 Financial Data Schedule, filed herewith.
Page A
Exhibit 23.1
Consent of Ernst & Young LLP
We consent to the incorporation by reference in the Registration Statements
(Form SB-2 No. 333-59395) pertaining to 2,875,000 shares of common stock, (Form
S-3 No. 333-1149) pertaining to 2,264,006 shares of common stock issuable upon
conversion of preferred stock and exercise of warrants, (Form S-3 No. 33-57116)
pertaining to 1,083,333 shares of common stock and 50,000 shares of common stock
issuable upon exercise of warrants, (Form S-8 No.33-45536) pertaining to
1,810,000 shares of common stock, (Form S-8 No. 33-63047) pertaining to the 1991
Stock Option Plan, (Form S-8 Nos.33-45523 and 333-49919) pertaining to the 1991
Stock Plan, (Form S-8 No. 33-36385) pertaining to the 1990 Restricted Stock
Plan, (Form S-8 No. 33-22052) pertaining to the 1988 Employee Incentive Stock
Plan and (Form S-8 No. 2-93693-C) pertaining to the 1983 Employee Stock Option
Plan of GV Medical, Inc., of our report dated February 5, 1999 with respect to
the financial statements of SpectraScience, Inc., included in this Annual Report
(Form 10-KSB) for the year ended December 31, 1998.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
March 29, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS SUBMITTED IN THIS QUARTERLY REPORT ON FORM 10-KSB FOR THE
YEAR ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 301,970
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 185,625
<CURRENT-ASSETS> 572,848
<PP&E> 829,319
<DEPRECIATION> 581,788
<TOTAL-ASSETS> 820,379
<CURRENT-LIABILITIES> 600,639
<BONDS> 0
1,184,451
0
<COMMON> 0
<OTHER-SE> (964,711)
<TOTAL-LIABILITY-AND-EQUITY> 820,379
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 2,466,124
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (51,982)
<INCOME-PRETAX> (2,414,142)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,414,142)
<EPS-PRIMARY> (0.52)
<EPS-DILUTED> 0
</TABLE>
