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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 1O-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OF 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number: 0-21284
SALIVA DIAGNOSTIC SYSTEMS, INC.
(Name of small business issuer in its charter)
DELAWARE 91-1549305
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
11719 NE 95TH STREET
VANCOUVER, WA 98682
(Address of principal executive offices and zip code)
(360) 696-4800
(Issuer's telephone number, including area code)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: NONE
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT: COMMON STOCK, PAR
VALUE $.01 PER
SHARE
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 disclosure of delinquent filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure will be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-KSB or any amendment to
this Form 10-KSB. / /
Issuer's revenues for its most recent fiscal year were $907,957.
The aggregate market value of voting stock held by non-affiliates of the
Registrant at April 15, 1999 was $2,404,647 computed by reference to the last
traded sale price as reported on the OTC Bulletin Board on such date.
The number of shares outstanding of the Registrant's common stock as of April
15, 1999 was 8,113,544 shares.
Transitional Small Business Disclosure Format (check one): Yes / / No /X/
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SALIVA DIAGNOSTIC SYSTEMS, INC.
FORM 10-KSB INDEX
<TABLE>
<CAPTION>
PAGE
PART I
<S> <C> <C>
Item 1 Description of Business 2
Item 2 Description of Property 10
Item 3 Legal Proceedings 10
Item 4 Submission of Matters to a Vote of Security Holders 11
PART II
Item 5 Market for Common Equity and Related Stockholder Matters 11
Item 6 Management's Discussion and Analysis or Plan of Operation 13
Item 7 Financial Statements 20
Item 8 Changes in and Disagreements with Accountants on Accounting 20
and Financial Disclosure
PART III
Item 9 Directors, Executive Officers, Promoters and Control Persons; Compliance 21
With Section 16(a) of the Exchange Act
Item 10 Executive Compensation 23
Item 11 Security Ownership of Certain Beneficial Owners and Management 25
Item 12 Certain Relationships and Related Transactions 26
Item 13 Exhibits and Reports on Form 8-K 27
</TABLE>
1
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Saliva Diagnostic Systems, Inc., a Delaware corporation (the "Company"), is
primarily engaged in the development, manufacturing and marketing of rapid
in-vitro assays for use in the detection of infectious diseases and other
conditions, and medical collection devices.
The Company was incorporated in California in 1986 as E&J Systems, Inc. In
January 1992, the Company merged with and into a Delaware corporation and
changed its name to Saliva Diagnostic Systems, Inc. The Company completed an
initial public offering of its common stock in March 1993. In 1994, the
Company's 90% owned subsidiary, Saliva Diagnostic Systems (Asia) Ltd. ("SDS
Asia"), formed Saliva Diagnostic Systems (Singapore) Pte. ("SDS Singapore"). In
1995, the Company purchased the minority interest (10%) in SDS Asia and the
outstanding minority interest (19%) in SDS Singapore. As a result, SDS Asia and
SDS Singapore became wholly owned subsidiaries of the Company. In October 1997,
the Company closed its Singapore facilities and ceased operations of SDS
Singapore. The Company intends to complete the statutory liquidation of SDS
Singapore in 1999. In 1995, a director of the Company agreed to hold the
minority interest (10%) in Saliva Diagnostic Systems, UK, Ltd. in trust for the
benefit of the Company and, as a result this entity became a wholly owned
subsidiary of the Company and was renamed SDS International, Ltd. Unless
otherwise indicated, all references to the Company include the Company and its
wholly owned subsidiaries. The Company's principal executive offices are located
at 11719 NE 95th Street, Vancouver, Washington, 98682.
The Company's capital requirements have been, and will continue to be,
significant. The Company has been dependent on private placements of its debt
and equity securities to fund its capital requirements. In the second fiscal
quarter of 1999, the Company expects to receive $470,000 (net of issuance costs
of $30,000) from the sale of 500 shares of its Series 1998-B Convertible
Preferred Stock. The Company believes that its current cash position and these
expected proceeds, combined with revenues and other cash receipts, will be
insufficient to fund the Company's operations through 1999. Substantial
additional financing will be required in 1999. The Company is dependent upon its
efforts to raise capital to finance the cost of development, manufacturing and
marketing of its products, to conduct clinical trials and submissions for FDA
approval of its products and to design and develop new products. Development,
marketing, manufacturing and clinical testing may require capital resources
substantially greater than the resources which will be available to the Company.
The Company has incurred significant operating losses since its inception,
resulting in an accumulated deficit of $34,508,780 at December 31, 1998. Such
losses are expected to continue for the foreseeable future and until such time,
if ever, as the Company is able to attain sales levels sufficient to support its
operations. The Company's independent certified public accountants have included
an explanatory paragraph in their reports stating that the Company's significant
operating losses and significant capital requirements raise substantial doubt
about the Company's ability to continue as a going concern. There can be no
assurance that the Company will be able to obtain the additional capital
resources necessary to continue its business, or that such financing will be
available on commercially reasonable terms or at all. SEE NOTE 2 OF NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS. SEE ITEM 3 - LEGAL PROCEEDINGS.
Effective with the close of business on March 10, 1998, the Company's securities
were delisted from The Nasdaq SmallCap Market for failure to meet the new Nasdaq
continued listing requirements. As a result of the Nasdaq delisting, an investor
may find it difficult to dispose of, or to obtain accurate quotations as to the
price of, the Company's securities. SEE ITEM 5 - MARKET FOR COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS.
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PRODUCTS
To date, the Company has developed three rapid HIV tests, Sero-Strip HIV,
Hema-Strip HIV and Saliva-Strip HIV, and one H.pylori rapid test, Stat-Simple
H.pylori. The Company has commenced production and marketing of two medical
specimen collectors in the U.S., Saliva-Sampler(R) and Omni-Swab, and one
medical specimen collector in the United Kingdom, Omni-SAL(R).
RAPID IMMUNOASSAYS. The Company has developed four rapid tests utilizing
immunochromatography for the detection of antibodies to selected pathogens,
including HIV (the Human Immunodeficiency Virus), the virus that causes AIDS,
and H.pylori (Helicobacter pylori), a bacterium linked to peptic ulcers and
gastric cancer. The Company's rapid tests are designed to require only a few
simple steps and minutes to use. The tests produce visual results in 15
minutes or less and may be used without special equipment, storage or
training. The Company's data and independent evaluations demonstrate that its
tests are generally equivalent in performance to widely used FDA-licensed
tests for HIV and H.pylori.
The Company's rapid tests utilize a capillary flow assay in which all reagents
are provided on solid phases in a dried format (test strip). A buffer solution
is introduced after sample collection. The resulting mixture of sample and
buffer migrate along the test strip by capillary action, reconstituting a dye
conjugate. A red control line will develop at a designated point on the upper
portion of the strip if the assay has been performed properly and if all
reagents are functionally active. The conjugate binds in the presence of
antibodies to a pre-applied antigen to form a second red line (positive) at a
designated point on the lower portion of the strip. In the absence of specific
antibodies, a second line does not develop.
Stat-Simple H.pylori ("Stat-Simple") is the Company's rapid assay for
H.pylori antibody detection. The device is based on the Company's
patent-pending whole blood sampling technology and licensed test components.
The test uses a minute sample of whole blood from a "finger-stick" for
analysis. Results are available at point-of-care without the need for
sophisticated equipment. The Stat-Simple technology is identical to that of
Hema-Strip HIV, as described below. Stat-Simple was recently cleared for
diagnostic use in humans in the U.S. by the FDA. SEE "REGULATION - FOOD AND
DRUG ADMINISTRATION" BELOW.
Sero-Strip HIV ("Sero-Strip") analyzes a small amount of serum or plasma to
detect HIV antibodies. Sero-Strip is packaged as a multiple-use kit designed for
professional health care settings where many patients are tested and specimens
may be stored. The test kit may be stored without refrigeration for up to 18
months after the date of manufacture.
Hema-Strip HIV ("Hema-Strip") is a single use test kit that collects, processes
and analyzes a minute amount of whole blood to detect HIV antibodies. Sample
collection requires only a few seconds. The whole blood sampling technology used
in Hema-Strip is identical to that utilized in Sero-Strip; however, an added
filter traps red blood cells from the whole blood sample permitting the
migration of serum to flow onto the strip and negating the need for the user to
separate serum from the whole blood sample. The test kit may be stored without
refrigeration for up to 18 months after the date of manufacture.
Saliva-Strip HIV ("Saliva-Strip") collects, processes and analyzes saliva to
detect HIV antibodies. The test is currently designed for single use,
incorporates the Saliva-Sampler(R) or Omni-SAL(R) device, and is based on the
Company's proprietary saliva collection technology. The Company believes
Saliva-Strip's temperature stability is similar to that of Sero-Strip and
Hema-Strip. The Company has commenced trial marketing of Saliva-Strip outside
the U.S. This test has an accuracy which is slightly less than the Company's
whole blood sampling tests. The Company believes that the performance
characteristics of Saliva-Strip will allow it to be used in situations where the
collection of blood is not practical or feasible.
MEDICAL SPECIMEN COLLECTION DEVICES. The Company has commenced production and
marketing of two medical specimen collectors: Omni-SAL(R) (known as
Saliva-Sampler(R) in the U.S.) and Omni-Swab. SEE "--MARKETING, SALES AND
DISTRIBUTION."
3
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Omni-SAL(R) is a patented saliva collection device currently sold to several
commercial companies for use with their laboratory assays for the detection of
HIV infection, drugs-of-abuse and cigarette smoking. It has also been used in
research to collect saliva samples for studies of other infectious diseases. The
Company is marketing the device in the U.S. under the name Saliva-Sampler(R).
Omni-Swab is a sample collection device comprised of a serrated cotton swab with
an ejectable head. It is used to collect various body fluids and cells,
primarily for the purpose of DNA identification.
The specimens traditionally used for human diagnostic testing and
quantitative measurement of most physiologically active substances, drugs and
toxins in the body, are blood and urine. Substantially all of the assay-based
diagnostic test kits currently available on the market were approved by the
FDA for use with these testing specimens. Political and social factors may
create impediments to the use of saliva as a specimen or of rapid tests as
diagnostic tools. These factors include whether certain diagnostic tests,
such as HIV antibody tests, should be conducted by other than trained
specialists and whether rapid tests in nontraditional testing environments
will lead to invasion of privacy. Limitations on the Company's ability to
market rapid tests caused by political and social factors could have a
material adverse effect on the Company's operations.
PRODUCT DEVELOPMENT
The Company has conducted preliminary research that indicates its rapid
whole-blood test format may be expanded to detect diseases other than HIV and
H. pylori. The Company has conducted research on hepatitis A and
schistosmiasis, and is currently evaluating materials for use in a test for
tuberculosis. The Company is currently co-developing with a U.S. diagnostics
manufacturer a rapid immunoassay to detect antibodies to hepatitis C for use
with the Company's patent-pending whole-blood sampling technology. The
Company is also co-developing with an overseas diagnostics developer a
malaria test for use with this whole-blood technology. The Company is
currently evaluating an option to purchase and resell a urine-based
drugs-of-abuse test manufactured by another company, which the Company would
have the rights to distribute under its private label on a worldwide basis.
The Company expended approximately $442,000 and $665,000 in research and
development costs, respectively, in fiscal years 1998 and 1997. SEE NOTE 1 OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
Limited revenues have been generated from sales of the Company's rapid tests.
The Company will be required to devote considerable additional efforts and
obtain substantial additional financing to further develop and finalize its
products. Satisfactory completion of development, testing and evaluations,
obtaining approvals of regulatory authorities and achieving sufficient
production levels of such products will be required prior to their being
available for commercial sale. The Company's products remain subject to all the
risks inherent in the introduction of new diagnostic products, including
unanticipated problems. The Company may not have sufficient funds to continue
design and development, which could result in abandonment of or substantial
change in the design or development of such products. There can be no assurance
that the Company's products will be successfully developed, be developed on a
timely basis or prove to be as effective as products based on existing or newly
developed technologies. The inability to successfully complete development, or a
determination by the Company, for financial or other reasons, not to undertake
to complete development of any product, particularly in instances in which the
Company has made significant capital expenditures, will have a material adverse
effect on the Company.
MARKETING, SALES AND DISTRIBUTION
The Company is currently marketing its medical specimen collection devices
(Omni-SAL(R), Saliva-Sampler(R) and Omni-Swab) both in the U.S. and overseas.
The Company is currently marketing two of its three HIV rapid tests (Sero-Strip
HIV and Hema-Strip HIV) outside the U.S. The Company's HIV rapid tests and
Omni-SAL(R) are not yet approved for marketing in the U.S. Prior to marketing
and distribution of its
4
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rapid tests in the U.S., the Company must obtain premarket approvals ("PMAs")
from the FDA in order to complete a major clinical trial. Financing such a trial
will require significant cash reserves or strategic alliances, which may not be
obtained on favorable terms or at all.
The Company has directed its initial primary marketing and distribution efforts
for its HIV-related products to international markets. SEE "MANUFACTURING AND
SUPPLY" AND "REGULATION--DOMESTIC REGULATION" below.
In November 1997, the Company signed two agreements with BioChem ImmunoSystems,
Inc. ("BioChem"), a division of BioChem Pharma, Inc., a Montreal-based
pharmaceutical and diagnostics company, for international distribution of the
Company's HIV rapid tests. Under the terms of the agreements, which expire by
their terms in November 2000, the Company licensed Biochem's patented peptides
for HIV detection for use in its rapid test kits. In return, BioChem will
distribute the Company's rapid HIV tests for international sales under its own
private label. The agreements provide for sharing clinical trials costs in
countries where BioChem intends to market or sell the products and independent
clinical trials are required. The Canadian Health Protection Board has approved
the companies' joint application to conduct clinical trials in Canada for the
Company's HIV rapid tests. These clinical trials, for which the Company will
bear two-thirds of the costs, began in late 1998.
In March 1994, the Company granted a non-exclusive, worldwide license to
Orgenics, Ltd., an Israeli corporation ("Orgenics"), pursuant to which Orgenics
may make or have made diagnostic products incorporating the Company's
Omni-SAL(R) technology, and may use, sell, or license such products worldwide.
The license agreement expires on the later of January 31, 2111 or the date on
which any patents for the Omni-SAL(R) technology expire. Under the license,
Orgenics pays royalties on sales of Orgenics' products incorporating the
Company's Omni-SAL(R) technology. In the event the Company ceases production of
Omni-SAL(R), Orgenics has the option to purchase injection molds and equipment
from the Company to produce Omni-SAL(R) subject to payment of royalties to the
Company on sales of Omni-SAL(R) products produced and sold by Orgenics. To date,
no significant royalties form Orgenics have been recorded.
In September 1998, the Company terminated a distribution agreement with Fremont
Novo Sciences. LLC ("Fremont"). This agreement allowed Fremont to manufacture
and distribute the Company's rapid tests in India, subject to oversight by the
Company. The Company terminated this agreement for nonperformance by Fremont. In
February 1999, Fremont filed a demand for arbitration with respect to
termination of the agreement. SEE "ITEM 3 - LEGAL PROCEEDINGS."
In January 1999, the Company entered into an agreement with Cadila Healthcare,
Ltd. ("Cadila") a subsidiary of Zydus Pathline, based in Ahmedabad, India.
Pursuant to the agreement, Cadila has agreed to purchase certain minimum
quantities of the Company's rapid tests at a fixed price in exchange for
exclusive distribution rights in India, Nepal, Bangladesh and Sri Lanka.
The Company has submitted its HIV rapid tests to the World Health Organization
of the United Nations ("WHO") for evaluation. Some smaller countries without
regulatory agencies of their own rely on results of WHO evaluations as part of
their approval of products for use and sale in their countries. In April 1997,
WHO notified the Company that Sero-Strip was found to conform with its
requirements. Accordingly, WHO agreed to include the Company's Sero-Strip among
the approved products for WHO bulk purchases during the years ending February
28, 1998 and 1999. To date, no significant sales have been recorded related to
WHO. WHO has also agreed to evaluate Hema-Strip during 1999.
Sales to two customers accounted for 42% of total product sales in 1998. Sales
to one customer accounted for approximately 17% of total product sales in 1997.
The loss of sales to any of the Company's major customers could have a material
adverse effect on the Company's business, financial condition and results of
operations. SEE NOTE 1 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
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The Company has limited marketing, sales and distribution resources. Achieving
market acceptance will require substantial efforts and capabilities in these
areas. The Company relies in large part on forming partnerships for marketing,
sales and distribution of its products. There can be no assurance that the
Company will form alliances with potential distributors, that such alliances
will be on terms favorable to the Company or that such distributors will be
successful in promoting the Company's products.
MANUFACTURING AND SUPPLY
The Company outsources most of its product manufacturing and supply to third
parties. The Company's saliva collection device is distributed to the overseas
market under the trade name Omni-SAL(R). Omni-SAL(R) is packaged at Wesley Coe,
Ltd. in the U.K. from components provided by the Company through its U.S.-based
contractors. Saliva-Sampler(R), the U.S. version of Omni-SAL(R), is manufactured
at MML Diagnostic Packaging, Inc. in the U.S. Omni-Swab is manufactured by MML
for distribution in the U.S. and overseas. There can be no assurance that Wesley
Coe Ltd. or MML will be able to meet the Company's requirements or will continue
to manufacture the Company's products on acceptable terms.
The Company owns injection molding tools for production of parts related to
Omni-SAL(R) and Saliva-Sampler(R) and its rapid test products. These tools are
located at the facilities of outsource injection molders in Arizona, New Jersey,
and Singapore. The Company has entered into an agreement with MedTech, Inc., a
New Jersey medical products injection molder and assembler, for integrated
production of Omni-SAL(R) and Saliva-Sampler(R). The Company expects to reduce
costs of production by centralizing injection molding, assembly and packaging of
its products at a single location. There can be no assurance that reduced costs
will result from the current or any future arrangement with MedTech, or that
MedTech will meet the Company's requirements.
Manufacturers located in the U.S. or manufacturing products to be sold in the
U.S. must comply with the FDA's good manufacturing practices regulations ("GMP")
and pass pre-approval and periodic GMP inspections by the FDA. The Company has
been advised by MML and MedTech that such companies are in compliance with GMP
and other FDA regulations. There can be no assurance that MML or MedTech will
continue to comply with GMP, that the Company will locate other manufacturers
that comply with GMP or that the Company will secure agreements with such
manufacturers on acceptable terms.
In July 1998, the FDA determined that the Company's Vancouver, Washington
facility is in compliance with GMP. Until the Company enters into an arrangement
with a third-party distributor, which the Company is currently seeking.
Sero-Strip and Hema-Strip are being assembled and packaged at this facility. The
FDA also granted Certificates of Exportability for the Company's HIV rapid tests
for all countries that require such certificates. The Company intends to use its
Vancouver facility only to manufacture test strips for its rapid tests. The
Company will provide these strips to third parties with which it contracts for
assembly and packaging into final products.
Although the Company believes that it will not encounter difficulties in
obtaining components necessary for manufacture of its products, there can be no
assurance that the Company will be able to enter into satisfactory agreements or
arrangements for the purchase of commercial quantities of such components. The
failure to enter into agreements or otherwise arrange for adequate or timely
supplies of components, and the possible inability to secure alternative sources
of components, could have a material adverse effect on the Company's ability to
manufacture its products. In addition, development and regulatory approval of
the Company's products in the U.S. are dependent upon the Company's ability to
procure certain components and certain packaging materials from FDA-approved
sources. Since the FDA approval process requires manufacturers to specify their
proposed suppliers of certain components in their PMAs, if any such component
were no longer available from the specified supplier, FDA approval of a new
supplier would be required, resulting in potential manufacturing delays.
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REGULATION
DOMESTIC REGULATION
FOOD AND DRUG ADMINISTRATION. In the U.S., under the Federal Food, Drug, and
Cosmetics Act (the "FDC Act"), the FDA regulates all aspects, including
manufacturing, testing, and marketing, of medical devices that are made or
distributed in or from the U.S.
All medical devices are categorized by the FDA as Class I, Class II, or Class
III devices. Class I devices are subject only to general control provisions of
the FDC Act, such as purity, labeling and GMP. Class II devices are required to
also ensure reasonable safety and efficacy through performance standards and
other controls. Class III devices must, in addition to fulfilling all other
provisions of the FDC Act, meet extensive and rigorous FDA standards that may
require clinical trials.
A manufacturer of medical devices which can establish that a new device is
substantially equivalent to a legally marketed Class I or Class II medical
device, or to a Class III medical device for which the FDA has not required a
PMA, can seek FDA marketing clearance for the device by filing a 510(k)
Premarket Notification ("510(k) Notice"). The 510(k) Notice for diagnostic
devices is normally supported by various types of information, which is required
to be submitted along with the 510(k) Notice. This information typically
includes performance data indicating that the device is as safe and effective
for its intended use as a legally marketed predicate device.
Two of the Company's products, Saliva-Sampler (R) and Stat-Simple, have
received FDA clearance through the 510(k) process for domestic distribution
for IN VITRO diagnostic use in humans. The FDA clearance is subject to
certain standard limitations, including persons who may be tested, persons
who may administer the test and how the test results may be interpreted. Both
of these products have been classified as Class II devices. In January 1995,
the FDA classified Omni-Swab as a Class I medical device, allowing the
Company to seek 510(k) approval without submitting extensive safety and
efficacy data to the FDA.
The Company believes that all of its HIV rapid tests that have not been
submitted to the FDA would, if submitted to the FDA, fall under the Class III
category of medical devices, the standard classification for HIV diagnostic
devices. There can be no assurance that the Company's position with respect to
these products will prevail with the FDA.
Manufacturers and distributors of diagnostic devices requiring human clinical
trials which also present significant risk if incorrectly used or interpreted,
are required to obtain an Investigational Device Exemption ("IDE") from the FDA
prior to the commencement of human clinical trials. An application for an IDE
must be supported by preclinical data, including any results of human testing
from areas where approval has already been obtained from appropriate
governmental agencies, of human testing obtained through "Research Use Only" use
of a device (for which FDA approval is not required), of animal model testing
and of certain forms of mechanical testing, together with certain data regarding
the manufacturer of the device. Upon approval and award of the IDE, human
clinical trials may begin.
In 1998, representatives from the Company met with members of the Centers for
Biologics Evaluation and Research of the FDA and agreed upon the content of
the IDE for the Company's HIV rapid tests, including the numbers of subjects
and clinical sites necessary for approval. The Company is currently
discussing performance of human clinical trials for its HIV rapid tests with
several investigators and has begun to prepare the IDE application. The
Company has generated substantial supporting clinical data through
investigations by others overseas and intends to submit an IDE application to
the FDA during 1999. The Company is seeking the substantial additional
financing it will need to perform the clinical trials required to support the
IDE application. There can be no assurance that the Company will obtain this
financing on favorable terms or at all, or that the Company will submit the
IDE application to the FDA in 1999 or at all.
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The process of obtaining FDA clearance or approval is costly and time-consuming,
and there can be no assurance that any of the Company's products not yet
approved or cleared will be approved or cleared for marketing by the FDA or
other regulatory agencies. Delays in obtaining regulatory clearance or approval
may materially adversely affect the development, testing or marketing of the
Company's products and the ability of the Company to generate product revenues
therefrom. If and when the Company's products are approved by the FDA, they will
be subject to continuing regulation by the FDA and state and local agencies. The
FDA also audits clinical studies for compliance with applicable requirements.
The failure to comply with these regulations can result in regulatory action,
including warning letters, product seizure, injunction, product recalls, civil
fines and prosecution. An FDA enforcement action could have a material adverse
effect on the Company. To date, the Company has not been the subject of any FDA
enforcement actions.
OVERSEAS REGULATION AND DISTRIBUTION.
Regulatory approval for medical devices varies from country to country. Some
countries do not require regulatory approval when registering a product for sale
to the private sector. Others rely on evaluations by agencies such as WHO. SEE
"--MARKETING, SALES AND DISTRIBUTION."
The following lists the Company's products, where the products may be sold and
where regulatory approval is pending:
1. Hema-Strip. This product may be sold for IN VITRO diagnostic use in humans
in the following areas: United Kingdom, Russia, Brazil, India, Kenya,
Ghana, Sierra Leone, Rumania, Mexico, South Africa, Malaysia, Columbia,
Dominican Republic, Czech Republic and other areas which rely upon approval
in those countries. Approval is pending in Canada, China, Taiwan,
Argentina, Vietnam, Thailand, Chile, Peru, Hungary, Australia, the
Philippines and Poland.
2. Sero-Strip. This product may be sold for IN VITRO diagnostic use in humans
in United Kingdom, Russia, Brazil, India, South Africa, Columbia, Dominican
Republic, Ivory Coast, Sierra Leone, Ghana, Kenya, Rumania, Malaysia.
Approval is pending in Canada, China, Taiwan, Argentina, Thailand, Chile,
and Peru.
3. Saliva -Strip. This product is in its final stages of development and may
currently be sold in the United Kingdom.
4. Omni-SAL(R) and Saliva-Sampler(R). These products are not regulated in most
markets and may be sold for the purpose of obtaining a saliva specimen.
Omni-SAL(R) may currently be sold in most overseas markets, and
Saliva-Sampler(R) may currently be sold in the U.S. For specific use, e.g.
drugs of abuse testing or HIV testing, specific approvals will be
necessary.
5. Omni-Swab. This product may be sold in the U.S. and most overseas markets
where it is generally not regulated or is classified as a device and
therefore not subject to regulation.
6. Stat-Simple. This product may be sold for IN VITRO diagnostic use in humans
in the U.S., the United Kingdom, Western Europe, Mexico, and other markets
where the sale of this device is not regulated. Approval is pending in
Canada, Argentina, Brazil, Hungary, Germany, Australia, Chile and Peru.
The process of obtaining regulatory approval from foreign countries can be
costly and time consuming, and involves many of the same risks as obtaining FDA
approval. There can be no assurance that any of the Company's products not yet
approved will receive regulatory approval in any country, or that the Company
will seek regulatory approval for any of its products in any country.
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COMPETITION
The saliva and blood-based collection and diagnostic testing market is highly
competitive. Other entities, including Epitope, Inc., SmithKline Beecham
Corp., Abbot Laboratories, Quidel, Inc., Trinity Biotech, plc, and other
specialized biotechnology firms, as well as universities and other research
institutions, have developed or are developing technologies and products
which are competitive with the Company's products. Many of these competitors
are established and have substantially greater research, marketing and
financial resources than the Company. The Company expects that the number of
products competing with its products will increase as the perceived benefits
of rapid point-of-care testing become more widely recognized. This may result
in lower prices for the Company's point-of-care products and reduced
revenues. In the biotechnology industry, technological change and
obsolescence is rapid and frequent. There can be no assurance that the
Company will be able to compete successfully with its competitors, keep pace
with technological changes or avoid product obsolescence.
INTELLECTUAL PROPERTY
To date, ten patents covering the Company's specimen collection devices have
been awarded, four in the U.S. and six in other countries. Expiration dates for
the patents range from 2008 to 2012. The Company intends to seek other patent
protections in the U.S. and other countries for certain aspects of its
collection devices and rapid test technology. The Company has filed a U.S.
patent application for its whole blood sampling technology. No assurance can be
given that the Company will file any patent applications in the U.S. or abroad,
that patents will be issued to the Company pursuant to its patent applications,
or that the Company's patent portfolio will provide the Company with a
meaningful level of commercial protection.
Immunochromatography, the principle upon which the Company's rapid tests are
based, is a technology covered by existing patents. The Company has purchased a
license from the principal patent holder, Unilever PLC, to whom royalty payments
are due for strip-based rapid tests sold. To obtain the license, the Company
paid approximately $50,000 and will be responsible for royalty fees equal to 5%
of the net sales in all territories where the Unilever patent is enforceable.
Products covered by the license include those related to HIV, H.pylori,
tuberculosis and hepatitis A. In 1998, the Company paid royalties of
approximately $26,000 to Unilever PLC.
The Company also depends on trade secrets and proprietary information to protect
much of the technology that it has developed. The Company has entered into
confidentiality agreements with its employees, certain third party suppliers,
potential customers, joint venture partners, distributors and consultants.
Despite such efforts, there can be no assurance that confidentiality of the
Company's proprietary information can be obtained or maintained.
The Company believes that patent and trade secret protection are important to
its business. However, the issuance of a patent and the existence of trade
secret protection does not in itself ensure the Company's success. Competitors
may be able to produce products competing with a patented Company product
without infringing on the Company's patent rights. Issuance of a patent in one
country generally does not prevent the manufacture or sale of the patented
products in other countries. The issuance of a patent to the Company is not
conclusive as to validity or as to the enforceable scope of the patent. The
validity or enforceability of a patent can be challenged by litigation after its
issuance, and if the outcome of such litigation is adverse to the owner of the
patent, the owner's rights could be diminished or withdrawn. Additionally, trade
secret protection does not prevent independent discovery and exploitation of a
secret product or technique by other parties.
A large number of individuals and commercial enterprises seek patent protection
for technologies, products and processes in fields related to the Company's area
of product development. SEE "-COMPETITION." To the extent such efforts are
successful, the Company may be required to obtain licenses in order to
accomplish certain of its product strategies. There can be no assurance that
such licenses will be available to the Company or available on acceptable terms.
The Company is aware of certain filed patents issued to
9
<PAGE>
developers of diagnostic products with potential applicability to the Company's
diagnostic technology. There can be no assurance that the Company would prevail
if a patent infringement claim were to be asserted against it.
EMPLOYEES
As of December 31, 1998, the Company employed 17 full-time persons, including
two engaged in research and development, one in regulatory affairs, five in
manufacturing, two in sales and marketing, and seven in administration. None of
the Company's employees are covered by collective bargaining agreements, and the
Company believes its relations with its employees are good.
ITEM 2. DESCRIPTION OF PROPERTY
The Company's executive offices and laboratory facility are located at 11719 NE
95th Street, Vancouver, Washington in an approximately 7,000 square foot
facility. The premises are occupied pursuant to a lease with an unaffiliated
party which expires in August 2002. SDS International, Ltd. occupies facilities
of approximately 1,800 square feet pursuant to a lease with an unaffiliated
party which expires in May 2003. The Company believes its facilities are
adequate for its purposes.
ITEM 3. LEGAL PROCEEDINGS
In August 1994, Hardy v. Saliva Diagnostic Systems, Inc., Ronald L. Lealos,
Eugene Seymour and Richard S. Kalin, was filed in United States District Court,
District of Connecticut by Luc Hardy, a former director and officer of the
Company. The complaint alleged several causes of action against the Company and
individual defendants, including former directors and officers of the Company,
including breach of Mr. Hardy's employment agreement with the Company,
intentional interference with contract by the individual defendants, slander and
deceptive trade practices, all arising from his employment termination by the
Company. A judgment was entered against the Company on March 23, 1999 for
approximately $1,675,000. Pursuant to a settlement agreement dated March 25,
1999, the Company issued approximately 1,500,000 shares of its common stock and
will pay approximately $290,000 in cash over a two-year period to Mr. Hardy. As
a part of this settlement, Mr. Hardy has agreed to enter into a two-year
consulting agreement pursuant to which Mr. Hardy will provide consulting
services to the Company. The settlement agreement provides that Mr. Hardy will
file a satisfaction and release of the judgment upon the Company issuing the
1,500,000 shares of common stock, filing a registration statement covering
resales of those shares by April 30, 1999 and paying $50,000 to Mr. Hardy by
June 24, 1999. On March 29, 1999, Mr. Hardy filed a motion for reconsideration
of the Court's rulings that denied double damages on certain damages awarded to
Mr. Hardy and denied offer of judgment interest on the prejudgment interest
award. The Company is currently awaiting a decision on these motions. There can
be no assurance that such motions will not be granted or that the grant of such
motions will not have a further material adverse effect on the Company.
In February 1998, Lealos v. Saliva Diagnostic Systems, Inc. was filed in
Superior Court in Clark County in the State of Washington by Ronald Lealos,
former President and CEO of the Company. The complaint alleged that Mr. Lealos
was entitled to certain cash payments and benefits under an employment agreement
whereby he would serve as the Company's president, and that the Company's
failure to make such payments and grant such benefits constituted anticipatory
breach and breach of that contract. The complaint sought damages in excess of
$1,000,000. In addition, the complaint alleged that the Company wrongfully
rescinded options to purchase 38,500 shares of common stock in breach of a stock
option agreement with Mr. Lealos. The Company denied all allegations of the
complaint and filed a counterclaim for Mr. Lealos' wrongful conduct seeking
damages of approximately $1,500,000. In December 1998, the Company filed a
motion for summary judgment on the claims stated in the complaint. The Court
granted the motion in February 1999 in favor of the Company. Subsequently, Mr.
Lealos has moved to amend the original complaint to allege new grounds for
recovery of lost compensation, including quantum meruit. The Court granted this
motion in February 1999. A trial based on the amended complaint and the
Company's counterclaims is scheduled for October 1999. The Company intends to
file a motion to dismiss the amended complaint prior to the trial
10
<PAGE>
date. Although management of the Company intends to vigorously defend against
the suit, there can be no assurance that the litigation will not be decided
adverse to the Company and that such an adverse decision would not have a
material adverse effect on the Company.
In February 1999, a demand for arbitration with the American Arbitration
Association was filed by Fremont Novo Sciences, LLC, former distributor of the
Company's products in India. The demand alleges that the Company wrongfully
terminated and breached the Sub-License Agreement among the Company, SDS
Singapore and Fremont. The demand seeks a declaration that the Sub-License
Agreement remains in effect and damages in an amount to be determined, including
lost profits. In April 1999, the Company filed an answering statement denying
Fremont's claims and seeking damages in an amount to be determined for Fremont's
breach and non-performance of the Sub-License Agreement and for tortious
interference with the Company's business and contracts. Although management of
the Company intends to vigorously defend against Fremont's allegations and
pursue its claims against Fremont, there can be no assurance that the
arbitration will not be decided adverse to the Company and that such an adverse
decision would not have a material adverse effect on the Company.
Other than that set forth above, to the best knowledge of the Company, no other
material legal proceedings are pending.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of the shareholders of the Company was held on December 11,
1998. The only item considered at the meeting was the election of the Company's
four directors. The results of the voting with respect to the Company's nominees
for director identified in the Company's proxy statement relating to the annual
meeting were as follows:
<TABLE>
<CAPTION>
VOTES FOR VOTES WITHHELD
<S> <C> <C>
Kenneth J. McLachlan 2,462,237 73,811
Hans R. Vauthier, Ph.D. 2,462,137 73,911
Eric R. Stoer. Esq 2,462,137 73,911
Paul P. Bernstein 2,462,262 73,786
</TABLE>
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
On August 3, 1998, the Company effected a one-for-ten reverse split of shares of
its outstanding common stock. Unless otherwise stated, all share amounts and
values in this annual report reflect the reverse stock split.
Until the close of market on March 10, 1998, the Company's common stock was
quoted on The Nasdaq SmallCap Market, and subsequent to that date the Company's
common stock was quoted on the OTC Bulletin Board. The Company's stock trades
under the symbol "SALV."
11
<PAGE>
The following table sets forth the high and low bid quotations as reported by
The Nasdaq SmallCap Market for periods ending prior to March 11, 1998 and the
OTC Bulletin Board for the periods March 11, 1998 through March 31, 1998 and
thereafter. The OTC Bulletin Board quotations represent prices between dealers,
do not include retail markup, markdown or commissions, and may not represent
actual transactions.
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C>
1998
January 1 - March 10 $ 0.44 $ 0.22
March 11 - March 31 0.31 0.15
Second Quarter 0.65 0.08
Third Quarter 1.31 0.11
Fourth Quarter 1.02 0.38
1997
First Quarter $ 2.06 $ 1.16
Second Quarter 1.78 0.94
Third Quarter 1.47 0.63
Fourth Quarter 1.22 0.31
</TABLE>
Effective with the close of the market on March 10, 1998, the Company's
securities were delisted from The Nasdaq SmallCap Market for failure to meet the
new Nasdaq continued listing requirements. Trading, if any, in the Company's
securities is and will be conducted in the over-the-counter market on the OTC
Bulletin Board, an electronic bulletin board established for securities that do
not meet the Nasdaq listing requirements, or in what are commonly referred to as
the "pink sheets." As a result of the Nasdaq delisting, an investor may find it
more difficult to dispose of, or to obtain accurate quotations as to the price
of, the Company's securities. In addition, the Company's securities are subject
to so-called "penny stock" rules that impose additional sales practice
requirements on broker-dealers who sell such securities. Consequently, removal
from the Nasdaq system may affect the ability or willingness of broker-dealers
to sell the Company's securities and the ability of purchasers of the Company's
securities to sell their securities in the secondary market.
There were approximately 460 shareholders of record and 8,700 beneficial owners
of the Company's common stock at April 15, 1999. There were no cash dividends
declared or paid in fiscal years 1998 or 1997. The Company does not anticipate
declaring such dividends in the foreseeable future.
Warrants to purchase approximately 140,000 shares of the Company's common stock
for $12.50 per share, which expired on December 31, 1998, traded on the Nasdaq
SmallCap Market under the symbol "SALVW" until the close of the market on March
10, 1998.
The following securities were sold by the Company during the 1998 fiscal year in
reliance upon the exemption from the registration provisions of the Securities
Act of 1933, as amended, afforded by Section 4(2) thereof and/or Regulation D
promulgated thereunder, as transactions by an issuer not involving a public
offering:
In January 1998, the Company sold to Biscount Overseas Limited 1,500 shares of
the Company's Series 1998-A Convertible Preferred Stock for an aggregate
purchase price of $1,500,000. Net cash proceeds to the Company were $1,380,000.
SEE "MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION - LIQUIDITY AND
CAPITAL RESOURCES" FOR THE TERMS OF THE SERIES 1998-A CONVERTIBLE PREFERRED
STOCK.
In May 1998, the Company sold to Paul Bernstein a total of 156,250 shares of its
common stock for an aggregate purchase price and net proceeds to the Company of
$250,000.
12
<PAGE>
In June 1998, the Company issued to Duke Van Kalken 16,000 shares of its common
stock pursuant to a settlement and release agreement between Mr. Van Kalken and
the Company. The Company received no cash proceeds.
In August 1998, the Company entered into a securities purchase agreement, which
was amended by a letter agreement of April 1999, pursuant to which Biscount
Overseas Limited was and is obligated to purchase an aggregate 1,500 shares of
the Company's Series 1998-B Convertible Preferred Stock over an approximately
eight-month period for an aggregate purchase price of $1,500,000. Net cash
proceeds to the Company at the end of that period will total $1,410,000. SEE
"MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION - LIQUIDITY AND
CAPITAL RESOURCES" FOR THE TERMS OF THE SERIES 1998-B CONVERTIBLE PREFERRED
STOCK.
In March 1999, the Company issued to Luc Hardy 1,500,000 shares of its common
stock pursuant to a settlement agreement between Mr. Hardy and the Company. The
Company received no cash proceeds.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
GENERAL
Since July 1990, the Company has been engaged almost exclusively in research and
development activities focused on developing proprietary saliva based collection
devices and rapid assays for infectious diseases. Other than sales of the
Company's collection devices, the Company has not yet commenced any significant
product commercialization. The Company has incurred significant operating losses
since its inception, resulting in an accumulated deficit of $34,508,780 at
December 31, 1998. Such losses are expected to continue for the foreseeable
future and until such time, if ever, as the Company is able to attain sales
levels sufficient to support its operations. In the second fiscal quarter of
1999, the Company expects to receive $470,000 (net of issuance costs of $30,000)
from the sale of 500 shares of its Series 1998-B Convertible Preferred Stock.
The Company believes that its current cash position and these expected proceeds,
combined with revenues and other cash receipts, will be insufficient to fund the
Company's operations through 1999. Substantial additional financing will be
required in 1999. The Company's independent certified public accountants have
included an explanatory paragraph in their reports stating that the Company's
significant operating losses and significant capital requirements raise
substantial doubt about the Company's ability to continue as a going concern.
There can be no assurance that the Company will be able to obtain the additional
capital resources necessary to continue its business, or that such financing
will be available on commercially reasonable terms or at all. SEE NOTE 2 OF
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. SEE "ITEM 3 - LEGAL PROCEEDINGS."
On August 3, 1998, the Company effected a one-for-ten reverse split of shares of
its outstanding common stock. All share amounts and values described below
reflect the reverse stock split.
RESULTS OF OPERATIONS
REVENUES. The Company's revenues consist of product sales. Revenues decreased
36.2% to $907,957 in 1998 from $1,422,296 in 1997. The decrease in revenues was
primarily attributable to delays related to closure of the Company's Singapore
facility and the establishment of a manufacturing base in Vancouver in early
1998, and the decrease of product sales in India in 1998. Sales to two customers
accounted for approximately 42% of total sales in 1998. Sales to one customer
accounted for approximately 17% of total product sales in 1997.
COST OF PRODUCTS SOLD. Costs of products sold decreased to $1,200,308 (132.2% of
product sales) in 1998 from $1,426,638 (100.3% of product sales) in 1997. The
decrease was attributable to decreased sales. The increase as a percentage of
revenues was attributable to transferring production from Singapore to Vancouver
and delays in setting up the manufacturing equipment.
13
<PAGE>
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses decreased
33.5% to $442,299 in 1998 from $665,475 in 1997, primarily as a result of
reduced payroll and related expenses and changes in the amount of clinical trial
activity and related expense. The Company has maintained its focus on
controlling costs in all departments, including research and development, and
thus intentionally reduced these costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses decreased 24.1% to $3,999,983 in 1998 from $5,270,955 in
1997, primarily as a result of the closure of facilities in Singapore, a
reduction in the number of administrative personnel and an ongoing focus on
controlling costs.
RESTRUCTURING EXPENSE. Results of operations of 1997 included a $278,537 charge
associated with a restructuring plan designed to reduce costs and improve
manufacturing and operational efficiencies. Under the plan, the Company closed
its Singapore manufacturing operations in October 1997. The restructuring charge
included approximately $161,000 related to termination of employees,
approximately $37,000 associated with the settlement of the lease obligation in
Singapore, $47,000 for other costs related to closing the Singapore location and
$10,000 non-cash charge for the write off of leasehold improvements. The closure
of the Singapore manufacturing operations was concluded in May 1998. Accrued
restructuring, included in accrued expense was $13,040 at December 31, 1998,
representing residual amounts which will be paid during the statutory
liquidation of the SDS Singapore. In early 1998, the Company issued to the
former director of its Singapore operations 16,000 shares of its common stock in
settlement of a severance agreement. The fair value of these shares, $25,600,
was recorded as compensation expense in 1998.
INTEREST EXPENSE AND LOAN FEES. Interest expense decreased to $10,819 in 1998
from $413,993 in 1997 due to a non-recurring interest charge in 1997 on the
Convertible Debentures, which were converted to common stock in late 1997.
INCOME TAXES. The Company is in a net deferred tax asset position and has
generated net operating losses to date. Accordingly, no provision for or benefit
from income taxes has been recorded in the accompanying statements of
operations. The Company will continue to provide a valuation allowance for its
deferred tax assets until it becomes more likely than not, in management's
assessment, that the Company's deferred tax assets will be realized. The Company
has a net operating loss carryforward of approximately $24 million which is
available to offset future taxable income, if any, expiring through the year
2012. The Internal Revenue Code rules under Section 382 could limit the future
use of these losses based on ownership changes and the value of the Company's
stock. SEE NOTE 9 OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company has financed its capital requirements through
proceeds from its public offering of common stock in March 1993 and the exercise
of common stock purchase warrants pursuant to such offering, proceeds from sales
of convertible debentures, proceeds from private placements of common stock and
preferred stock, and the exercise of common stock purchase warrants and stock
options. In March 1997, the Company raised net proceeds of approximately
$1,380,000 (net of issuance costs of $120,000) from the private sale of $1.5
million convertible debentures. In June 1997 and August 1997, the Company
entered into three separate common stock subscription agreements for the
issuance and sale of a total of 408,291 shares of common stock for an aggregate
purchase price of $2,063,000 (net of issuance costs). In January 1998, the
Company entered into a securities purchase agreement with an investor for the
issuance and sale of 1,500 shares of the Company's newly designated Series
1998-A Convertible Preferred Stock (the "1998-A Preferred Stock") for an
aggregate purchase price of $1,380,000 (net of issuance costs of $120,000). In
May 1998, the Company entered into a securities purchase agreement with an
investor for the issuance and sale of 156,250 shares of its common stock for an
aggregate purchase price of $250,000. In August 1998, the Company entered into a
securities purchase agreement with an investor for the issuance and sale of a
total of 1,500 shares of the Company's Series 1998-B Convertible Preferred Stock
(the "1998-B Preferred Stock") for an aggregate purchase price of $1,410,000
(net of issuance costs of $90,000). Pursuant to such securities purchase
agreement, the investor purchased 500 shares of 1998-B Preferred Stock for an
aggregate purchase price of $470,000 (net of issuance costs of $30,000) in
August 1998. In December 1998 the Company sold
14
<PAGE>
an additional 500 shares of the 1998-B Preferred Stock to the investor for an
aggregate purchase price of $470,000 (net of issuance costs of $30,000) and
issued an additional 145 shares of the 1998-B Preferred Stock to the investor in
satisfaction of certain obligations under the terms of the 1998-A Preferred
Stock and 1998-B Preferred Stock held by the investor. Additionally, pursuant to
a letter agreement entered into in April 1999 amending the terms of the
securities purchase agreement, the investor is obligated to purchase an
additional 500 shares of 1998-B Preferred Stock for an aggregate purchase price
of $470,000 (net of issuance costs of $30,000). The investor has paid $200,000
of the aggregate purchase price and has agreed to pay the remaining $270,000 of
the purchase price upon the filing of a satisfaction and release with the court
in the lawsuit recently settled between the Company and Luc Hardy.
Cash used in operating activities in 1998 was $2,658,306. This was primarily a
result of a net loss of $4,676,987, adjustments for depreciation and
amortization, decreases in accounts receivable and inventories and non-cash
settlement expense of $1,385,000. Accounts receivable decreased due to decreased
sales and timing of sales in the fourth quarter of 1998, and inventories
decreased due to improved control of raw materials purchasing.
Accrued expenses totaled $1,604,536 at December 31, 1998 compared to $1,805,498
at December 31, 1997. Accrued wages and salaries decreased to $429,513 at
December 31, 1998 from $493,352 at December 31, 1997. Accrued restructuring
costs decreased to $13,040 at December 31, 1998 from $135,522 at December 31,
1997 due to the completion of the closure of the Singapore operation. The
residual amount will be paid during the statutory liquidation of the Singapore
subsidiary. Legal expenses accrued relating to pending litigation and other
matters were $508,210 and $331,554 at December 31, 1998 and 1997, respectively.
Litigation contingencies decreased to $440,000 at December 31, 1998 from
$750,000 at December 31, 1997 due to the settlement of the Hardy v. Saliva
Diagnostic Systems matter. The value of shares issued pursuant to the Hardy
settlement agreement of $1,385,000 are included in additional paid in capital at
December 31, 1998. SEE ITEM 3 -"LEGAL PROCEEDINGS."
Cash used in investing activities in 1998 was $8,696, which represented
acquisition costs of property and equipment related to the construction of
drying facilities and re-engineering of molds, offset by proceeds from the sale
of property and equipment, primarily in Singapore.
Cash provided by financing activities in 1998 was $2,547,214. This was primarily
a result of net proceeds of $2,320,000 from the sale of 1998-A and 1998-B
Convertible Preferred Stock and $250,000 from the sale of common stock.
On January 9, 1998, the Company issued to The Tail Wind Fund Ltd. ("Tail Wind")
85,652 shares of its common stock, and to Joseph Kaufman ("Kaufman") 34,233
shares of its common stock, which they were entitled to receive pursuant to the
terms of a letter agreement dated June 27, 1997 among the Company, Tail Wind and
Kaufman. The letter agreement provided for the issuance of such additional
shares upon the occurrence of certain conditions related to the trading price of
the Company's common stock during a specified period.
On January 26, 1998, the Company entered into a securities purchase agreement
with an investor for the issuance and sale of shares of its 1998-A Preferred
Stock. Pursuant to the securities purchase agreement, the Company sold a total
of 1,500 shares of the 1998-A Preferred Stock to the investor for an aggregate
purchase price of $1,380,000 (net of issuance costs of $120,000). The investor
is entitled to receive a number of shares of the Company's common stock upon
conversion of the 1998-A Preferred Stock as determined by dividing the purchase
price of the 1998-A Preferred Stock by the lesser of (i) $3.375, and (ii) 80% of
the average closing bid price of the Company's common stock for the five trading
days prior to conversion. On July 30, 1998, the Company amended the Securities
Purchase Agreement to eliminate the redemption rights pursuant to the Securities
Purchase Agreement for the 1998-A Preferred Stock. As of December 31, 1998, all
outstanding shares of the 1998-A Preferred Stock had been converted into
1,804,251 shares of common stock.
15
<PAGE>
In connection with the issuance and sale of the 1998-A Preferred Stock, the
Company entered into a separate registration rights agreement with the investor
under which the Company was required to file a registration statement covering
resales of shares of the common stock issuable upon conversion of the 1998-A
Preferred Stock. The Agreement provides that the Company would pay certain
amounts to the investor if the registration statement was not filed on or before
February 26, 1998 or was not declared effective by the Securities and Exchange
Commission by April 26, 1998. A registration statement on Form S-3 was filed on
February 26, 1998. Because the Company was no longer eligible to file on Form
S-3 due to the delisting of the Company's securities from Nasdaq, the Company
had filed pre-effective amendments to the registration statement on Form SB-2.
The terms of the 1998-A Preferred Stock provided that, if the registration
statement was not declared effective by April 26, 1998, the Company would pay,
upon demand of the investor, an amount equal to two percent (2%) of the purchase
price of the 1998-A Preferred Stock for the period from April 26, 1998 until the
date the registration statement is declared effective. The investor waived the
right to receive any such payment in exchange for 145 shares of the Company's
1998-B Preferred Stock, which were issued to the investor on December 11, 1998.
The value of these shares, $145,000, has been included as deemed dividends on
preferred stock in the accompanying consolidated financial statements.
In connection with the issuance of the 1998-A Preferred Stock, the Company paid
a cash fee to the investor of 7.5% of the gross proceeds ($112,500) and
attorney's fees equal to 0.5% of the gross proceeds ($7,500). The Company also
issued warrants to the investor to purchase up to 75,000 shares of common stock
at an exercise price of $3.375 per share, which expire on January 26, 2003. The
fair value of these warrants of $248,250 has been reflected as a discount to the
1998-A Preferred Stock and was accreted as deemed preferred dividends over the
conversion period, which ended July 25, 1998. The investor was entitled to
receive a number of shares of the Company's common stock upon conversion of the
1998-A Preferred Stock as determined by dividing the purchase price of the
1998-A Preferred Stock by the lessor of (i) $3.375 or (ii) 80% of the average
closing bid price of the Company's common stock for the five trading days prior
to conversion. The fair value of this beneficial conversion feature, $300,000,
was recorded as a discount to the 1998-A Preferred Stock and was accreted to
deemed preferred dividends over the conversion period which ended July 25, 1998.
The following summarizes deemed dividends and earned dividends on the Series A
Preferred Stock and related accretion as of December 31, 1998.
<TABLE>
<CAPTION>
Accreted or Earned
Total as of
Value December 31, 1998
-------------- --------------------
<S> <C> <C>
Beneficial conversion feature $ 300,000 $ 300,000
Issuance costs 120,000 120,000
Warrants 248,250 248,250
Preferred stock issued in settlement
of registration delay 145,000 145,000
Earned dividends (6% of preferred
principal value) 36,193 36,193
---------- ----------
Total $ 849,443 $ 849,443
---------- ----------
---------- ----------
</TABLE>
On April 28, 1998, the Company issued to the Tail Wind Fund, Ltd. 149,663 shares
of its common stock, which Tail Wind was entitled to receive pursuant to the
terms of a common stock purchase agreement dated as of June 30, 1997 between
Tail Wind and the Company. The agreement provided for the issuance of such
additional reset shares upon the occurrence of certain conditions related to the
market price of the Company's common stock during a specified period.
Also on April 28, 1998, the Company issued to Biscount Overseas Limited 153,756
shares of its common stock upon the conversion of 140 shares of the 1998-A
Preferred Stock.
16
<PAGE>
On May 26, 1998, the Company entered into a common stock subscription agreement
with Paul Bernstein for the issuance and sale of 156,250 shares of its common
stock for an aggregate purchase price of $250,000.
On July 22, 1998, the Company issued to Biscount Overseas Limited 68,291 shares
of its common stock upon the conversion of 60 shares of the 1998-A Preferred
Stock.
On July 28, 1998, the Company issued to Tail Wind 51,377 shares of its common
stock, which Tail Wind was entitled to receive pursuant to the terms of the
common stock purchase agreement dated as of June 30, 1997 between Tail Wind and
the Company, which provided for the issuance of such additional reset shares
upon the occurrence of certain conditions related to the market price of the
Company's common stock during a specified period. Under the terms of such common
stock purchase agreement, Tail Wind remains entitled to receive an additional
17,410 shares of common stock.
On August 3, 1998, the Company appointed Paul Bernstein as a member of the Board
of Directors.
On August 3, 1998, the Company entered into a securities purchase agreement with
an investor for the issuance and sale of a total of 1,500 shares of its 1998-B
Preferred Stock for an aggregate purchase price of $1,410,000 (net of issuance
costs of $90,000). In August 1998, pursuant to the securities purchase
agreement, the Company sold a total of 500 shares of the 1998-B Preferred Stock
to the investor for an aggregate purchase price of $470,000 (net of issuance
costs of $30,000). The investor is entitled to receive a number of shares of the
Company's common stock upon conversion of the 1998-B Preferred Stock as
determined by dividing the purchase price of the 1998-B Preferred Stock by the
lesser of (i) $1.69, and (ii) 80% of the average closing bid price of the
Company's common stock for the five trading days prior to conversion. In
December 1998, the Company sold an additional 500 shares of the 1998-B Preferred
Stock to the investor for an aggregate purchase price of $470,000 (net of
issuance costs of $30,000) and issued an additional 145 shares of the 1998-B
Preferred Stock to the investor in satisfaction of certain obligations under the
terms of the 1998-A Preferred Stock and 1998-B Preferred Stock held by the
investor. Pursuant to a letter agreement entered into in April 1999 amending the
terms of the securities purchase agreement, the investor is obligated to
purchase an additional 500 shares of 1998-B Preferred Stock for an aggregate
purchase price of $470,000 (net of issuance costs of $30,000). The investor has
paid $200,000 of the aggregate purchase price and has agreed to pay the
remaining $270,000 of the purchase price upon the filing of a satisfaction and
release with the court in the lawsuit recently settled between the Company and
Luc Hardy.
The 1998-B Preferred Stock is convertible into common stock of the Company at a
beneficial conversion ratio and, as a result, a discount of $286,250 in the
aggregate, was recorded at the date of issuance of the 1,000 shares of the
1998-B Preferred Stock in 1998. The $286,250 discount will accreted to deemed
preferred dividends over the conversion period, which ends March 11, 1999.
In connection with the issuance of the 1998-B Preferred Stock, the Company
issued warrants to purchase up to 25,000 shares of Common stock at an exercise
price of $3.375 per share, which expire on January 26, 2003. The fair value of
these warrants of $253,750 was accreted to deemed preferred dividends over the
conversion period which ended November 1, 1998. The following summarizes deemed
dividends and earned dividends on the Series B Preferred Stock and related
accretion as of December 31, 1998.
<TABLE>
<CAPTION>
Total Accreted as of
Value December 31, 1998
------------ ------------------
<S> <C> <C>
Beneficial conversion feature $ 286,250 $ 188,334
Warrants 253,750 253,750
--------- ---------
Total $ 540,000 $ 442,084
--------- ---------
--------- ---------
</TABLE>
17
<PAGE>
On July 31, 1998, the U.S. Food and Drug Administration ("FDA") determined that
the Company's Vancouver facility is in compliance with the FDA's Good
Manufacturing Practices (GMP) regulations and granted Certificates of
Exportability for the Company's HIV rapid tests for all countries that require
such certificates. The Company intends to use its Vancouver facility only to
manufacture test strips for its rapid tests.
On August 7, 1998, the FDA advised the Company that it has cleared the Company's
Stat-Simple(R) test for diagnostic use in humans. Stat-Simple(R) is a
finger-prick test for the bacterial infection responsible for the majority of
stomach ulcers and certain other gastrointestinal diseases in humans, and may
allow physicians to diagnose the infection at the time of patient visit, thereby
avoiding the expense and time consumed in traditional laboratory-based testing.
The Company's capital requirements have been and will continue to be
significant. The Company currently has an accumulated deficit due to its history
of losses. The Company is dependent upon its effort to raise capital to finance
its future operations, including the cost of manufacturing and marketing of its
products, to conduct clinical trials and submissions for FDA approval of its
products and to continue the design and development of its new products.
Marketing, manufacturing and clinical testing may require capital resources
substantially greater than the resources available to the Company.
In the second fiscal quarter of 1999, the Company expects to receive $470,000
(net of issuance costs of $30,000) from the sale of 500 shares of its Series
1998-B Convertible Preferred Stock. The Company believes that its current cash
position and these expected proceeds, combined with revenues and other cash
receipts, will be insufficient to fund the Company's operations through 1999.
Substantial additional financing will be required in 1999. There can be no
assurance that the Company will be able to obtain the additional capital
resources necessary to implement or continue its programs, or that such
financing will be available on commercially reasonable terms or at all. The
Company will continue to seek public or private placement of its equity
securities and corporate partners to develop products. There can be no assurance
that the Company will be able to sell its securities on commercially reasonable
terms or to enter into agreements with corporate partners on favorable terms or
at all. The Company's future capital needs will depend upon numerous factors,
including the progress of the approval for sale of the Company's products in
various countries, including the U.S., the extent and timing of the acceptance
of the Company's products, the cost of marketing and manufacturing activities
and the amount of revenues generated from operations, none of which can be
predicted with certainty. The Company's significant operating losses and capital
requirements raise substantial doubt about the Company's ability to continue as
a going concern. SEE "ITEM 3 - LEGAL PROCEEDINGS."
REVERSE STOCK SPLIT
On August 3, 1998, the Company effected a one-for-ten reverse split of shares of
its outstanding common stock, which was previously approved by the Company's
shareholders at a special meeting held on February 28, 1998. Warrants and
options to purchase the Company's common stock, preferred stock, and other
securities convertible into shares of the Company's common stock, will be
adjusted in accordance with their terms to reflect the reverse stock split.
YEAR 2000 ISSUE
The Company is assessing its computer systems and software to determine
readiness for the Year 2000. For this purpose, the term "computer systems and
software" includes systems that are commonly thought of as information
technology ("IT") systems, including enterprise software, operating systems,
networking components, application and data servers, PC hardware, accounting,
data processing and other information systems, as well as systems that are not
commonly thought of as IT systems, such as telephone systems, fax machines,
manufacturing equipment and other miscellaneous systems and equipment. Both IT
and non-IT systems may contain imbedded technology, which complicates the
Company's Year 2000 assessment, remediation and testing efforts. The inability
of computer software programs and operating systems
18
<PAGE>
accurately to recognize, interpret and process date codes designating the year
2000 and beyond could cause systems to yield inaccurate results or encounter
operating problems, including disruption of the business operations these
systems control. The Company believes it was 100% complete with its internal
assessment at the end of December 1998.
The Company also may be exposed to risks from computer systems of parties with
which the Company transacts business. The Company has contacted most of its
critical suppliers to determine the extent to which the Company may be
vulnerable to those parties' failures to remedy their own Year 2000 issues and
to ascertain what actions, if needed, may be taken by the Company in response to
such risks. To date, the Company has received responses from approximately 10%
of the suppliers contacted to date, most of which have indicated they are, or
expect to be, Year 2000 compliant. It is expected that the Company's assessment
of critical suppliers' Year 2000 compliance will be completed by the end of June
1999.
The Company currently estimates that it will spend between $15,000 and $20,000
in addressing the Year 2000 issue, of which approximately $1,000 has been
incurred as of December 31, 1998. The estimates are subject to change as
additional information is obtained in connection with the Company's assessment
of the Year 2000 issue.
The Company believes that Year 2000 issues will not pose significant problems
for the Company. However, if all Year 2000 issues are not properly identified,
or assessment, remediation and testing are not effected timely with respect to
Year 2000 problems that are identified, there can be no assurance that the Year
2000 issue will not have a material adverse impact on the Company's business,
financial condition or results of operations, or adversely affect the Company's
relationships with customers, vendors or others. Additionally, there can be no
assurance that the Year 2000 issues of other entities, such as one or more of
the Company's critical customers or suppliers, will not have a material adverse
impact on the Company's systems or its business, financial condition or results
of operations.
The Company has begun, but not yet completed, a comprehensive analysis of the
operational problems and costs (including loss of revenues) that would be
reasonably likely to result from the failure by the Company and certain third
parties to complete efforts necessary to achieve Year 2000 compliance on a
timely basis. A contingency plan has not been developed for dealing with the
most reasonably likely worst case scenario, and such scenario has not yet been
clearly identified. The Company currently plans to complete such analysis and
contingency planning by the end of June 1999.
The costs of the Company's Year 2000 assessment, remediation and testing efforts
and the dates on which the Company believes it will complete such efforts are
based upon management's best estimates. There can be no assurance that these
estimates will prove to be accurate, and actual results could differ materially
from those currently anticipated.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards requiring that every derivative instrument be recorded in
the balance sheet as either an asset or liability measured at its fair value.
SFAS No. 133 also requires that changes in the derivative's fair value be
recognized currently in results of operations unless specific hedge accounting
criteria are met. SFAS No. 133 is effective for fiscal years beginning after
June 15, 1999. The Company does not expect SFAS No. 133 to have a material
impact on its consolidated financial statements.
19
<PAGE>
ITEM 7. FINANCIAL STATEMENTS
The Consolidated Financial Statements, together with the report thereon of
Arthur Andersen LLP are included in this report as follows:
<TABLE>
<S> <C>
Report of Arthur Andersen LLP F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-2
Consolidated Statements of Operations - F-3
For the Years Ended December 31, 1998 and 1997
Consolidated Statement of Stockholders' Equity - F-4
For the Years Ended December 31, 1998 and 1997
Consolidated Statements of Cash Flows - F-5
For the Years Ended December 31, 1998 and 1997
Notes to Consolidated Financial Statements F-6
</TABLE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
As reported on Form 8-K, Item 4, filed with the Securities and Exchange
Commission on June 9, 1997, on May 30, 1997 Saliva Diagnostic Systems, Inc. (the
"Company") dismissed its independent accountants, Hollander, Gilbert & Co. Such
dismissal was recommended and approved by the Company's Board of Directors, and
ratified by the Company's shareholders at the Company's annual meeting of
shareholders held on May 30, 1997.
The audit reports of Hollander, Gilbert & Co. on the Company's consolidated
financial statements as of and for the fiscal years ended December 31, 1996 and
1995 did not contain an adverse opinion or a disclaimer of opinion nor were they
qualified or modified as to uncertainty, audit scope, or accounting principles
except: they were modified as to uncertainty of the Company to continue as a
going concern. During fiscal years 1996 and 1995 and the subsequent interim
period through May 30, 1997, there were no disagreements with Hollander, Gilbert
& Co. on any matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which, if not satisfied to
Hollander, Gilbert & Co.'s satisfaction, would have caused it to make reference
to the subject matter of the disagreement in connection with its reports. In
addition, there were no such events as described under Item 304(a)(1)(iv)(B) of
Regulation S-B during fiscal years 1996 and 1995 and the subsequent interim
period through May 30, 1997.
Also on May 30, 1997, the Company engaged Arthur Andersen LLP to be its
independent auditors. The Company did not consult with Arthur Andersen LLP at
any time prior to its engagement regarding the application of accounting
principles to a completed or contemplated specified transaction or the type of
audit opinion that might be rendered on the Company's consolidated financial
statements. Prior to engaging Arthur Andersen LLP, the Company did not receive
any written or oral advice from Arthur Andersen LLP on accounting, auditing, or
financial reporting issues.
20
<PAGE>
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
DIRECTORS OF THE COMPANY
<TABLE>
<CAPTION>
NAME OF DIRECTOR AGE POSITION WITH THE COMPANY
---------------- --- -------------------------
<S> <C> <C>
Kenneth J. McLachlan 52 President, Chief Executive Officer, Chief Financial
Officer and Director
Hans R. Vauthier, Ph.D. 74 Director
Eric F. Stoer, Esq. 54 Director
Paul P. Bernstein 64 Director
</TABLE>
The following are brief summaries of the business experience of the directors of
the Company, including, where applicable, information as to other directorships
held by each of them. There are no family relationships among any of the
directors and executive officers of the Company.
KENNETH J. MCLACHLAN has served on the Board of Directors since December 1995.
In December 1996, Mr. McLachlan was appointed by the Board to serve as the
Company's President and Chief Executive Officer. Mr. McLachlan has served as the
Company's Chief Financial Officer since June 1996. In 1993, Mr. McLachlan
founded an international finance and consulting firm in the Netherlands. From
1988 to 1993, Mr. McLachlan served as Chief Financial Officer and Executive Vice
President of Corange--Boehringer Mannheim, a privately-owned multinational
health care group.
HANS R. VAUTHIER, PH.D. has served on the Board of Directors since May 1996.
Since 1981, Dr. Vauthier has been a principal of Vauthier & Partner A.G., a
consulting firm located in Basle, Switzerland which assists pharmaceutical
companies in discovering and developing new products. Dr. Vauthier received his
doctorate in economics and business administration from the University of Bern
in Switzerland.
ERIC F. STOER, ESQ. was elected to the Board of Directors of the Company at its
annual meeting of shareholders in May 1997. Mr. Stoer has been a partner in the
Washington, DC office of the law firm of Bryan Cave LLP since 1990. His practice
is concentrated in the areas of corporate and business law with an international
focus. Mr. Stoer has served on the boards of directors of a number of
pharmaceutical testing and consulting companies, including Boehringer Mannheim
Pharmaceuticals.
PAUL P. BERNSTEIN was appointed to the Board of Directors in July 1998 and
elected to the Board of Directors at the Company's annual meeting of
shareholders in December 1998. Mr. Bernstein has been a co-founder and
shareholder of Sanford C. Bernstein & Co., Inc., an investment banking and
research firm, since 1967.
21
<PAGE>
EXECUTIVE OFFICERS OF THE COMPANY
<TABLE>
<CAPTION>
NAME AGE CURRENT POSITION(S) WITH COMPANY
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Kenneth J. McLachlan 52 President, Chief Executive Officer and
Chief Financial Officer
David Barnes, M.D. 53 Managing Director, SDS International, Ltd.
Stefan Paskell 50 Executive Vice President and General Manager
Paul D. Slowey, Ph.D. 43 Chief Operating Officer and Vice President of Marketing
</TABLE>
The following are brief summaries of the business experience of the Executive
Officers of the Company. For information on the business background of Mr.
McLachlan , see "DIRECTORS OF THE COMPANY" above.
DAVID BARNES, M.D. served on the Board of Directors of the Company from November
1993 to 1996. Dr. Barnes has been the Managing Director of SDS International,
Ltd. since commencement of its operations. Prior to his position as Managing
Director of SDS International, Ltd., Dr. Barnes was Director of Medical Services
for Hemotex Ltd., a laboratory service primarily involved with the insurance
industry in the United Kingdom.
STEFAN PASKELL joined the Company as acting General Manager in April 1998. In
February 1999, Mr. Paskell was promoted to Executive Vice President and General
Manager of the Company. From 1987 to present, Mr. Paskell has been Chief
Executive Officer and Chairman of Washington Biotechnology, a biotechnology
research and development corporation based in Seattle, Washington. Mr. Paskell
was a Director and Vice President of Bainbridge Sciences, Inc. from 1987 to
1991, and a General Manager of New Horizons Diagnostics Corp., a medical
diagnostics research, development, and manufacturing company based in Columbia,
Maryland from 1981 to 1987.
PAUL D. SLOWEY, PH.D. began employment as Director of Sales and Marketing at the
Company in August 1996. In May 1997, Dr. Slowey was promoted to Chief Operating
Officer and Vice President of Sales and Marketing of the Company. From February
1990 until he joined the Company, Dr. Slowey was employed at INCSTAR Corp., a
Minnesota manufacturer of diagnostic products, as International Marketing
Manager and Director of International Sales.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the Company's executive officers and directors, and persons who own
more than ten percent of a registered class of the Company's equity securities
to file reports of ownership and changes in ownership with the Securities and
Exchange Commission ("SEC") and the National Association of Securities Dealers,
Inc. Executive officers, directors and greater than ten percent stockholders are
required by SEC regulation to furnish the Company with copies of all Section
16(a) forms they file. Based solely on its review of the copies of such forms
received by it, or written representations from certain reporting persons, the
Company believes that for year ended December 31, 1998, all executive officers,
directors and greater than 10% shareholders complied with all applicable filing
requirements, except for Mr. Paul Bernstein, who filed a late report on Form 3
reporting beneficial ownership of 156,250 shares of the Company's common stock,
and Biscount Overseas Limited, which to date has not filed a report on Form 3.
22
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION
The following table provides certain summary information for 1998, 1997 and 1996
concerning compensation awarded to, earned by or paid the Company's Chief
Executive Officer and each of the other executive officers of the Company whose
total annual salary and bonus exceeded $100,000 (collectively, the "named
executive officers") for the fiscal year ended December 31, 1998.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
ANNUAL COMPENSATION (1) ----------------
-------------------------------------------- AWARDS
SECURITIES
OTHER UNDERLYING
FISCAL ANNUAL OPTIONS ALL OTHER
YEAR SALARY COMPENSATION (#) COMPENSATION
-------- ----------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Kenneth J. McLachlan (2) 1998 - $180,000 - -
President, 1997 - 180,000 100,000 -
Chief Executive Officer 1996 - 51,000 - -
and Chief Financial Officer
David Barnes, MD 1998 $125,000 - - -
Managing Director, 1997 135,000 - 7,500 -
SDS International, Ltd. 1996 135,000 - - -
</TABLE>
(1) Amounts shown include compensation earned in each respective fiscal year.
No bonuses were paid in any of the fiscal years reported.
(2) Includes 100,000 options granted to International Business Consultants
("IBCO"), a Jersey company of which Mr. McLachlan is a principal, pursuant
to a Management Consulting Agreement entered into as of December 5, 1997
between IBCO and the Company under which IBCO provides Mr. McLachlan's
services to the Company. SEE "ITEM 12 - CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS." Amounts paid in 1996 included payments to Mr. McLachlan
pursuant to a consulting contract which commenced in June 1996 and which
was superseded by the Agreement with IBCO. Of the amount shown as other
annual compensation for 1998, $75,000 had not been paid as of December 31,
1998. Mr. McLachlan has served as the Company's Chief Financial Officer
since June 1996 and was appointed President and Chief Executive Officer by
the Board of Directors in December 1996.
In December 1997, the Company entered into a management consulting agreement
with International Business Consultants, pursuant to which International
Business Consultants provides Mr. McLachlan's services as President and Chief
Executive Officer of the Company. SEE "ITEM 12 - CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS."
In August 1994, the Company entered into an employment agreement with Dr. David
Barnes for the position of Managing Director of SDS International, Ltd. The
employment agreement provides for an annual base salary of 79,200 (pound
sterling) (approximately US $125,000) plus the use of a car. If the agreement is
terminated for any reason, Dr. Barnes is entitled to receive his base salary for
the remaining term of the agreement.
23
<PAGE>
OPTION GRANTS IN LAST FISCAL YEAR
No options were granted to the named executive officers during the fiscal year
ended December 31, 1998.
The following table provides certain information concerning the value of
unexercised options held as of December 31, 1998 with respect to the named
executive officers. There were no options exercised by the named executive
officers in 1998. All options held by the named executive officers are currently
exercisable.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT IN-THE-MONEY OPTIONS
DECEMBER 31, 1998 AT DECEMBER 31, 1998 (1)
---------------------- ------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Kenneth J. McLachlan 100,000 0 0 0
David Barnes, MD 18,000 0 0 0
</TABLE>
(1) At December 31, 1998 there were no "in-the-money" options as calculated
based on the closing price of $0.45 per share the Company's common stock on
that date.
24
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of common stock of the Company as of April 15, 1999 as to (i) each
person who is known by the Company to own beneficially more than 5% of the
outstanding shares of common stock, (ii) each director or nominee for director
of the Company, (iii) each of the executive officers named in the Summary
Compensation Table herein and (iv) all directors and executive officers as a
group. Except as otherwise noted, the Company believes the persons listed below
have sole investment and voting power with respect to the common stock owned by
them.
<TABLE>
<CAPTION>
COMMON STOCK
- ------------------------------------------------------- -----------------------------------------------
NUMBER OF SHARES % SHARES
BENEFICIALLY OWNED BENEFICIALLY
NAME AND ADDRESS (1) OWNED
- ------------------------------------------------------- --------------------- -------------------------
<S> <C> <C>
Kenneth J. McLachlan
607 Collingwood House
Dolphin Square
London SW1 3NF England 170,000 (2) 2.07%
Hans R. Vauthier
Steinengraben 28
Ch-4051
Basel, Switzerland 25,000 (3) *
Eric F. Stoer, Esq.
c/o Bryan Cave LLP
700 Thirteenth Street
Washington, DC 20005 25,000 (4) *
Paul P. Bernstein
350 E. 79th Street
Apt. 19-A
New York, NY 10021 156,250 1.93%
David Barnes, M.D.
c/o SDS International, Ltd.
11 Sovereign Close
Sovereign Court
London, England E1 9HW, UK 35,800 (5) *
Biscount Overseas Limited
c/o J. Owadyeh
3 Freilager Str.
Zurich, Switzerland CH-8043 3,250,619 (6) 30.34%
Luc Hardy
303 Cognewaugh Road
Greenwich - Cos Cob, CT 06807 1,500,000 18.49%
All Executive Officers, Directors and Director
nominees as a group, (seven persons) 478,780 (7) 5.76%
</TABLE>
* Less than 1%.
25
<PAGE>
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission, and includes voting power and
investment power with respect to shares. Shares issuable upon the exercise
of outstanding stock options that are currently exercisable or become
exercisable within 60 days from April 15, 1999 are considered outstanding
for the purpose of calculating the percentage of common stock owned by such
person but not for the purpose of calculating the percentage of common
stock owned by any other person.
(2) Includes 20,000 shares registered in the name of Bank of Bermuda Trust
Company, trustee for the Morar Trust, an irrevocable trust established for
the benefit of Mr. McLachlan's children. Also includes 50,000 shares
registered in the name of Reads Trust Company Limited, trustee of an
irrevocable trust established for the benefit of Mr. McLachlan's children.
Mr. McLachlan has no power to vote or dispose of these shares pursuant to
the terms of the trusts. Also includes options to purchase 100,000 shares
of common stock which were granted to International Business Consultants, a
Jersey company, of which Mr. McLachlan is a principal, in connection with
consideration paid by the Company to International Business Consultants for
Mr. McLachlan's services to the Company.
(3) Includes options to purchase 25,000 shares of common stock.
(4) Includes options to purchase 25,000 shares of common stock.
(5) Includes options to purchase 35,800 shares of common stock.
(6) The information as to beneficial ownership is based in part on Schedule 13D
filed with the Securities and Exchange Commission by Biscount Overseas
Limited on January 12, 1999. The Schedule 13D reported beneficial ownership
of 650,619 shares of common stock, 1,893,939 shares issuable upon
conversion of the 1,000 outstanding shares of 1998-B Preferred Stock,
(based upon conversion at the market price of the common stock on December
22, 1998), and 100,000 shares issuable upon the exercise of warrants. Based
upon the market price of the common stock on April 15, 1999, the 1,000
shares of 1998-B Preferred Stock would be convertible into 2,500,000 shares
of common stock.
(7) Includes Kenneth J. McLachlan, Eric F. Stoer, Hans R. Vauthier, Paul P.
Bernstein, David Barnes, Stefan Paskell and Paul D. Slowey, the current
directors and executive officers of the Company. Includes options to
purchase an aggregate of 193,300 shares of common stock.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In December 1997, the Company entered into a Management Consulting Agreement
(the "Agreement") with International Business Consultants ("IBCO"), under which
IBCO agreed to provide the services of Kenneth J. McLachlan as the Company's
President and Chief Executive Officer from December 5, 1997 until December 31,
1998, with an automatic one year extension on January 1, 1999 and each year
thereafter unless written notice is given by either the Company or IBCO 90 days
prior thereto. Under the Agreement, IBCO will provide the services of Kenneth J.
McLachlan as President and Chief Executive Officer of the Company in exchange
for a base salary of $180,000 per annum or such greater amount as the Board of
Directors of the Company may from time to time determine. Upon entering into the
Agreement, IBCO was granted options to purchase 25,000 shares of the Company's
common stock at $4.06 per share. IBCO was also granted options to purchase
75,000 shares of the Company's common stock at $4.06 per share as compensation
for Mr. McLachlan's previous service to the Company. SEE "--ITEM 10 - EXECUTIVE
COMPENSATION." Additionally, under the Agreement, IBCO is entitled to an annual
incentive bonus of 10% of the annual net income of the Company, during the term
which IBCO renders services to the Company under the Agreement, payable, at the
option of the Company, in cash or common stock of the Company. IBCO may be
terminated for "cause" or "good reason," as defined in the Agreement.
26
<PAGE>
In January 1997, subsequent to his resignation as President and CEO of the
Company in December 1996, Ronald Lealos filed a lawsuit against the Company
in Superior Court in Clark County in the State of Washington. The complaint
in the lawsuit alleged various breach of contract claims. This lawsuit was
dismissed without prejudice as a prerequisite to a settlement agreement
between Mr. Lealos and the Company. The parties did not reach a settlement
and, in February 1998, Mr. Lealos filed a complaint against the Company in
the same court which alleged substantially the same claims. In March 1998,
the Company filed an answer to the complaint and asserted numerous
counterclaims against Mr. Lealos, including counterclaims for breach of
fiduciary duty and conversion. The Court granted the motion in February 1999
in favor of the Company. Subsequently, Mr. Lealos has moved to amend the
original complaint to allege new grounds for recovery of lost compensation,
including quantum meruit. The Court granted this motion in February 1999. A
trial based on the amended complaint and counterclaims is scheduled for
October 1999. SEE "ITEM 3-LEGAL PROCEEDINGS."
In 1992, the Company loaned to Mr. Lealos, then President and Director of the
Company, $93,000 to purchase shares of the Company's common stock. The loan
accrues interest at 6% annually. In 1995, the sum of $9,175 was paid toward the
principal of the loan, leaving a remaining principal balance of $83,825 which
was due in full on December 31, 1996. The loan is among the subjects of the
Company's counterclaims against Mr. Lealos.
In June and August 1997, the Company sold shares of its common stock in a
private placement pursuant to Regulation D, promulgated under the Securities Act
of 1933, as amended ("Regulation D"). Pursuant to common stock subscription
agreements between the Company and the investors named therein, the Company sold
a total of 408,290 shares of common stock for an aggregate purchase price of
$2,063,000, net of issuance costs. Bermuda Trust Company, trustee for the Morar
Trust, of which the children of Kenneth J. McLachlan are beneficiaries, was an
investor in the private placement and purchased 20,000 shares for an aggregate
purchase price of $100,000.
In May 1998, in a private placement pursuant to Regulation D, the Company sold a
total of 156,250 shares of its common stock to Paul P. Bernstein for an
aggregate purchase price of $250,000.
Eric F. Stoer, a director of the Company, is a partner in the law firm of Bryan
Cave LLP, which provided legal services to the Company in 1998 and which
continues to provide legal services in 1999 at arms length rates.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits included herein:
<TABLE>
<CAPTION>
Exhibit
No. Description
- --- -----------
<S> <C>
3.1 Certificate of Incorporation, as amended, incorporated by reference
to Exhibits 2.1 through 2.6 of the Company's Registration Statement
No. 33-46648 filed on Form S-1 (the "Form S-1"); and to Exhibit 2.7
of the Company's Annual Report on Form 10-KSB for its fiscal year
ended December 31, 1995
3.2 Certificate of Amendment, dated February 25, 1997, incorporated
by reference to Exhibit 2.2 of the Company's Annual Report on
Form 10-KSB for its fiscal year ended December 31, 1996
3.3 Certificate of Amendment, dated November 21, 1997, incorporated by
reference to Exhibit 3.3 of the Company's Annual Report on Form
10-KSB for its fiscal year ended December 31, 1997 (the "1997
10-KSB")
3.4 Certificate of Amendment, dated July 31, 1998, incorporated by
reference to Exhibit 3.4 of the Company's Quarterly Report on Form
10-QSB for its fiscal quarter ended June 30, 1998 (the "1998
10-QSB")
3.5 Company's By-laws, as amended, incorporated by reference to
Exhibit 3.4 of 1997 10-KSB
4.1 Specimen of Certificate Representing Common stock, incorporated
by reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-46648)
4.2 Form of Underwriter's Warrant, incorporated by reference to
Exhibit 4.2 of the Form S-1.
4.3 7.5% Convertible Debenture due February 28, 1999, issued by the
Company to The Tail Wind Fund, Ltd. on March 11, 1997,
incorporated by reference to Exhibit 4 to the Company's Quarterly
Report on Form 10-QSB for its fiscal quarter ended March 31, 1997
</TABLE>
27
<PAGE>
<TABLE>
<S> <C>
4.4 Common Stock Purchase Warrant for 8,995 shares, issued by the
Company to Grayson & Associates on March 14, 1997, incorporated
by reference to Exhibit 4.3 of the Company's Registration
Statement on Form SB-2 (Registration No. 333-26795)
4.5 Letter Agreement dated May 28, 1997 between the Company and The
Tail Wind Fund Ltd., incorporated by reference to Exhibit 4.9 to
the Company's Current Report on Form 8-K dated June 5, 1997 (File
No. 000-21284) (the "June 1997 8-K")
4.6 Letter Agreement dated June 27, 1997 between the Company and The
Tail Wind Fund Ltd, incorporated by reference to Exhibit 4.10 to
the June 1997 8-K
4.7 Common Stock Subscription Agreement dated as of June 30, 1997 by
and between the Company and The Tail Wind Fund Ltd., incorporated
by reference to Exhibit 4.2 of the June 1997 8-K
4.8 Common Stock Subscription Agreement dated as of June 30, 1997 by
and between the Company and the investors set forth on Schedule A
thereto, incorporated by reference to Exhibit 4.3 of the June
1997 8-K.
4.9 Registration Rights Agreement dated as of June 30, 1997 between
the Company and The Tail Wind Fund Ltd., incorporated by
reference to Exhibit 4.4 of the June 1997 8-K.
4.10 Form of Registration Rights Agreement dated as of June 30, 1997
between the Company and the investors set forth on Schedule A to
the Common Stock Subscription Agreement dated as of June 30, 1997
by and between the Company and the investors set forth on Schedule
A thereto, incorporated by reference to Exhibit 4.5 of the June
1997 8-K.
4.11 Form of Warrant issued to each of Grayson & Associates, Inc. and
The Tail Wind Fund Ltd., incorporated by reference to Exhibit 4.1
of the June 1997 8-K.
4.12 Common Stock Subscription Agreement dated as of August 22, 1997 by
and between the Company and David Freund, incorporated by reference
to Exhibit 10.5 of Amendment No. 1 to the Company's Registration
Statement on Form S-3 dated September 26, 1997 (Registration No.
333-33429) (the "S-3/A").
4.13 Registration Rights Agreement dated as of August 22, 1997 between
the Company and David Freund, incorporated by reference to Exhibit
10.6 of the S-3/A.
4.14 Certificate of Designations, Rights and Preferences of the Series
1998-A Convertible Preferred Stock, incorporated by reference to
Exhibit 4.1 of the Company's Current Report on Form 8-K, dated
January 26, 1998.
4.15 Warrant dated as January 26, 1998 issued to Biscount Overseas
Limited, incorporated by reference to Exhibit 4.3 of the Company's
Registration Statement on Form S-3 dated February 26, 1998
(Registration No. 333-46961) (the "1998 S-3")
4.16 Amended Certificate of Designations, Rights and Preferences of the
Series 1998-A Convertible Preferred Stock, incorporated by
reference to Exhibit 4.14 of the 1998 10-QSB
4.17 Certificate of Designations, Rights and Preferences of the Series
1998-B Convertible Preferred Stock, incorporated by reference to
Exhibit 4.16 of the 1998 10-QSB
4.18 Securities Purchase Agreement dated as of January 26, 1998 between
the Company and Biscount Overseas Limited, incorporated by
reference to Exhibit 10.1 of the Company's Current Report on Form
8-K, dated January 26, 1998 (the "January 8-K")
4.19 Registration Rights Agreement dated as of January 26, 1998 between
the Company and Biscount Overseas Limited, incorporated by
reference to Exhibit 10.2 of the Company's January 8-K
4.20 Placement Agent Agreement dated as of January 26, 1998 between the
Company and Aryeh Trading, Inc. incorporated by reference to
Exhibit 10.3 of the January 8-K
4.21 Amendment to Securities Purchase Agreement dated as of January 26,
1998, dated as of July 30, 1998 between the Company and Biscount
Overseas Limited, incorporated by reference to Exhibit 4.22 of the
Company's Registration Statement on Form SB-2 dated September 2,
1998 (Registration No. 333-62787) (the "September SB-2")
4.22 Amendment to Registration Rights Agreement dated as of January 26,
1998, dated as of July 30, 1998 between the Company and Biscount
Overseas Limited, incorporated by reference to Exhibit 4.23 of the
September SB-2
4.23 Placement Agent Agreement dated as of July 30, 1998 between the
Company and Arych Trading Inc., incorporated by reference to
Exhibit 4.24 of the September SB-2
4.24 Letter Agreement dated December 11, 1998, between the Company and
Biscount Overseas Limited regarding Series 1998-B Convertible
Preferred Stock. *
</TABLE>
28
<PAGE>
<TABLE>
<S> <C>
4.25 Letter Agreement dated April 23, 1999, between the Company and
Biscount Overseas Limited regarding Series 1998-B Convertible
Preferred Stock *
10.1 Consulting Agreement, dated May 20, 1996, between the Company and
International Business Consultants Limited, incorporated by
reference to Exhibit 10.1 to the Company's Annual Report on Form
10-KSB for its fiscal year ended December 31, 1996 (the "1996
10-KSB"). #
10.2 Employment Agreement, dated August 9, 1994, between the Company and
David Barnes, incorporated by reference to Exhibit 10.3 to the 1996
10-KSB. #
10.3 1992 Stock Option Plan, incorporated by reference to Exhibit 10.1
of the Form S-1. #
10.4 1994 Stock Option Plan, incorporated by reference to Exhibit A of
the Proxy Statement for the Company's 1994 Annual Meeting. #
10.5 Lease Agreement between the Company and East Ridge Business Park,
incorporated by reference to Exhibit 10.14 of the Form S-1.
10.6 Lease Agreement for additional premises between the Company and
East Ridge Business Park, incorporated by reference to Exhibit
10.14 of the Form S-1.
10.7 Amendment, dated June 14, 1996, to Lease Agreement between the
Company and East Ridge Business Park, incorporated by reference to
Exhibit 10.10 to the 1996 10-KSB.
10.8 License Agreement, dated March 22, 1994, between the Company and
Orgenics, Ltd., incorporated by reference to Exhibit 10.7 of the
1993 10-KSB.
10.9 License Agreement between Saliva Diagnostic Systems, Inc. and
Saliva Diagnostic Systems (Singapore) Pte. Ltd., incorporated by
reference to Exhibit 10.10 to the Company's Annual Report on Form
10-KSB for its fiscal year ended December 31, 1994 (the "1994
10-KSB")
10.10 Consulting Agreement, dated December 5, 1997, between the Company
and International Business Consultants Limited, incorporated by
reference to Exhibit 10.16 of the 1997 10-KSB
10.11 Sub-License Agreement by and among Saliva Diagnostic Systems,
Pte. Ltd., Saliva Diagnostic Systems, Inc., Fremont Novo
Sciences, L.L.C. and the Company dated February 21, 1995,
incorporated by reference to Exhibit 10.17 of the 1997 10-KSB
10.12 Amendment to Sub-License Agreement, dated March 8, 1995,
incorporated by reference to Exhibit 10.18 of the 1997 10-KSB
10.13 Agreement between Unilever PLC and the Company dated December 15,
1997, incorporated by reference to Exhibit 10.19 of the 1997 10-KSB
10.14 Distribution Agreement between Cadila Healthcare, Ltd. and the
Company, dated January 18, 1999*
21 List of Subsidiaries, incorporated by reference to Exhibit 21.1
of the Form S-1
24 Powers of Attorney (included on the signature pages to this
Annual Report)
27 Financial Data Schedule *
</TABLE>
* Filed herewith.
# Denotes officer/director compensation plan or arrangement.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter ended
December 31, 1998.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Dated: April 30, 1999
SALIVA DIAGNOSTIC SYSTEMS, INC.
By: /s/ Kenneth J. Mclachlan
---------------------------
Kenneth J. McLachlan
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
<S> <C> <C>
/s/ Kenneth J. Mclachlan President, Chief Executive Officer,
- ------------------------ Chief Financial Officer and Director
Kenneth J. McLachlan (principal accounting officer) April 30, 1999
/s/ Hans R. Vauthier Director April 30,1999
- --------------------
Hans R. Vauthier
/s/ Eric F. Stoer Director April 30, 1999
- -----------------
Eric F. Stoer
Director April 30, 1999
- ---------------------
Paul P. Bernstein
</TABLE>
30
<PAGE>
Report of Independent Public Accountants
To the Board of Directors and Shareholders of
Saliva Diagnostic Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Saliva
Diagnostic Systems, Inc. (a Delaware Corporation) and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statement of
operations, shareholders' deficit and cash flows for the years then ended. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Saliva Diagnostic
Systems, Inc. and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for the years then ended in conformity
with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company has suffered recurring losses
from operations and has a net capital deficiency that raises substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Arthur Andersen LLP
Portland, Oregon,
March 18, 1999 (Except with respect to
the matters discussed in Note 15, as to
which the date is March 25, 1999)
F-1
<PAGE>
SALIVA DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
----------------------------------------
1998 1997
---------------- ----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 151,524 $ 271,312
Accounts receivable, less allowance of $83,603 (1998)
and $42,000 (1997) 95,242 154,052
Inventories 205,792 458,177
Prepaid expenses 25,974 51,876
---------------- ----------------
Total current assets 478,532 935,417
Property and equipment, less accumulated
depreciation of $782,463 (1998) and $995,853 (1997) 208,950 434,457
Deposits 14,307 40,162
Restricted cash 59,420 120,500
Patents and trademarks, less accumulated
amortization of $57,605 (1998) and $48,375 (1997) 99,310 108,541
---------------- ----------------
$ 860,519 $ 1,639,077
---------------- ----------------
---------------- ----------------
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable $ 439,227 $ 347,835
Accounts payable to related party 75,000 -
Accrued expenses 1,604,536 1,805,498
Accrued interest payable 68,240 68,240
Current portion of long-term debt and
obligations under capital leases 59,387 33,779
---------------- ----------------
Total current liabilities 2,246,390 2,255,352
Long-term debt and obligations under capital
leases, net of current portion - 59,401
---------------- ----------------
Total liabilities 2,246,390 2,314,753
Commitments and Contingencies (Note 13)
Shareholders' deficit:
Series 1998-B Convertible Preferred Stock:
1,645 shares authorized, 1,145 shares issued and
outstanding, liquidation preference of $1,159,000 1,085,000 -
Common stock, $.01 par value, 50,000,000 shares
authorized, issued and outstanding:
5,231,888 (1998) and 2,934,462 (1997) 52,319 29,344
Additional paid-in capital 32,069,415 27,905,263
Note receivable from shareholder for stock (83,825) (83,825)
Accumulated deficit (34,508,780) (28,526,458)
---------------- ----------------
Total shareholders' deficit (1,385,871) (675,676)
---------------- ----------------
$ 860,519 $ 1,639,077
---------------- ----------------
---------------- ----------------
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-2
<PAGE>
SALIVA DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Revenues
Product sales $ 907,957 $ 1,422,296
Costs and expenses:
Cost of products sold 1,200,308 1,426,638
Research and development expense 442,299 665,475
Selling, general and administrative expense 3,999,983 5,270,955
Restructuring expense -- 278,537
----------- -----------
Loss from operations (4,734,633) (6,219,309)
Interest income 16,117 28,850
Interest expense (10,819) (413,993)
Other income (expense) 52,348 (7,760)
----------- -----------
Net loss (4,676,987) (6,612,212)
Dividends including deemed dividends on preferred stock 1,305,335 --
----------- -----------
Net loss available to common stockholders $(5,982,322) $(6,612,212)
----------- -----------
----------- -----------
Basic and diluted net loss per share $ (1.50) $ (2.66)
----------- -----------
----------- -----------
Shares used in basic and diluted per share calculations 3,997,768 2,489,490
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
SALIVA DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
<TABLE>
<CAPTION>
Series 1998-B
Common Stock Preferred Stock Additional
----------------- ------------------ Paid-in Note
Shares Amount Shares Amount Capital Receivable
----------- --------- ---------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1996 2,209,078 $22,091 $23,136,612 $(83,825)
Beneficial conversion feature related to
Convertible Debentures issued March 1997 375,000
Conversion of Debentures into common stock 173,682 1,737 1,498,263
Write-off of unamortized financing costs (99,800)
Issuance of common stock pursuant to
Debenture and private placement conversion
reset provisions 139,936 1,399 (1,399)
Issuance of common stock
in payment of interest on Debentures 2,760 27 29,368
Sale of common stock in private placements 408,291 4,083 2,059,331
Exercise of stock options 715 7 451
Compensation expense on issuance of
stock options 907,437
Net loss
----------- --------- ---------- ------------ -------------- ------------ -
Balances, December 31, 1997 2,934,462 29,344 27,905,263 (83,825)
Issuance of common stock 156,250 1,563 248,437
Issuance of common stock in connection
with severance agreement 16,000 160 25,440
Issuance of common stock pursuant to private
placement conversion reset provisions 320,925 3,209 (3,209)
Series 1998-A preferred stock:
Issuance of preferred stock, net 1,500 831,750 548,250
Earned dividends 36,193
Accretion of deemed preferred dividends
including accretion of warrants,
issuance costs, beneficial conversion
feature and registration penalty 145 813,250
Conversion to common stock 1,804,251 18,043 (1,500) (1,500,000) 1,481,957
Series 1998-B preferred stock:
Issuance of preferred stock 1,000 940,000
Accretion of deemed preferred dividends
including accretion of warrants and
beneficial conversion feature 442,084
Earned dividends
Common stock issuable in connection
with settlement agreement 1,385,000
Net loss
--------- ------- ----- ---------- ----------- --------
Balances, December 31, 1998 5,231,888 $52,319 1,145 $1,085,000 $32,069,415 $(83,825)
--------- ------- ----- ---------- ----------- --------
--------- ------- ----- ---------- ----------- --------
</TABLE>
F-4
<PAGE>
<TABLE>
<CAPTION>
Accumulated
Deficit Total
-------------- ---------------
<S> <C> <C>
Balances, December 31, 1996 $(21,914,246) $1,160,632
Beneficial conversion feature related to
Convertible Debentures issued March 1997 375,000
Conversion of Debentures into common stock 1,500,000
Write-off of unamortized financing costs (99,800)
Issuance of common stock pursuant to
Debenture and private placement conversion
reset provisions
Issuance of common stock
in payment of interest on Debentures 29,395
Sale of common stock in private placements 2,063,414
Exercise of stock options 458
Compensation expense on issuance of
stock options 907,437
Net loss (6,612,212) (6,612,212)
------------- ---------------
Balances, December 31, 1997 (28,526,458) (675,676)
Issuance of common stock 250,000
Issuance of common stock in connection
with severance agreement 25,600
Issuance of common stock pursuant to private
placement conversion reset provisions
Series 1998-A preferred stock:
Issuance of preferred stock, net 1,380,000
Earned dividends (36,193)
Accretion of deemed preferred dividends
including accretion of warrants,
issuance costs, beneficial conversion
feature and registration penalty (813,250)
Conversion to common stock
Series 1998-B preferred stock:
Issuance of preferred stock 940,000
Accretion of deemed preferred dividends
including accretion of warrants and
beneficial conversion feature (442,084)
Earned dividends (13,808) (13,808)
Common stock issuable in connection
with settlement agreement 1,385,000
Net loss (4,676,987) (4,676,987)
------------ -----------
Balances, December 31, 1998 $(34,508,780) $(1,385,871)
------------ -----------
------------ -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
SALIVA DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(4,676,987) $(6,612,212)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 213,903 225,606
Compensation expense on issuance of stock options -- 907,437
Settlement expense payable in common stock 1,385,000 --
(Loss) gain on sale of property and equipment (43,479) 25,900
Loss on write off of assets 62,003 --
Interest expense related to conversion of Debentures -- 404,395
Changes in current assets and liabilities:
Accounts receivable 58,810 24,384
Inventories 252,385 (189,746)
Prepaid expenses and deposits 112,837 (17,451)
Accounts payable and accrued expenses (22,778) 1,335,260
----------- -----------
Net cash used in operating activities (2,658,306) (3,896,427)
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisitions of property and equipment (41,381) (62,770)
Proceeds from sale of property and equipment 32,685 --
Deposits -- 48,332
----------- -----------
Net cash used in investing activities (8,696) (14,438)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of Common Stock, net of
issuance costs 250,000 2,063,414
Proceeds from sale of Preferred Stock, net of
issuance costs 2,320,000 --
Proceeds from Convertible Debentures, net of
issuance costs -- 1,380,000
Exercise of common stock options and warrants -- 458
Repayment of long term debt and capital lease obligations (22,786) (38,075)
----------- -----------
Net cash provided by financing activities 2,547,214 3,405,797
----------- -----------
Net decrease in cash and cash equivalents (119,788) (505,068)
Cash and cash equivalents, beginning of period 271,312 776,380
----------- -----------
Cash and cash equivalents, end of period $ 151,524 $ 271,312
----------- -----------
----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 10,819 $ 7,800
SUPPLEMENTAL DISCLOSURE OF NON-CASH INFORMATION:
Conversion of deposit to property and equipment $ -- $ 100,153
Conversion of Debentures into common stock -- 1,380,000
Dividends and deemed dividends on Preferred Stock 1,305,335 --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
SALIVA DIAGNOSTIC SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Saliva Diagnostic Systems, Inc., a Delaware corporation (the Company), is
primarily engaged in the development, manufacturing and marketing of rapid
in-vitro assays for use in the detection of infectious diseases and other
conditions, and medical specimen collection devices.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, SDS International, Ltd. (1998 and 1997) and
Saliva Diagnostic Systems (Asia) Ltd. (1997). All significant intercompany
accounts and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consists of cash and short-term highly liquid
investments purchased with original or remaining maturities of three months or
less.
INVENTORIES
Inventories are stated at the lower of cost or market determined on a first-in,
first-out (FIFO) basis.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation is computed on the
straight-line method based upon the estimated useful life of the assets.
Leasehold improvements are amortized over the life of the related lease. Useful
lives are generally as follows:
<TABLE>
<S> <C>
Office furniture and equipment five to seven years
Machinery and equipment seven years
Exhibits seven years
Vehicles five years
</TABLE>
PATENTS AND TRADEMARKS
The costs of patents and trademarks are being amortized on the straight line
method over 17 years.
REVENUE RECOGNITION
Revenue is recognized when products are shipped to customers.
PRODUCT LIABILITY
The Company has not established any allowance for product liability at present
because of the limited distribution of its product and limited history which
reflect no instance of problems with product liability.
RESEARCH AND DEVELOPMENT
Research and development expenditures include those costs associated with the
Company's on-going research and development activities. All research and
development costs are expensed as incurred.
INCOME TAXES
The Company is in a net deferred tax asset position and has generated net
operating losses to date. Accordingly, no provision for or benefit from income
taxes has been recorded in the accompanying statements of operations. The
Company will continue to provide a valuation allowance for its deferred tax
assets until it becomes more likely than not, in management's assessment, that
the Company's deferred tax assets will be realized.
F-7
<PAGE>
LOSS PER SHARE
Basic earnings per common share is computed using the weighted average number of
shares of common stock outstanding for the period. Diluted earnings per common
share is computed using the weighted average number of shares of common stock
and dilutive common equivalent shares related to stock options and warrants
outstanding during the period.
A net loss was reported in the both 1998 and 1997, and accordingly, the
denominator was equal to the weighted average outstanding shares with no
consideration for outstanding options and warrants to purchase shares of the
Company's common stock, because to do so would have been anti-dilutive. Stock
options for the purchase of 200,450 and 315,350 shares and warrants for the
purchase of 144,418 and 194,722 shares for the years ended December 31, 1998 and
1997, respectively, were not included in loss per share calculations, because to
do so would have been anti-dilutive. The Company also has 1,145 shares of Series
1998-B preferred stock outstanding, which may be converted into common stock
pursuant to the agreement under which it was issued. SEE NOTE 7. These common
equivalent shares have not been included in loss per share calculations, because
to do so would have been anti-dilutive
COMPREHENSIVE INCOME (LOSS)
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" (SFAS 130) during the first quarter of 1998.
This statement establishes standards for reporting and displaying comprehensive
income and its components in a full set of general purpose financial statements.
The objective of SFAS 130 is to report a measure of all changes in equity of an
enterprise that result from transactions and other economic events of the period
other than transactions with owners. Comprehensive loss did not differ from
currently reported net loss in the periods presented.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate fair value because of the short-term nature of
these instruments. Fair value estimates are made at a specific point in time,
based on relevant market information about the financial instrument when
available. These estimates are subjective in nature and involve uncertainties
and matters of significant judgment and therefore, cannot be determined with
precision.
Changes in assumptions could significantly affect the estimates.
CONCENTRATION OF CREDIT RISK
Financial instruments which subject the Company to concentrations of credit risk
consist primarily of trade receivables from large domestic and foreign
companies. Sales to two customers accounted for approximately 42% of total sales
in 1998. Sales to one customer accounted for approximately 17% of total product
sales in 1997. At December 31, 1998 accounts receivable from two customers
comprised 35% of total net accounts receivable. The Company's foreign sales in
1998 and 1997 were 37% and 41% of total sales, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Actual results could differ
from those estimates.
RECLASSIFICATIONS
Certain 1997 balances have been reclassified to conform with the current year's
presentation.
EFFECT OF RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). This statement establishes
accounting and reporting standards requiring that every derivative instrument be
recorded in the balance sheet as either an asset or liability measured at its
fair value. SFAS 133 also requires that changes in the derivative instrument's
fair value be recognized currently in results of operations unless specific
hedge accounting criteria are met. SFAS 133 is effective for fiscal years
F-8
<PAGE>
beginning after June 15, 1999. The Company expects that adoption of SFAS 133
will have no impact on the Company's financial condition or results of
operations.
2. SUBSTANTIAL DOUBT REGARDING ABILITY TO CONTINUE AS A GOING CONCERN
SIGNIFICANT OPERATING LOSSES - ACCUMULATED DEFICIT
Since July 1990, the Company has been engaged almost exclusively in research and
development activities focused on developing proprietary saliva based collection
devices and rapid assays for infectious diseases. Other than sales of the
Company's collection devices, the Company has not yet commenced any significant
product commercialization. The Company has incurred significant operating losses
since its inception, resulting in an accumulated deficit of $34,508,780 at
December 31, 1998. Such losses are expected to continue for the foreseeable
future and until such time, if ever, as the Company is able to attain sales
levels sufficient to support its operations. There can be no assurance that the
Company will achieve or maintain profitability in the future. Despite the
Company's stock financings in 1998 (SEE NOTE 7), substantial additional
financing will be required in 1999. There can be no assurances that such
financing will be achieved.
The Company's capital requirements have been and will continue to be
significant. The Company's capital base is smaller than that of many of its
competitors, and there can be no assurance that the Company's cash resources
will be able to sustain its business. The Company is dependent upon its effort
to raise capital to finance its future operations, including the cost of
development, manufacturing and marketing of its products, to conduct clinical
trials and submissions for FDA approval of its products and to continue the
design and development of its new products. Marketing, manufacturing and
clinical testing may require capital resources substantially greater than the
resources available to the Company. The Company will continue to seek public or
private placement of its equity securities and corporate partners to develop
products. The Company's future capital needs will depend upon numerous factors,
including the progress of the approval for sale of the Company's products in
various countries, including the United States, the extent and timing of the
acceptance of the Company's products, the cost of marketing and manufacturing
activities and the amount of revenues generated from operations, none of which
can be predicted with much certainty. The accompanying consolidated financial
statements have been prepared assuming that the Company will continue as a going
concern. The Company's significant operating losses and significant capital
requirements, however, raise substantial doubt about the Company's ability to
continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
3. RESTRUCTURING
Results of operations of 1997 included a charge associated with a restructuring
plan designed to reduce costs and improve manufacturing and operational
efficiencies. Under the plan, the Company closed its Singapore manufacturing
operations in October 1997. The Company has out-sourced manufacturing previously
performed in Singapore to qualified sources and locations. Total costs accrued
in connection with the restructuring were $279,000 and included approximately
$161,000 related to termination of employees, approximately $37,000 associated
with the settlement of the lease obligation in Singapore, $71,000 for other
costs related to closing the Singapore location and $10,000 non-cash charge for
the write-off of leasehold improvements. Accrued restructuring, included in
accrued expenses, was $13,040 at December 31, 1998, representing residual
amounts which will be paid during the statutory liquidation of the Singapore
subsidiary.
4. INVENTORIES
Inventories consisted of the following:
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
--------------- -----------------
<S> <C> <C>
Raw materials $ 140,394 $ 280,438
Work in process 31,701 11,569
Finished goods 33,697 166,170
--------------- -----------------
$ 205,792 $ 458,177
--------------- -----------------
--------------- -----------------
</TABLE>
F-9
<PAGE>
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
Office furniture and equipment $ 49,330 $ 57,988
Machinery and equipment 815,798 1,105,025
Leasehold improvements 38,631 71,568
Vehicles 81,828 164,774
Exhibits 5,826 30,955
----------- -----------
991,413 1,430,310
Less: accumulated depreciation
and amortization (782,463) (995,853)
----------- -----------
$ 208,950 $ 434,457
----------- -----------
----------- -----------
</TABLE>
6. ACCRUED EXPENSES
Accrued expenses consisted of the following:
<TABLE>
<CAPTION>
December 31,
------------------------------------
1998 1997
-------------- -------------
<S> <C> <C>
Accrued wages and salaries $ 429,513 $ 493,352
Accrued payroll taxes 107,357 92,144
Accrued restructuring expenses 13,040 135,522
Accrued litigation expenses 440,000 750,000
Accrued legal expense 508,210 331,554
Other accrued liabilities 106,416 2,926
-------------- -------------
$ 1,604,536 $ 1,805,498
-------------- -------------
-------------- -------------
</TABLE>
7. SHAREHOLDERS' DEFICIT
On August 3, 1998, the Company amended the Company's Certificate of
Incorporation declaring that each ten outstanding shares of the Company's common
stock be converted and reconstituted into one share of common stock. As a
result, all share amounts and per share amounts in these financial statements
have been restated to reflect the reverse stock split.
On February 20, 1997, at a Special Meeting of Shareholders, the shareholders of
the Company approved an amendment to the Company's Certificate of Incorporation
increasing the number of authorized shares of the Company's common stock, par
value $.01 per share, from 25,000,000 to 33,000,000 shares.
On November 21, 1997, at a Special Meeting of Shareholders, the shareholders of
the Company approved amendments to the Company's Certificate of Incorporation
(i) increasing the number of authorized shares of the Company's common stock,
par value $.01 per share, from 33,000,000 to 50,000,000, and (ii) authorizing
the creation of a new class of stock, designated "Preferred Stock." The
Preferred Stock is issuable in one or more series on terms and conditions to be
established by the Board of Directors of the Company. Designations, preferences,
conversion rights, cumulative rights, and relative, participation, optional and
other rights, including voting rights, qualifications, limitations or
restrictions, thereof, are determined by the Board of Directors of the Company.
1998 FINANCINGS
On January 26, 1998, the Company entered into a securities purchase agreement
with an investor for the issuance and sale of shares of its 1998-A Preferred
Stock. Pursuant to the securities purchase agreement, the Company sold a total
of 1,500 shares of the 1998-A Preferred Stock to the investor for an aggregate
purchase price of $1,380,000 (net of issuance costs of $120,000). The investor
is entitled to receive a number of shares
F-10
<PAGE>
of the Company's common stock upon conversion of the 1998-A Preferred Stock as
determined by dividing the purchase price of the 1998-A Preferred Stock by the
lesser of (i) $3.375, and (ii) 80% of the average closing bid price of the
Company's common stock for the five trading days prior to conversion. On July
30, 1998, the Company amended the Securities Purchase Agreement to eliminate the
redemption rights pursuant to the Securities Purchase Agreement for the 1998-A
Preferred Stock. As of December 31, 1998, all outstanding shares of the 1998-A
Preferred Stock had been converted into 1,804,251 shares of common stock.
In connection with the issuance and sale of the 1998-A Preferred Stock, the
Company entered into a separate registration rights agreement with the investor
under which the Company was required to file a registration statement covering
resales of shares of the common stock issuable upon conversion of the 1998-A
Preferred Stock. The Agreement provides that the Company will pay certain
amounts to the investor if the registration statement was not filed on or before
February 26, 1998 or was not declared effective by the Securities and Exchange
Commission by April 26, 1998. A registration statement on Form S-3 was filed on
February 26, 1998. Because the Company was no longer eligible to file on Form
S-3 due to the delisting of the Company's securities from Nasdaq, the Company
had filed pre-effective amendments to the registration statement on Form SB-2.
The terms of the 1998-A Preferred Stock provided that, if the registration
statement is not declared effective by April 26, 1998, the Company shall pay,
upon demand of the investor, an amount equal to two percent (2%) of the purchase
price of the 1998-A Preferred Stock for the period from April 26, 1998 until the
date the registration statement is declared effective. The investor has waived
the right to receive any such payment in exchange for 145 shares of the
Company's 1998-B Preferred Stock, which were issued to the investor on December
11, 1998. The value of these shares, $145,000, has been included as deemed
dividends on preferred stock in the accompanying consolidated financial
statements.
In connection with the issuance of the 1998-A Preferred Stock, the Company paid
a cash fee to the investor of 7.5% of the gross proceeds ($112,500) and
attorney's fees equal to 0.5% of the gross proceeds ($7,500). The Company also
issued warrants to the investor to purchase up to 75,000 shares of common stock
at an exercise price of $3.375 per share, which expire on January 26, 2003. The
fair value of these warrants of $248,250 has been reflected as a discount to the
1998-A Preferred Stock and was accreted as deemed preferred dividends over the
conversion period, which ended July 25, 1998. The investor was entitled to
receive a number of shares of the Company's common stock upon conversion of the
1998-A Preferred Stock as determined by dividing the purchase price of the
1998-A Preferred Stock by the lessor of (i) $3.375 or (ii) 80% of the average
closing bid price of the Company's common stock for the five trading days prior
to conversion. The fair value of this beneficial conversion feature, $300,000,
was recorded as a discount to the 1998-A Preferred Stock and was accreted to
deemed preferred dividends over the conversion period which ended July 25, 1998.
The following summarizes deemed dividends and earned dividends on the Series A
Preferred Stock and related accretion as of December 31, 1998.
<TABLE>
<CAPTION>
Total Accreted or Earned as of
Value December 31, 1998
-------- ------------------------
<S> <C> <C>
Beneficial conversion feature $300,000 $300,000
Issuance costs 120,000 120,000
Warrants 248,250 248,250
Preferred stock issued in settlement
of registration delay 145,000 145,000
Earned dividends (6% of preferred
principal value) 36,193 36,193
-------- --------
Total $849,443 $849,443
-------- --------
-------- --------
</TABLE>
F-11
<PAGE>
On August 3, 1998, the Company entered into a securities purchase agreement with
an investor for the issuance and sale of a total of 1,500 shares of Series
1998-B Preferred Stock for an aggregate purchase price of $1,410,000 (net of
issuance costs of $90,000). In August 1998, pursuant to the securities purchase
agreement, the Company sold a total of 500 shares of the 1998-B Preferred Stock
to the investor for an aggregate purchase price of $470,000 (net of issuance
costs of $30,000). The investor is entitled to receive a number of shares of the
Company's common stock upon conversion of the 1998-B Preferred Stock as
determined by dividing the purchase price of the 1998-B Preferred Stock by the
lesser of (i) $1.69, and (ii) 80% of the average closing bid price of the
Company's common stock for the five trading days prior to conversion. In
December 1998, the Company sold an additional 500 shares of the 1998-B Preferred
Stock to the investor for an aggregate purchase price of $470,000 (net of
issuance costs of $30,000) and issued an additional 145 shares of the 1998-B
Preferred Stock to the investor in satisfaction of certain obligations under the
terms of the 1998-A Preferred Stock and 1998-B Preferred Stock held by the
investor. Pursuant to a letter agreement entered into in April 1999 amending the
terms of the securities purchase agreement, the investor is obligated to
purchase an additional 500 shares of 1998-B Preferred Stock for an aggregate
purchase price of $470,000 (net of issuance costs of $30,000). The investor has
paid $200,000 of the aggregate purchase price and has agreed to pay the
remaining $270,000 of the purchase price upon the filing of a satisfaction and
release with the court in the lawsuit recently settled between the Company and
Luc Hardy.
The 1998-B Preferred Stock is convertible into common stock of the Company at a
beneficial conversion ratio and, as a result, a discount of $286,250 in the
aggregate, was recorded at the date of issuance of the 1,000 shares of the
1998-B Preferred Stock in 1998. The $286,250 discount will accreted to deemed
preferred dividends over the conversion period, which ends March 11, 1999.
In connection with the issuance of the 1998-B Preferred Stock, the Company
issued warrants to purchase up to 25,000 shares of Common stock at an exercise
price of $3.375 per share, which expire on January 26, 2003. The fair value of
these warrants of $253,750 was accreted to deemed preferred dividends over the
conversion period which ended November 1, 1998. The following summarizes deemed
dividends and earned dividends on the Series B Preferred Stock and related
accretion as of December 31, 1998.
<TABLE>
<CAPTION>
Total Accreted as of
Value December 31, 1998
-------- -----------------
<S> <C> <C>
Beneficial conversion feature $286,250 $188,334
Warrants 253,750 253,750
-------- --------
Total $540,000 $442,084
-------- --------
-------- --------
</TABLE>
1997 FINANCINGS
In March 1997, the Company raised net proceeds of approximately $1,380,000 (net
of issuance costs of $120,000) from the private sale of the 7.5% convertible
debentures due February 28, 1999 (the "Debentures"). In connection with the
issuance of the Debentures, the Company also issued warrants to Grayson &
Associates, Inc. ("Grayson") in consideration of certain financial consulting
services performed on behalf of the Company related to the sale of the
Debentures. The warrants entitle the holder thereof to purchase up to 8,955
shares of common stock from the Company for a purchase price of $13.40 per share
on or before March 14, 2002. (The warrantholder has certain demand and piggyback
registration rights with respect to the shares that may be issued upon exercise
of the warrants.) In May and June 1997, the holders of the Debentures agreed to
an acceleration of conversion and to hold the common stock issued pursuant to
such conversion (the "Early Conversion Shares") in accordance generally with the
original conversion schedule. On June 5, 1997, $800,000 in principal amount of
the Debentures were converted into a total of 83,360 shares of the Company's
common stock and on June 30, 1997 the remaining $700,000 in principal amount of
the Debentures were converted into a total of 90,323 shares of the Company's
common stock. A total of $29,395 of accrued interest on the converted Debentures
payable June 30, 1997 was paid to holders of the Debentures in the form of 2,760
shares of the Company's common stock. In addition, the Company
F-12
<PAGE>
agreed to certain conversion reset provisions, pursuant to which the holders of
the Early Conversion Shares may receive certain additional shares of the
Company's common stock under certain conditions. In accordance with such
provisions, one holder of the Debentures exercised his right to receive an
additional 5,720 shares on October 15, 1997 and 34,233 shares on January 9,
1998, and the other holder of the Debentures exercised its right to receive an
additional 30,592 shares on November 5, 1997 and 85,652 shares on January 9,
1998. No further rights or obligations for the issuance of common stock are
outstanding under the terms of the Debentures.
The number of shares of common stock issuable upon the conversion of the
Debentures was determined by dividing the principal amount of the Debentures
converted by the Conversion Price, as defined in the Debentures. The conversion
price was defined as the lesser of 115% of Company's common stock market price
at issuance of the Debenture (i.e. $19.191 per share) or 80% of the Company's
common stock market price at conversion of the Debenture.
A discount had been recorded at the date of issuance of the Debentures,
resulting from an allocation of proceeds to the discounted conversion feature,
which was to be amortized to interest expense over the conversion period.
Additionally, financing costs related to these Debentures were deferred and
amortized, using the effective interest method, over the term of the Debentures.
The discount and remaining unamortized financing costs of $375,000 and $99,800,
respectively, were written off to interest expense and additional paid in
capital, respectively, upon conversion of the Debentures.
On June 30, 1997, the Company entered into two separate common stock
subscription agreements for the issuance and sale of shares of the Company's
common stock pursuant to Regulation D, promulgated under the Securities Act of
1933, as amended (the "Offering"). Pursuant to a common stock Purchase Agreement
between the Company and certain investors named therein (the "Investors"), the
Company sold a total of 242,000 shares of common stock to the Investors for an
aggregate purchase price of $1,210,000, $612,500 of which was subscribed for by
Investors as of June 30, 1997. Pursuant to a Common Stock Purchase Agreement
between the Company and The Tail Wind Fund Ltd. ("Tail Wind"), the Company sold
a total of 41,291 shares of common stock to Tail Wind for an aggregate purchase
price of $300,000. The closing on $337,500 principal amount of the Offering to
the Investors and $300,000 principal amount of the Offering to Tail Wind took
place on July 14, 1997; the closing of $547,500 principal amount of the Offering
to the Investors took place on July 17, 1997; and the closing of the remaining
$325,000 principal amount of the Offering to the Investors took place on July
22, 1997.
On August 22, 1997, the Company entered into a Common Stock Subscription
Agreement for the issuance and sale of shares of the Company's common stock
pursuant to Regulation D, (the "August Offering.") Pursuant to a Common Stock
Purchase Agreement between the Company and an investor named therein (the
"August Investor") the Company sold a total of 125,000 shares of common stock
for an aggregate purchase price of $750,000. The Closing of the August Offering
took place on August 26, 1997.
Tail Wind and the August Investor are entitled to receive additional shares of
common stock under their respective agreements subject to certain conditions
related to the trading price of the Company's common stock during a specified
period. In accordance with such provisions, the August Investor exercised his
right to receive an additional 103,571 shares on December 16, 1997. Tail Wind
may still be able to exercise its rights under certain circumstances. The common
stock purchased in the Offering and the August Offering (collectively referred
to as "the Offerings") is subject to certain resale restrictions. In connection
with the Offerings, the Company also entered into separate registration rights
agreements with the Investors, Tail Wind, and the August Investor under each of
which the Company is required to file a registration statement covering resales
of shares of the common stock sold in the Offering within 30 days after the date
on which the closing relating to those shares occurred. A registration statement
on Form S-3 covering resales of such shares was declared effective on September
30, 1997. Because the Company is no longer eligible to file on Form S-3 due to
the delisting of the Company's securities from Nasdaq, the Company intends to
file a post effective amendment to the registration statement on Form SB-2.
F-13
<PAGE>
In connection with the Offerings, the Company paid a finder's fee to Grayson &
Associates, Inc. ("Grayson") of $104,800 in cash and warrants to purchase 16,160
shares of the Company's common stock for an exercise price of $5.00 per share,
and 3,303 shares of the Company's common stock for an exercise price of $7.2656
per share, all of which expire on June 30, 2002. The Company also issued to Tail
Wind warrants to purchase up to 10,000 shares of the Company's common stock,
exercisable at any time from January 1, 1998 to January 1, 2003, at an exercise
price of $10.00 per share. Grayson and Tail Wind have certain registration
rights with respect to the shares of common stock that may be issued upon
exercise of their respective warrants. The registration statement on Form S-3
which was declared effective on September 30, 1997, covered resales of these
shares.
NASDAQ DELISTING
Effective with the close of the market on March 10, 1998, the Company's
securities were delisted from The Nasdaq SmallCap Market for failure to meet the
new Nasdaq continued listing requirements. Trading in the Company's securities
is and will be conducted in the over-the-counter market on the OTC Bulletin
Board, an electronic bulletin board established for securities that do not meet
the Nasdaq listing requirements, or in what are commonly referred to as the
"pink sheets."(SEE ITEM 5 - MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS).
NOTE RECEIVABLE RELATED TO SALE OF STOCK
In January 1992, the Company sold to its President, who resigned in December
1996, 36,691 shares of common stock for $92,970 for a note payable to the
Company in that amount. In 1995, $9,145 of principal on the note was paid. The
note bore interest at 6% per annum, and was originally due December 1994, but
later extended until December 1995. In December 1995, the Company extended the
note for another year. The note was due on December 31, 1996 and, at December
31, 1998, $83,825 plus unpaid accrued interest was outstanding.
8. STOCK-BASED COMPENSATION PLANS
The Company has two stock option plans, a "1992 Plan", under which 35,000 shares
of its common stock have been reserved for issuance, and a "1994 Plan", under
which 35,000 shares of its common stock have been reserved for issuance. Under
both plans, the Company's Board of Directors may grant either incentive stock
options with an exercise price of not less than the fair market value of the
common stock at the date of grant or non-qualified stock options with an
exercise price of not less than 85% of the fair market value of the common stock
at the date of grant. The Board of Directors shall determine the period of each
option and the time or times at which options may be exercised and any
restrictions on the transfer of stock issued upon exercise of any options. Both
plans also provide for certain automatic grants to each non-employee director at
a price of 100% of fair market value of the common stock at the time of grant.
Options generally vest over a period of six months and are exercisable over a
period of five years.
The following table summarizes all stock option activity for options granted
under the 1992 Plan and the 1994 Plan, and for non-plan options, during the
years ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>
Number of Option Price
Shares Range
-------- --------------
<S> <C> <C>
Outstanding at December 31, 1996 181,525 $4.30 - $68.75
Options granted 175,000 4.06
Options exercised (715) 4.30 - 6.00
Options expired or canceled (40,460) 4.30 - 23.80
-------- --------------
Outstanding at December 31, 1997 315,350 4.06 - 68.75
Options granted -- --
Options exercised -- --
Options expired or canceled (114,900) 6.00 - 68.75
------- --------------
Outstanding at December 31, 1998 200,450 $4.06 - $26.25
------- --------------
------- --------------
</TABLE>
F-14
<PAGE>
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
The Company has adopted the disclosure provisions of Financial Accounting
Standards Board Statement No. 123 ("SFAS 123") which defines a fair value based
method of accounting for employee stock options and similar equity instruments
and encourages all entities to adopt that method of accounting for all employee
stock-based compensation plans. However, SFAS 123 also allows an entity to
continue to measure compensation cost for such plans using the method of
accounting prescribed by Accounting Principles Board Opinion No. 25 ("APB 25").
Entities electing to remain with the accounting as prescribed by APB 25 must
make pro forma disclosures of net income and, if presented, earnings per share,
as if the fair value based method of accounting defined in SFAS 123 had been
adopted.
The Company has elected to account for its stock-based compensation plans using
APB 25. The Company has computed, for pro forma disclosure purposes, the value
of options granted during fiscal year 1997 using the Black-Scholes pricing
model. No options were granted in 1998.
The following weighted average assumptions were used in the computations for the
year ended December 31, 1997:
<TABLE>
<CAPTION>
1997
----------------
<S> <C>
Expected dividend yield 0%
Expected stock price volatility 203%
Risk-free interest rate 6%
Expected life of options - years five
</TABLE>
The total value of options granted during 1997 was $805,000, which vested upon
grant. The weighted average fair value of options granted during 1997 was $4.60.
If the Company had accounted for its stock-based compensation plans in
accordance with SFAS 123, the Company's net loss and net loss per share would
have approximated the pro forma amounts show below:
<TABLE>
<CAPTION>
1998 1997
---------------- -----------------
<S> <C> <C>
Net loss available to common stockholders as reported $ (5,982,322) $ (6,612,212)
Net loss available to common stockholders pro forma (5,982,322) (7,017,212)
Loss per share as reported (1.50) (2.66)
Loss per share pro forma (1.50) (2.82)
</TABLE>
The effect of applying SFAS 123 in this pro forma disclosure is not indicative
of future results. SFAS 123 does not apply to awards prior to January 1, 1995.
F-15
<PAGE>
The following table summarizes the information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- --------------------------------------------------------------------- --------------------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Exercise Number Exercise
Exercise Prices Outstanding at Contractual Price Exercisable at Price
Per Share Dec. 31, 1998 Life (Months) Per Share Dec. 31, 1998 Per Share
--------- ------------- ------------- --------- ------------- ---------
<S> <C> <C> <C> <C> <C>
$4.06 - $6.00 180,100 104.1 $ 4.12 180,100 $ 4.12
$13.75 15,000 5.5 $13.75 15,000 $13.75
$21.88 - $26.25 5,350 3.8 $23.45 5,350 $23.45
------------- --------------
200,450 200,450
------------- --------------
------------- --------------
</TABLE>
The following table summarizes the information about warrants outstanding at
December 31, 1998:
<TABLE>
<CAPTION>
Number of Warrant Price
Warrants Range
-------------- ----------------
<S> <C> <C>
Outstanding at December 31, 1996 153,000 $1.00 - $1.25
Warrants granted 41,722 0.50 - 1.34
-------------- ----------------
Outstanding at December 31, 1997 194,722 0.50 - 1.34
Warrants granted 100,000 3.375
Warrants cancelled (147,000) 1.00 - 1.25
-------------- ----------------
Outstanding at December 31, 1998 147,722 $0.50 - $3.375
-------------- ----------------
-------------- ----------------
</TABLE>
Of the above warrants, 60,000 are exercisable at 50% of the Nasdaq closing bid
price of the day before exercise.
9. INCOME TAXES
The Company is in a net deferred tax asset position and has generated net
operating losses to date. Accordingly, no provision for or benefit from income
taxes has been recorded in the accompanying statements of operations. The
Company will continue to provide a valuation allowance for its deferred tax
assets until it becomes more likely than not, in management's assessment, that
the Company's deferred tax assets will be realized.
The Company has a net operating loss carryforward of approximately $24 million
which is available to offset future taxable income, if any, expiring through the
year 2017. The Internal Revenue Code rules under Section 382 could significantly
limit the future use of these losses based on ownership changes and the value of
the Company's stock.
10. LONG-TERM DEBT
The Company has a note payable to a bank which bears interest at 6.94% per annum
and is payable in equal annual installments over 60 months. At December 31,
1998, the note was secured by a time deposit in the amount of $59,240. The note
was paid by the Company in January 1999, using the time deposit.
F-16
<PAGE>
11. OPERATING LEASES
The Company leases its offices and laboratory spaces, under operating leases
with initial terms of three to seven years. Future minimum lease payments by
year and in the aggregate, under noncancelable operating leases with initial or
remaining lease terms in excess of one year, consisted of the following at
December 31, 1998:
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------
<S> <C>
1999 $ 170,819
2000 170,640
2001 166,433
2002 121,559
Thereafter 7,953
-------------
$ 637,404
-------------
-------------
</TABLE>
Rent expense for the years ended December 31, 1998 and 1997 was $197,942 and
$330,920, respectively.
12. SEGMENT AND GEOGRAPHIC INFORMATION
in 1998, the Company adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131). SFAS 131 establishes standards for reporting information about
operating segments and related disclosures about products and services,
geographic areas and major customers. The Company operates exclusively in one
segment. Substantially all revenues result from the sale of rapid in-vitro
assays, proprietary specimen collection devices and other diagnostic devices.
SEE NOTE 1 - CONCENTRATION OF CREDIT RISK.
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1998 1997
--------------- ----------------
<S> <C> <C>
Product sales:
United States $ 766,460 $ 584,467
Asia - 453,308
United Kingdom 141,497 384,521
--------------- ----------------
Total $ 907,957 $ 1,422,296
--------------- ----------------
--------------- ----------------
Operating loss:
United States $ (4,149,777) $ (5,734,653)
Asia (126,762) (225,307)
United Kingdom (458,094) (259,349)
--------------- ----------------
Total $ (4,734,633) $ (6,219,309)
--------------- ----------------
--------------- ----------------
Identifiable assets:
United States $ 780,556 $ 1,422,034
Asia 10,730 -
United Kingdom 69,233 217,043
--------------- ----------------
Total $ 860,519 $ 1,639,077
--------------- ----------------
--------------- ----------------
Depreciation and amortization:
United States $ 209,348 $ 198,728
Asia 195 23,181
United Kingdom 4,360 3,697
--------------- ----------------
Total $ 213,903 $ 225,606
--------------- ----------------
--------------- ----------------
</TABLE>
F-17
<PAGE>
13. COMMITMENTS AND CONTINGENCIES
In February 1998, Lealos v. Saliva Diagnostic Systems, Inc. was filed in
Superior Court in Clark County in the State of Washington by Ronald Lealos,
former President and CEO of the Company. The complaint alleged that Mr. Lealos
was entitled to certain cash payments and benefits under an employment agreement
whereby he would serve as the Company's president, and that the Company's
failure to make such payments and grant such benefits constituted anticipatory
breach and breach of that contract. The complaint sought damages in excess of
$1,000,000. In addition, the complaint alleged that the Company wrongfully
rescinded options to purchase 38,500 shares of common stock in breach of a stock
option agreement with Mr. Lealos. The Company denied all allegations of the
complaint and filed a counterclaim for Mr. Lealos' wrongful conduct seeking
damages of approximately $1,500,000. In December 1998, the Company filed a
motion for summary judgment on the claims stated in the complaint. The Court
granted the motion in February 1999 in favor of the Company. Subsequently, Mr.
Lealos has moved to amend the original complaint to allege new grounds for
recovery of lost compensation, including quantum meruit. This Court granted this
motion in February 1999. A trial based on the amended complaint and the
Company's counterclaims is scheduled for October 1999. The Company intends to
file a motion to dismiss the amended complaint prior to the trial date. Although
management of the Company intends to vigorously defend against the suit, there
can be no assurance that the litigation will not be decided adverse to the
Company and that such an adverse decision would not have a material adverse
effect on the Company.
Immuno chromatography, the principle on which the Company's rapid tests are
based is a technology covered by existing patents. The Company has purchased a
license from the principal patent holder, Unilever PLC of the U.K., to whom
royalty payments are due for all rapid tests sold. To obtain the license, the
Company paid approximately $50,000 and will be responsible for royalty fees
equal to 5% of the net sales in all territories where the Unilever patent is
enforceable. Products covered by the license include those related to HIV,
H.pylori, Tuberculosis and Hepatitis A. In 1998, royalties of approximately
$26,000 were paid to Unilever PLC.
14. RELATED PARTIES
A member of the Board of Directors is a partner in a law firm which provides
legal services to the Company. During 1998 and 1997, the Company incurred
$463,650 and $437,863, respectively, in services provided by this law firm.
As of December 31, 1998, the Company owed International Business Consultants,
$75,000 (of a total of $180,000 due for 1998) under a management consulting
agreement, under which International Business Consultants provides the services
of Ken McLachlan, the Company's President and Chief Executive Officer, to the
Company. International Business Consultants is a Jersey company in which Ken
McLachlan is a principal.
15. SUBSEQUENT EVENTS
On March 2, 1999, 500 shares of convertible preferred stock were converted into
1,364,516 shares of common stock, which included 45,951 shares of common stock
in lieu of dividends.
HARDY V. SALIVA DIAGNOSTIC SYSTEMS, INC., RONALD L. LEALOS, EUGENE SEYMOUR AND
RICHARD S. KALIN, was filed in United States District Court, District of
Connecticut in August 1994 by Luc Hardy, a former director and officer of the
Company. The complaint alleged several causes of action against the Company and
individual defendants, including former directors and officers of the Company,
including breach of Mr. Hardy's employment agreement with the Company,
intentional interference with contract by the individual defendants, slander and
deceptive trade practices, all arising from his employment termination by the
Company. A judgment was entered against the Company on March 23, 1999 for
approximately $1,675,000. Pursuant to a settlement agreement dated March 25,
1999, the Company issued approximately 1,500,000 shares of its common stock and
will pay approximately $290,000 in cash over a two-year period
F-18
<PAGE>
to Mr. Hardy. Under the settlement agreement, the Company is obligated to issue
additional common shares or cash if the value of the common shares granted and
cash issued is less than certain amounts as specified in the settlement
agreement (not to exceed $1,675,000). The Company has recorded the maximum
guaranteed value under the settlement agreement in the accompanying financial
statements. As a part of this settlement, Mr. Hardy has agreed to enter into a
two-year consulting agreement pursuant to which Mr. Hardy will provide
consulting services to the Company. The settlement agreement provides that Mr.
Hardy will file a satisfaction and release of the judgment upon the Company
issuing the 1,500,000 shares of common stock, filing a registration statement
covering resales of those shares by April 30, 1999 and paying $50,000 to Mr.
Hardy by June 24, 1999. On March 29, 1999, Mr. Hardy filed a motion for
reconsideration of the Court's rulings that denied double damages on certain
damages awarded to Mr. Hardy and denied offer of judgment interest on the
prejudgment interest award. The Company is currently awaiting a decision on
these motions. There can be no assurance that such motions will not be granted
or that the grant of such motions will not have a further material adverse
effect on the Company.
In February 1999, a demand for arbitration with the American Arbitration
Association was filed by Fremont Novo Sciences, LLC, former distributor of the
Company's products in India. The demand alleges that the Company wrongfully
terminated and breached the Sub-License Agreement among the Company, SDS
Singapore and Fremont. The demand seeks a declaration that the Sub-License
Agreement remains in effect and damages in an amount to be determined, including
lost profits. In April 1999, the Company filed an answering statement denying
Fremont's claims and seeking damages in an amount to be determined for Fremont's
breach and non-performance of the Sub-License Agreement and for tortious
interference with the Company's business and contracts. Although management of
the Company intends to vigorously defend against Fremont's allegations and
pursue its claims against Fremont, there can be no assurance that the
arbitration will not be decided adverse to the Company and that such an adverse
decision would not have a material adverse effect on the Company.
F-19
<PAGE>
EXHIBIT 4.24
Saliva Diagnostic Systems, Inc.
11719 NE 95th Street
Vancouver, WA 98682
December 11, 1998
Biscount Overseas Limited
c/o Moishe Bodner, Aryeh Trading, Inc.
310 Madison Avenue, Suite 501
New York, NY 10017
Dear Moe:
This letter is to confirm our agreement to resolve open issues
about penalties under Section 2(b) of the Securities Purchase Agreement dated as
of January 26, 1998, as amended by the Amendment to Securities Purchase
Agreement dated as of July 30, 1998, each between Biscount and SDS.
The Registration Statement referred to in Section 2(b) of the
Agreement was made effective on December 9, 1998, which was approximately seven
months following the Required Effective Date. During this period, the SEC
ordered a full review of the Registration Statement, which was not anticipated
by SDS or Biscount and contributed to this delay. Further, for one of those
months, the Company was not required to request that the Registration Statement
be declared effective because it contained information required to be disclosed
in a 1934 Act report not yet filed by the Company. Thus, penalties have been
triggered for approximately six months in the aggregate amount of $180,000.
You have agreed to accept shares of 1998-B Preferred Stock in
lieu of cash as payment of such penalties. We have agreed to issue to you 145
shares of 1998-B Preferred Stock, which takes into account the additional value
you receive in the conversion discount and liquidation preference features of
the 1998-B Preferred Stock. This settlement satisfies all obligations regarding
penalties under Section 2(b) of the Agreement.
Please confirm that you agree with the above by signing below
and returning this letter to us. By your signature, you represent and warrant
that you have been authorized to sign and agree on behalf of Biscount Overseas
Limited. Thank you.
Sincerely yours,
/s/ Kenneth J. McLachlan
Kenneth J. McLachlan
Agreed and accepted:
Biscount Overseas Limited
By: Aryeh Trading Inc.
By: /s/ Moishe Bodner
------------------
Name: Moishe Bodner
Dated: December 11, 1998
<PAGE>
EXHIBIT 4.25
Saliva Diagnostic Systems, Inc.
11719 NE 95th St.
Vancouver, WA 98682
April 23, 1999
Moishe Bodner
International Securities Corp.
310 Madison Ave., Suite 501
New York, NY 10017
Dear Mr. Bodner
This letter will confirm SDS' agreement to modify the terms of the payment by
you and your group of the last tranche of funding for the Series B Preferred
Stock. We have agreed your $500,000 will be wired to SDS' account as follows:
1. $200,000 will be wired immediately, or no later than Monday, April 24,
1999.
2. The $200,000 payment shall be earmarked for payment of costs needed to file
the company's 10-K and follow-on pending registration statements due for
filing for the common stock associated with your investment and the common
stock to be issued to Luc Hardy in connection with his settlement agreement
with the company. Specifically, $30,000 each will be paid to the
accountants and attorneys. Up to $90,000 will be paid to current accounts
payable. Finally, $50,000 will be used exclusively for marketing and sales
activities.
3. Upon completion of the Luc Hardy settlement and the filing by Hardy of the
requisite documentation to effect satisfaction of judgment against the
company and dismissal of all judicial proceedings against the company, you
will wire transfer the balance due, i.e. net proceeds of $270,000.
4. In connection with ongoing business operations, the company agrees that the
net proceeds of this tranche of financing will be used for payment of
obligations incurred in the ordinary course of business on a going forward
basis. In the absence of any additional capital raised in excess of the
current payment by you, management agrees that accrued fee obligations due
management shall be repaid only after the company has achieved $3MM in
annualized sales and then only 50% of any operating profit shall be
available to repay accrued obligations to management. Once the company has
achieved $5MM or more in annualized sales, any constraint on payment of
accrued obligations to management shall terminate. Management shall be
fairly compensated with options to company stock for the agreement to
commitments to defer fees due them.
Nothing in this letter is intended to otherwise amend or modify the terms and
conditions of the Series B Preferred Stock purchase and registration rights
agreement between us.
With kindest regards,
Saliva Diagnostic Systems, Inc.
/s/ Stefan L. Paskell
Stefan L. Paskell
Executive Vice President
General Manager
<PAGE>
Accepted and agreed:
Biscount Overseas Limited
By: Aryeh Trading, Inc.
By: /s/ Moishe Bodner
<PAGE>
DISTRIBUTION AGREEMENT
This Agreement is entered into this 18th day of January, 1999 by and between
Saliva Diagnostic Systems, Inc. ("SDS"), Vancouver, Washington, USA; and Cadila
Healthcare, Ltd. ("Cadila"), India.
RECITALS
SDS manufactures a series of diagnostic devices and tests using saliva and blood
to test for the presence of a number of substances. These include
Hema-Strip-TRADEMARK- HIV 1/2, Sero-Strip-TRADEMARK- HIV 1/2,
Saliva-Strip-TRADEMARK- HIV 1/2, which test for the presence of HIV and
Stat-Simple-TRADEMARK- PYLORI.
A. SDS wishes to sell these devices ("the Products") through a Cadila who can
demonstrate to SDS's satisfaction the capacity to sell the Products in
substantial volumes and in a manner that will preserve and enhance the
valuable reputation and goodwill associated with SDS and/or the Products.
B. Cadila wishes to be a distributor authorized to sell the Products in the
Territory (see 1.1).
AGREEMENT
In consideration of the mutual promises below, the parties agree as follows:
1. APPOINTMENT
1.1 TERRITORY. SDS appoints Cadila as it exclusive Distributor for
the sale of the Products in the country/countries listed below
(the "Territory"), provided certain performance standards are
met by the Cadila, and the Cadila accepts such appointment
subject to the terms and conditions set forth herein.
Territory: INDIA, NEPAL, BANGLADESH, AND SRI LANKA
1.2 "The Products" includes existing products that are rapid strip
tests in the format of Sero-Strip-TRADEMARK- HIV 1/2,
Hema-Strip-TRADEMARK- HIV 1/2, Saliva-Strip-TRADEMARK- HIV 1/2
and Stat-Simple-TRADEMARK- PYLORI manufactured by SDS. Future
products to be marketed or introduced in the territory by SDS
shall be first offered to the Distributor.
1.3 INDEPENDENT DISTRIBUTOR. Cadila is an independent business and
neither has, nor will have, any power, right or authority, nor
will Cadila represent that it has any power, right, or
authority, to bind SDS or to assume or to create any obligation
or responsibility, express or implied on behalf of SDS.
Nothing stated in this Agreement shall be construed as
constituting Cadila and SDS as partners, joint ventures or as
creating relationships of employer and
1
<PAGE>
employee, master and servant, or principal and agent between
the parties.
1.4 RIGHT TO DISTRIBUTE THE PRODUCTS. This Agreement gives Cadila
the right to purchase the Products from SDS and to resell them
to purchasers within the Territory in accordance with the terms
and conditions of this Agreement. Cadila's compensation, if
any, will come from the margin between the price it pays SDS
for the Products and the price at which it sells those
products. Cadila has no right to any compensation from SDS.
2. TERM.
This Agreement shall take effect on the date first written above and shall
be for a period of five (5) years, with a five (5) year renewal option to
be negotiated 180 days prior to expiration of the first five (5) year term.
2.1 INTENT. SDS intends that this Distribution Agreement would be
transferred in the case of any change in ownership of SDS, and that
the Cadila would continue to represent the products as approved in the
Territory.
3. CADILA OBLIGATIONS.
3.1 BEST EFFORTS. Cadila agrees to use its best efforts to sell
the Products and to encourage the purchase of the Products by Cadila's
customers in the Territory. Cadila agrees to sell no similar products
in the Territory that has been defined in Section 1.1 and to sell no
products that directly compete with SDS products.
CADILA AGREES TO:
3.2 Prominently display SDS products in technical exhibits, catalogs
and sales bulletins.
3.3 Submit to SDS Technical Support details of customer complaints.
3.4 Maintain a dialog with SDS regarding customer satisfaction,
market problems and opportunities, and competitive information.
3.5 For planning and inventory control purposes only, provide a
quarterly forecast of required products. Significant changes to the
proposed forecast should be reported to SDS as early as possible to
allow changes to SDS's manufacturing schedules.
3.6 Provide marketing plan and update review quarterly.
3.7 Provide SDS with competitive information which may influence
market conditions.
2
<PAGE>
3.8 Provide SDS with information on new legislation or other
regulatory requirements (importation rules, labeling issues, etc.)
likely to impact sales of the Products within the Territory.
3.9 In the event of termination by either party, the business that
is then in existence will be smoothly transferred to SDS or its
designate, including, but not limited to, all samples, customer lists,
literature and promotional materials then held by the Cadila.
3.10 SALES FORCE. Cadila agrees to employ and maintain its own
knowledgeable full-time sales force of sufficient size in relation to
its anticipated sales volume. Cadila's sales staff will possess and
maintain knowledge and expertise concerning the Products that is
reasonably satisfactory to SDS.
3.11 REGULATORY APPROVAL; VALIDATION STUDY. Cadila is responsible
for obtaining all Government regulatory approvals (if any) necessary
to market the Products in the Territory. As part of the approval
process, Cadila shall conduct validation studies of the Products in
the Territory if required by law in the Territory, and in accordance
with a protocol mutually agreed upon by Cadila and SDS. Cadila agrees
that the results of those validation studies shall be made available
to SDS, who at its sole discretion may choose to use the data in
support of other clinical trials, including, but not limited to, US
FDA trials.
3.12 FAILURE TO GAIN APPROVAL IN A TERRITORY. If for any reason and
for any product, any of the clinical trials fail in any of the
assigned territories, such failure will mutually void this Cadila
Agreement for that product in that specific country. The Agreement
for other products in the territory will still remain in full force
and effect for approved products.
3.13 INTERNET SALES. Cadila agrees that it will not embark upon
sales over the Internet without the express written permission of SDS.
Cadila and SDS will work together to produce a suitable Internet
strategy for marketing the products, if appropriate in the Territory,
which does not infringe any local or International rules or
guidelines.
4. SDS OBLIGATIONS.
4.1 SALES OF THE PRODUCTS. SDS agrees to sell the Products to
Cadila with at least three-fourths (3/4ths) shelf life available on
delivery to Cadila, pursuant to orders SDS receives from Cadila in
accordance with the terms of this Agreement. Cadila shall not sell,
market or otherwise transfer the products outside the territory, nor
shall it sell, market or otherwise transfer the products to any third
persons when it knows, or has reason to know, that said third persons
intend to sell, market or otherwise transfer the products outside the
territory.
4.2 TECHNICAL SUPPORT. SDS agrees to provide Cadila with
reasonable technical support and advice for marketing the Products, if
requested.
3
<PAGE>
4.3 TECHNICAL DATA AND ASSISTANCE. SDS agrees to provide Cadila
with all technical data and assistance reasonably required by the
Government in the Territory in order to receive regulatory approval to
market the Products, provided that SDS shall not be obligated to
disclose such information if it cannot be assured that (a) the
information will be treated confidentially in the manner described in
Section 14 and (b) the information shall not be publicly available.
All information provided to the Governments within the Territory or
their Cadila clients shall be considered confidential and subject to
the provisions of Section 13.
4.4 Provide technical training and support to the Cadila and will
make its facility in Vancouver, Washington, USA available to Cadila
representatives and/or customers.
5. PRICES/SHIPMENT.
5.1 SDS will sell Sero Strip for $0.80 USD/test FOB Vancouver,
Washington, USA. Cadila is required to have full value insurance in
place for all products shipped from SDS.
6. PAYMENT TERMS.
Cadila will pay the full purchase price, including the cost of shipping
incurred by SDS, if any, which SDS voluntarily incurs on Cadila's behalf, for
product "FOB site of Manufacture." Cadila will prepay the full purchase
price for 40,000 tests per month for the first two months following receipt of
Form 10, or in any event no later than 4 weeks following receipt of Form 9.
Payment for subsequent orders will be by Draft Against Documents ("DA"), with
funds to be wired 30 days following receipt of faxed shipping documents from SDS
by the Bank. Wire transfer will be initiated no later than on the 30th day
following receipt of faxed shipping documents, as above, from the Bank of
Baroda.
Funds shall be wired to:
First Independent Bank
Battle Ground Branch
Battle Ground, Washington USA
ABA 123-305-378
SWIFT number: BOFAUS6P
Account of: Saliva diagnostic Systems, Inc.
Account Number: 02-002093
Bank phone: 360-699-4348
Attention: Mary Ellen White, Branch Manager
4
<PAGE>
or to whatever bank SDS subsequently identifies to Cadila. SDS shall
expeditiously send original shipping documents to Cadila's Bank.
7. MINIMUM PURCHASE QUOTAS.
7.1 FIRST TWO YEARS: SeroStrip: 40,000 per month and total of
400,000 tests in year-1 and 560,000 tests in year-2. HemaStrip HIV
and H. Pylori: quotas to be negotiated within three months of the
signing of this Agreement.
7.2 SUBSEQUENT YEAR. Cadila and SDS will establish a minimum
purchase quota for each of the subsequent years of this Agreement
within three months prior to the beginning of the third year.
8. PATENT AND TRADEMARK PROTECTION.
8.1 PATENT ASSISTANCE. SDS is pursuing the possibility of patent
or similar protection under the laws of the United States, and other
countries. Cadila will provide SDS with reasonable assistance in
obtaining patent rights in the Territory, and acknowledges the
validity of any such rights.
8.2 USE OF TRADEMARKS. Cadila acknowledges that the trademark
Sero-Strip-TRADEMARK- HIV 1/2, Hema-Strip-TRADEMARK- HIV 1/2,
Saliva-Strip-TRADEMARK- HIV 1/2 and Stat-Simple-TRADEMARK- PYLORI and
other trademarks and registrations and design marks used by SDS are
the sole property of SDS. Cadila shall not use SDS's trademarks and
registrations except in the normal course of advertising or selling
the Products and except in the manner approved by SDS. Upon
termination of this Agreement, Cadila shall cease completely all use
of SDS's trademarks. Cadila will immediately inform SDS by written
notice of any infringement of SDS's trademarks and registrations that
Cadila becomes aware of and, at SDS's request and expense, cooperate
with SDS as SDS deems it necessary to protect its trademarks and
registrations against such infringement.
9. WARRANTY AND DISCLAIMER.
9.1 PRODUCT DESCRIPTION AND SPECIFICATIONS. the Products are
warranted to Cadila to be consistent with the product description and
specifications supplied to Cadila. Units that do not conform will be
replaced by SDS without charge, or shall refund the Landed costs of
the units of the products that do not conform to specifications,
unless nonconformation is due to the actions of Cadila or a third
party.
9.2 LIMITED WARRANTY, INDEMNIFICATION, ETC.
a) SDS warrants that the products delivered to Cadila conform
to the specifications of the products as described in the
respective product protocols (package inserts) (i) at the time
of delivery and (ii) for at least twelve (12) months from the
date of manufacture provided that the products are stored under
proper conditions
5
<PAGE>
according to the specifications and other instructions provided
by SDS.
In the event that the products do not conform to such
specifications within the allotted time frame and such failure
does not result from the fault, negligence or willful
misconduct of the Cadila, SDS shall at its costs replace them
immediately upon written request by Cadila.
b) Cadila warrants that it will abide by all local rules and
regulations in each country in which it sells the products.
c) Cadila shall instruct its affiliates, subdistributors (if
appropriate) and customers to store and handle the products in
accordance with the specifications.
Cadila shall not grant any warranty to any third party which
exceeds the warranty granted herein without indemnifying SDS
for such warranty.
THIS WARRANTY IS IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR
IMPLIED, REGARDING THE PRODUCT, INCLUDING THE IMPLIED
WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR
PURPOSE.
10. LIMITATION OF REMEDIES AND LIABILITY.
SDS shall not be liable to Cadila or any person for SDS's failure to fill
any orders, for error in filling orders, or for any delay in delivery.
SDS's liability to Cadila for defective products is limited to SDS's
obligations under Section 9 and its standard written warranty, if any. In
no event shall SDS be liable for cost of procurement, substitute goods,
loss of profits, or for any other special, consequential, or incidental
damages, however caused.
11. TERMINATION.
11.1 TERMINATION FOR CAUSE. Either party may terminate this
Agreement for just cause: (a) upon any breach of this Agreement by the
other party if the breach is not cured within ninety (90) days written
notice of the breach or (b) immediately upon either party's
insolvency, bankruptcy, suspension of business, assignment of assets
for the benefit of creditors, voluntary dissolution, or appointment of
a trustee for all or a substantial portion of the party's assets.
11.2 FAILURE TO MEET MINIMUM QUOTAS. SDS may terminate this
Agreement immediately upon Cadila's failure to make at least 80
percent of its yearly purchase requirements. Purchase requirements
shall be 400,000 tests during year 1 and 560,000 tests during year 2.
6
<PAGE>
11.3 SURVIVAL. Upon termination or expiration of the term of this
Agreement, the rights and obligations of the parties under this
Agreement shall end, and neither party shall have any claim, including
any claim for termination damages, against the other; provided,
however, that the following obligations shall survive termination of
the Agreement; (a) Cadila's payment obligations specified in
Section 6; (b) Cadila's trademark protection obligations specified in
Section 8; (c) SDS's warranty obligations specified in Section 9; (d)
Cadila's indemnity obligations specified in Section 14.4; and (e) the
mutual attorneys' fees obligation specified in Section 14.6.
12. TAXES, DUTIES, IMPORT PERMITS, APPROVALS.
Cadila shall have the sole responsibility to pay all import duties and
fees, taxes and other charges levied by Government authorities in the
Territory upon or in connection with any transaction covered by this
Agreement, including, without limitation, taxes on sales, use, transactions
or inventory, and value-added taxes. Cadila shall have the sole
responsibility to obtain all permits, licenses and approvals from
Government authorities necessary to import and sell the Products in the
Territory, or to return any of the Products to SDS. Cadila shall also have
the sole responsibility to comply with any requirement to file this
Agreement with any Government authority in the Territory or to obtain the
approval of any Government authority in the Territory for this Agreement.
If any Government authority in the Territory invalidates any portion of
this Agreement, SDS shall have the option to terminate this Agreement
immediately by written notice to Cadila.
13. CONFIDENTIAL INFORMATION.
13.1 ACCESS TO INFORMATION. Cadila acknowledges that during the
term of this Agreement, it may have access to proprietary information,
trade secrets, and other confidential information of SDS, that such
information is a valuable asset of SDS and that its disclosure or
unauthorized use will cause SDS substantial harm. As used in this
Agreement, the term "Confidential Information" means: (1) proprietary
information of SDS; (2) information marked or designated by SDS as
confidential; (3) information, whether or not in written form and
whether or not designated as confidential, which is known to Cadila as
being treated by SDS as confidential; and (4) information provided to
SDS by third parties which it is obligated to keep confidential.
13.2 NONDISCLOSURE AND NONUSE. Cadila agrees that it will not
disclose to others or use any Confidential Information, unless and
until, and then only to the extent that, such items become available
to the public, other than by its act or failure to prevent accidental
or negligent loss or release to any unauthorized person of the
Confidential Information.
13.3 REMEDIES. Notwithstanding the provisions of Section 14.8, in
the event of the breach by Cadila of the terms of this Section 13, SDS
shall be entitled to specific performance, including immediate
issuance of a
7
<PAGE>
temporary restraining order or preliminary injunction, and to any
other remedies provided by law.
13.4 DURATION. The obligations set forth in this Section 13 will
continue beyond the term of this Agreement and for so long as Cadila
possesses Confidential information.
14. GENERAL PROVISIONS.
14.1 NONASSIGNMENT. Cadila will not assign, transfer, or sell its
rights under this Agreement, or delegate its duties hereunder, without
prior written consent of SDS. A transfer of a controlling interest in
Cadila shall constitute an assignment. SDS will not assign, transfer,
or sell its rights to this Agreemnt or delegate its duties hereunder
without prior written consent of Cadila.
14.2 ENTIRE AGREEMENT/MODIFICATION. This Agreement contains the
entire Agreement between the parties, and unless otherwise provided in
this Agreement, no modification or waiver of any of the provisions, or
future representation, promise, or addition shall be binding upon the
parties unless made in writing and signed by both parties. The terms
and conditions of this Agreement will prevail over any inconsistent or
additional terms contained in Cadila's purchase order or any other
document.
14.3 WAIVER. SDS may waive in writing any obligation Cadila has
under this Agreement, but such a waiver will not affect SDS's right to
require strict compliance with the Agreement in the future.
14.4 INDEMNIFICATION/INSURANCE. Cadila and SDS shall indemnify and
hold SDS and Cadila, their respective officers, directors, agents, and
employees harmless from any claims, demands, loss, damage, liability,
or expense, including attorneys' fees at trial, on appeal, and on any
petition for review, arising out of the acts or omissions of Cadila or
SDS, their agents or employees.
14.5 NOTICES. Any notice or report shall be deemed given if
delivered personally or by confirmed telex or facsimile to:
SDS (Saliva Diagnostic Systems, Inc.)
11719 N.E. 95th Street
Vancouver, WA 98682 USA
Phone 360-696-4800
FAX 360-254-7942
8
<PAGE>
Cadila Healthcare Ltd
201-203, 'Saffron',
Ambawadi,
Ahmedabad - 380 006, India
Phone: 656 43 73
FAX : 656 16 59
14.6 ATTORNEYS' FEES. In the event of a default under this
Agreement, the defaulting party will be liable for all expenses in
connection with the default, including without limitation attorneys'
fees. Additionally, in the event any suit or action is brought to
enforce or interpret any of the terms of this Agreement, the
prevailing party shall be entitled to recover from the other party all
reasonable attorneys' fees incurred at trial, on appeal, and on any
petition for review, together with such other expenses, costs, and
disbursements as may be allowed by law. Reasonable Attorneys' fees
and costs payable under this Article shall be determined by the
Arbitrator along with the award on merit. The Arbitrator shall have
sole discretion to allow or not to allow fees and costs.
14.7 GOVERNING LAW. The rights of the parties under this Agreement
shall be governed by the laws of the United Kingdom, excluding choice
of law rules and excluding the United Nations Convention on the
International Sale of Goods.
14.8 ARBITRATION. Any dispute, controversy or claim arising out of
or in connection with this Agreement, or the breach, termination, or
validity thereof, shall be settled by final and binding arbitration
conducted in English in accordance with the United Nations
Commission on International Trade Law Arbitration Rules as then in
force. The appointing authority shall be the American Arbitration
Association ("AAA"), and the arbitration shall take place in
Vancouver, Washington, United States of America. The arbitration
shall be heard and determined payable in United States Dollars,
subject to any tax or any other deduction. The award shall include
interest from the date of any breach or other violation of this
Agreement. The arbitrators shall also fix an appropriate rate of
interest from the date of the breach or other violation to the
date when the award is paid in full. Th parties agree that the award
of the arbitral tribunal will be the sole and exclusive remedy between
them regarding any and all claims and counterclaims presented to the
tribunal. All notices to be given in connection with the arbitration
shall be given pursuant to Section 14.5 of this Agreement.
15. FORCE MAJEURE. Failure of any Party to perform its obligations under this
Agreement (except the obligation to make payments when properly due) shall not
subject such Party to any liability or place it in breach of any term or
condition of this Agreement to the other Party if such failure is caused by any
cause beyond the reasonable control of such non-performing Party, including
without limitation acts of God, fire, explosion, flood, drought, war, riot,
sabotage, embargo, strikes or other labor trouble, failure in whole or in part
of suppliers to deliver on schedule materials,
9
<PAGE>
equipment or machinery, interruption of or delay in transportation, a national
health emergency or compliance with any order or regulation of any Government
entity acting with color of right; provided however, that the Party affected
shall promptly notify the other Party for the condition constituting force
majeure as defined herein and shall exert reasonable efforts to eliminate, cure
and overcome any such causes and to resume performance of its obligations with
all possible speed. If a condition constituting force majeure as defined herein
exists for more than ninety (90) consecutive days, the Parties shall meet to
negotiate a mutually satisfactory solution to the problem, if applicable.
IN WITNESS WHEREOF, the parties hereto have set their hands as of the day and
year first above written.
For Cadila Healthcare, Ltd., India
/s/ D.D. Sanghavi
- ---------------------------------------------------------
Date January 18, 1999
D.D. Sanghavi
Senior Vice President, Corporate Affairs and Administration
/s/ Arun Parikh
- ---------------------------------------------------------
Date January 18, 1999
Arun Parikh
Vice President, Legal
For Saliva Diagnostic Systems, Inc.
/s/ Stefan L. Paskell
- ---------------------------------------------------------
Date January 18, 1999
By: Stefan L. Paskell
Executive Vice President
General Manager, SDS
10
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS INCLUDED IN THE COMPANY'S REPORT ON FORM
10-KSB FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 151,524
<SECURITIES> 0
<RECEIVABLES> 178,845
<ALLOWANCES> 83,603
<INVENTORY> 205,792
<CURRENT-ASSETS> 478,532
<PP&E> 991,413
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0
1,085,000
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</TABLE>
