U.S. Securities and Exchange Commission
Washington, D.C. 2054
FORM 10-QSB
(Mark One)
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 1998
------------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number 0-25828
Electropharmacology, Inc.
-------------------------
Exact name of small business issuer as specified in its charter
Delaware 95-4315412
-------- ----------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
1109 N.W. 13th Street, Gainesville, FL 32601
--------------------------------------------
(Address of principal executive offices)
(352) 367-9088
--------------
(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (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 ___
---
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
Number of Shares Outstanding
Class On September 30, 1998
----- ---------------------
Common Stock, $ .01 par value 12,505,480
Transitional Small Business Disclosure Format:
Yes____ No X
---
<PAGE>
<TABLE>
<CAPTION>
ELECTROPHARMACOLOGY, INC.
INDEX TO 10-QSB
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Balance Sheets as of September 30, 1998 and December 31, 1997 2
Statements of Operations for the three months ended September 30,
1998 and 1997 3
Statements of Operations for the nine months ended September 30,
1998 and 1997 4
Statements of Cash Flows for the nine months ended September 30,
1998 and 1997 5
Notes to Financial Statements 7
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations for the nine months ended September 30,
1998 and 1997 24
PART II OTHER INFORMATION 36
ITEM 1. Legal Proceedings 36
ITEM 6. Exhibits and Reports on Form 8-K 37
Signatures 38
</TABLE>
<PAGE>
ELECTROPHARMACOLOGY, INC.
Balance Sheets
(Unaudited with respect to September 30, 1998)
<TABLE>
<CAPTION>
ASSETS September 30, December 31,
- ------ 1998 1997
--------------------------------------
<S> <C> <C>
Current assets :
Cash (See Note 1) $ 207,425 $ 111,496
Trade accounts receivable, net of allowance for doubtful accounts
of 26,367 at September 30, 1998 and 26,000 at December 31, 1997. 130,699 169,404
Inventory (See Note 1) 742,172 152,233
Prepaid expenses 166,693 157,065
Other assets 2,769 32,748
--------------------------------------
Total current assets 1,249,758 622,946
Property, plant and equipment, net 286,323 713,466
Patents and organizational costs, net of accumulated amortization
of 37,433 at September 30, 1998 and 14,226 at December 31, 1997. 147,733 89,129
Deposits 3,750 18,001
Investment in securities (See Note 7) 596,721 -
--------------------------------------
Total Assets $ 2,284,286 $ 1,443,542
======================================
LIABILITIES AND NET CAPITAL DEFICIENCY
- --------------------------------------
Current liabilities:
Notes payable (See Note 3) $ 199,043 $ 804,179
Accounts payable 355,829 380,313
Accrued expenses 465,777 260,060
Capitalized lease obligations 53,164 -
Notes payable to related parties (See Note 4) 129,580 73,926
--------------------------------------
Total Current liabilities 1,203,393 1,518,478
Long-term liabilities:
Notes payable (See Note 3) 1,169,499 -
Minority interest in limited partnership (See Note 7) 2,074,660 -
--------------------------------------
Total Liabilities 4,447,552 1,518,478
Commitments and contingencies
Net capital deficiency:
Convertible preferred stock, $0.01 par value - 10,000,000 shares
authorized; 7,500 shares and 242,500 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively. 75 2,430
Common stock, $0.01 par value - 30,000,000 shares authorized;
12,505,480 shares and 4,071,194 shares issued and outstanding at
September 30, 1998 and December 31, 1997, respectively. 125,054 40,711
Additional paid-in capital 25,529,384 15,254,912
Deferred compensation (42,249) (67,678)
Dividend distribution (627,571) -
Deficit (27,147,959) (15,305,311)
--------------------------------------
Net capital deficiency (2,163,266) (74,936)
--------------------------------------
Total liabilities and net capital deficiency $ 2,284,286 $ 1,443,542
======================================
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
Electropharmacology, Inc.
Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the three months ended
September 30,
-------------------------------------
1998 1997
------------------ --------------
<S> <C> <C>
Revenue:
Rentals $ - $ 327,862
Sales 60,548 143,050
-------------------------------------
Total revenue 60,548 470,912
Operating expenses:
Cost of revenue 60,650 128,204
Selling, general and administrative 485,891 604,805
Research and development (See Note 7) 11,500,000 37,809
-------------------------------------
Total operating expenses 12,046,540 770,818
-------------------------------------
Loss from operations (11,985,992) (299,906)
Other income (expense)
Interest expense (18,434) (3,266)
Interest and other income 3,076 2,473
Gain(Loss) on disposal of equipment, net (See Note 7) 718,727 (29,161)
-------------------------------------
Total other income (expense) 703,370 (29,954)
-------------------------------------
Net loss $ (11,282,622) $ (329,860)
=====================================
Net loss per share - basic and diluted (See Note 1) $ (1.59) $ (0.09)
=====================================
Weighted average number of common shares outstanding -
basic and diluted 7,501,125 3,747,971
=====================================
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
Electropharmacology, Inc.
Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
For the nine months ended
September 30,
-------------------------------------
1998 1997
------------------ ---------------
<S> <C> <C>
Revenue:
Rentals $ 359,143 $ 1,555,613
Sales 136,408 430,050
-------------------------------------
Total revenue 495,551 1,985,663
Operating expenses:
Cost of revenue 199,249 330,853
Selling, general and administrative 1,269,427 2,454,806
Research and development (See Note 7) 11,537,974 220,982
-------------------------------------
Total operating expenses 13,006,650 3,006,640
-------------------------------------
Loss from operations (12,511,099) (1,020,976)
Other income (expense)
Interest expense (55,083) (8,848)
Interest and other income 5,672 9,625
Gain(Loss) on disposal of equipment, net (See Note 7) 717,862 (29,161)
-------------------------------------
Total other income (expense) 668,451 (28,385)
-------------------------------------
Net loss $ (11,842,648) $ (1,049,361)
=====================================
Net loss per share - basic and diluted (See Note 1) $ (2.52) $ (0.31)
=====================================
Weighted average number of common shares outstanding -
basic and diluted 4,956,545 3,368,128
=====================================
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
Electropharmacology, Inc.
Statement of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the nine months ended
September 30,
--------------------------------
1998 1997
---- ----
<S> <C> <C>
Operating activities
Net loss $ (11,842,648) (1,049,361)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities:
Depreciation and amortization 148,126 217,071
Gain(Loss) on disposal of equipment, net (717,862) 29,161
Decrease in provision for doubtful accounts - (79,000)
Liability incurred for severance agreement - 128,700
Issuance of common stock and warrants for services 324,883 159,536
Amortization of deferred compensation 25,429 -
Issuance of stock options to related party 63,654 -
Write-off of in-process research and development 11,500,000 -
Changes in operating assets and liabilities :
Decrease in accounts receivable 102,972 345,806
Decrease in trade notes and other receivables 29,979 133,759
Decrease(Increase) in inventory 147,590 (334,299)
Decrease(Increase) in prepaid expenses (9,628) 19,128
Decrease in deposits 21,812 -
Increase in accounts payable and accrued expenses 88,212 341,537
--------------------------------
Net cash (used in) operating activities (117,481) (87,962)
--------------------------------
Investing activities
Proceeds from sale of equipment 164,420 7,300
Purchases of property and equipment (98) (504)
--------------------------------
Net cash provided by investing activities 164,322 6,796
--------------------------------
Financing activities
Proceeds from issuance of common stock and warrants - 11,293
Repayment of notes payable and capital lease obligations (99,277) (141,129)
--------------------------------
Net cash (used in) financing activities (99,277) (129,836)
--------------------------------
Net (decrease) in cash (52,436) (211,002)
Cash at beginning of period 111,496 223,523
--------------------------------
Cash at end of period $ 59,060 $ 12,521
================================
Supplemental disclosure of cash flow information:
Cash paid during the period for interest, net $ 21,867 $ 8,848
================================
5
<PAGE>
Supplemental disclosure of non-cash investing and
financing activities:
Issuance of common stock for services, net of unearned compensation 159,536
Asset recognized and liability incurred for the financing of the
directors and officers liability insurance premiums 159,338 169,472
Asset recognized and liability incurred for the financing of the
product liability insurance premiums 6,322 -
Liability incurred for execution of severance agreement with
related party - 128,700
Details of settlement with outside counsel:
Disposal of investment in securities 650,000 -
Issuance of common stock 128,166 -
Details of disposal of SofPulse business:
Investment in securities 1,246,721 -
Net assets disposed 615,998 -
Details of acquisition of HealthTech Development, Inc.:
Fair value of assets acquired 7,245 -
Liabilities assumed 51,297 -
Issuance of common stock 1,957,206 -
Details of acquisition of Gemini Biotech Limited Partnership:
Fair value of assets acquired 1,112,530 -
Liabilities assumed 1,387,799 -
Details of investment by Elan:
Issuance of convertible preferred stock 7,500,000 -
Conversion of preferred stock for common stock 630,000 -
Conversion of warrants for common stock 118,800 -
</TABLE>
See accompanying notes to financial statements.
6
<PAGE>
ELECTROPHARMACOLOGY, INC.
PART 1 - FINANCIAL INFORMATION
Item 1. Notes to Financial Statements (Unaudited)
Summary of Significant Accounting Policies
Basis of Presentation
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-QSB. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete audited financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the three- and nine-month periods ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 1998. For further information, refer to the financial statements
and footnotes thereto included in the Company's Annual Report on Form 10-KSB for
the year ended December 31, 1997.
Cash
As of September 30, 1998, the Company had restricted cash of
approximately $148,000 related to an outstanding loan obligation of the
Company's majority owned subsidiary, Gemini Biotech, Ltd. ("Gemini"), that was
acquired on August 24, 1998. (See "(7) Recent Corporate Reorganization and Elan
Transaction") These restricted funds must be used for future leasehold
improvements and certain machinery and equipment.
Inventory
Inventory is valued at the lower of cost (average cost method) or
market. Upon the acquisition of Gemini, the Company recorded additional
inventory of $730,000 in order to properly reflect the fair realizable market
value of certain of Gemini's assets.
7
<PAGE>
Notes to the Financial Statements(Unaudited)
Patents and Other Assets
Patents are amortized using the straight-line method over 17 years from
the date of issuance of the patent since all of the patents currently issued or
pending patent applications filed or licensed by the Company were filed prior to
the enactment of the General Agreements on Tariffs and Trade patent legislation
as of June 1995. Other assets are amortized using the straight-line method based
on the useful life.
Rental and Other Equipment and Depreciation and Amortization
Rental and other equipment is carried at cost. Depreciation and
amortization is computed using the straight-line method over the estimated
useful lives (or lease term if shorter) of the related assets as follows:
Rental equipment 5 years
Leasehold improvements 3 years
Office equipment 4 to 7 years
Laboratory equipment 4 to 7 years
Stock Based Compensation
The Company has elected to follow Accounting Principles Board ("APB")
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related
interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under Financial Accounting
Standards Board (FASB) Statement No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, requires use of option valuation models that were not developed
for use in valuing employee stock options. Under APB No. 25, because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
Net Loss per Share
In February 1997, the Financial Accounting Standards Board issued SFAS
No. 128 ("SFAS No. 128"), EARNINGS PER SHARE, which established new standards
for computing and presenting earnings per share. SFAS No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share.
All loss per share amounts have been presented to conform to the SFAS
No. 128 presentation. For the nine months ended September 30, 1998 and 1997,
options and warrants were
8
<PAGE>
Notes to the Financial Statements(Unaudited)
excluded from the computation of net loss per share because the effect of
inclusion would be antidilutive due to the Company's net operating losses.
During the third quarter of 1998, the Company recognized a dividend of
approximately $627,000 related to the induced conversion of convertible
preferred stock into common stock. This amount has been added to the Company net
loss in the computation of net loss per common share.
Use of Estimates and Concentration of Credit Risk
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Until May 27, 1998, the Company sold and/or rented its SofPulse product
to healthcare providers such as nursing homes, hospitals and physician practices
with no specific geographic concentration and extended credit based on an
evaluation of the customer's financial condition, generally without requiring
collateral. Exposure to losses on receivables was principally dependent on each
customer's financial condition. The Company monitors its exposure for credit
losses and maintains allowances for anticipated losses.
Deferred Compensation
Deferred compensation related to stock options is amortized over the
period during which the options become exercisable.
Income Taxes
The Company provides for income taxes under the provisions of FASB
Statement No. 109, ACCOUNTING FOR INCOME TAXES, which requires the asset and
liability method of accounting for income taxes. Under the asset and liability
method of FASB Statement No. 109, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using the enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
9
<PAGE>
Notes to the Financial Statements(Unaudited)
Reclassifications
Certain reclassifications have been made to the 1998 financial
statements to conform with the 1997 presentation.
(1) Inventory
Inventory as of September 30, 1998 consists primarily of acquired
inventory of certain molecular reagents from Gemini that was written up to its
fair realizable market value. The components of inventory as of the following
periods are summarized below:
December 31, 1997 September 30, 1998
----------------- ------------------
Work-in-process $ 23,366 $ 0
Raw material 128,867 0
Finished goods 0 742,172
-------------- ---------------
$ 152,233 $ 742,172
10
<PAGE>
Notes to the Financial Statements(Unaudited)
(2) Notes Payable
Notes payable at December 31, 1997 and September 30, 1998 consists of
the following:
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
------------ ------------
<S> <C> <C>
8% note payable to outside counsel $672,751 --
7.99% note payable to finance
directors and officer's insurance 120,311 121,483
9.75% notes payable to finance
commercial general liability insurance 11,117 5,649
Variable rate note payable to Benefit
Life Insurance Company, due July 1,
2006 -- 1,241,410
------------- --------------
804,179 1,368,542
Less: Current portion 804,179 199,043
------------- --------------
$ -- $1,169,499
============= ==============
</TABLE>
The note payable to outside counsel as of December 31, 1997 was due on
December 31, 1998, was collateralized by a security agreement on 55 SofPulse
units, and was satisfied as part of the sale of the SofPulse business to ADM
Tronics (See" (7) Recent Corporate Reorganization and Elan Transaction").
The note payable to finance directors and officers' insurance as of
December 31, 1997 was due on December 15, 1998; however, this note was
refinanced on April 17, 1998 and the due date was extended to December 15, 1999.
The note payable to finance commercial general liability insurance as
of December 31, 1997 was paid off April 21, 1998. A new note was entered into on
August 18, 1998 with a due date of June 3, 1999.
On June 27, 1997, Gemini entered into loan and note agreements (the
"Loan Agreement")
11
<PAGE>
Notes to the Financial Statements(Unaudited)
with an insurance company in the amount of $1,315,000. The loan amortizes over
101 payments ending July 1, 2006. Interest is at two points over prime. At
September 30, 1998 the rate was 9.75%. The collateral for the note is Gemini's
assets including accounts receivable, inventory, property and equipment owned by
Gemini and to be acquired in the future. In addition, the loan is guaranteed by
the Rural Biological Science Department of the U.S. Department of Agriculture.
Krishna Jayaraman, the Chief Executive Officer and President of the Company's
Gemini Biotech Division, a majority owned subsidiary of the Company, and his
wife, Shashikala Jayaraman, have personally guaranteed the repayment of this
indebtedness.
As of September 30, 1998, Gemini had been advanced approximately
$1,167,000 of the total loan. The insurance company had recorded the transaction
as though Gemini borrowed the entire $1,315,000 at the inception of the loan.
The insurance company had retained the balance as of September 30, 1998, of
approximately $148,000 in a bank. This amount is restricted awaiting
documentation for Gemini to draw down the balance.
The Loan Agreement states Gemini must maintain certain financial
covenants principally relating to working capital, fixed charge ratios and net
worth. The covenants also include a limitation on compensation and
distributions. All of the amounts outstanding under the Agreement will become
due and payable if an event of default occurs. As of September 30, 1998, Gemini
was not in compliance with certain of the ratios relating to net worth and
working capital. The insurance company currently has the right to accelerate
payment of the note.
(3) Notes Payable to Related Parties
In October 1997, the Company issued three notes payable to its Chief
Financial Officer, Chief Executive Officer and a member of the board of
directors totaling $65,926 in exchange for cash advances of $45,000 and
non-payment of salaries of $20,926. These notes bear interest at the prime rate
(7.75% at September 30, 1998) plus 1% and are due on demand. The balance due
under the agreements at December 31, 1997 and September 30, 1998 was $65,926,
respectively.
Effective as of August 24, 1998, as a result of the merger with HTD and
the acquisition of GBLP in conjunction with certain change of control provisions
in the President and Chief Executive Officer's employment contract, the Company
recorded a related party payable to the President and Chief Executive Officer
for $63,654 related to the exercise of 244,823 options to purchase common stock
at $.26 per share. The balance due under this agreement at September 30, 1998
was $63, 654.
12
<PAGE>
Notes to the Financial Statements(Unaudited)
On April 12, 1997, the Company and the former Chief Executive Officer
entered into a severance agreement that provides for, among other things, a cash
payment by the Company of $128,700 in settlement of all rights under his
employment agreement with the Company. The loan and accrued interest was paid in
installments through January 1998. The balance due under this agreement at
December 31, 1997 and September 30, 1998 was $8,000 and $-0-, respectively.
(4) Employment Agreements
As of December 31, 1997, the Company had employment agreements with
certain executive officers, the terms of which expired at various times through
December 31, 2001. In the recent corporate reorganization of the Company (See
"(7) Recent Corporate Reorganization and Elan Transaction"), these agreements
were terminated and replaced by memorandums by the Board of Directors to the
executive officers outlining in general the revised terms of employment of these
officers. In addition, on August 19, 1998, a new employment agreement was
entered into with the new Chief Executive Officer and President of the Gemini
Biotech Division, a majority owned subsidiary of the Company, the term of which
expires August 18, 2001.
On August 25, 1998, the Board of Directors issued a memorandum to Arup
Sen, outlining in general the terms of employment of Dr. Sen as Chief Executive
Officer of EPi, effective as of September 1, 1998. The memorandum provides for
an initial base salary of $130,000, which has increased to $150,000 and may
increase up to $200,000 in a series of stepped increments upon the achievement
of specified milestones. The memorandum also provides that the Company will
grant to Dr. Sen a ten- year option to purchase 500,000 shares of the Common
Stock at the stock price at the close of trading on the date of grant (August
25, 1998), 150,000 of which have vested based on the achievement of specific
milestones set by the Board of Directors, with the remainder to vest subject to
the achievement of other such milestones. In the event that Dr. Sen's employment
is terminated without "cause" before three years, Dr. Sen is entitled to a
severance of six months' base salary, subject to his mitigation of such payment
by seeking other employment. All his stock options will vest immediately and
will remain exercisable for the original term of the option in the event his
employment is terminated due to an acquisition by or merger with a third party
not recommended and/or approved by Dr. Sen.
On August 25, 1998, the Board of Directors issued a memorandum to David
Saloff, outlining in general the terms of employment of Mr. Saloff as Executive
Vice President- Sales and Marketing of the Company, effective as of September 1,
1998. The memorandum provides for an initial base salary of $80,000, which may
increase up to $110,000 upon certain events, including the achievement of
certain annual revenues to be calculated by annualizing the prior six months'
revenues. The memorandum also provides that Mr. Saloff will be entitled to an
override on sales
13
<PAGE>
Notes to the Financial Statements(Unaudited)
revenue at a specified percentages of the annualized revenue calculated based on
the previous month's revenues. Once Mr. Saloff's aggregate annual compensation
equals or exceeds $200,000, then the Company and Mr. Saloff will negotiate a new
mutually acceptable compensation arrangement. The memorandum also provides that
the Company will grant to Mr. Saloff on August 25, 1998, a ten- year option to
purchase 200,000 shares of the Common Stock at the stock price of close of
trading on the date of grant, with 20% of the shares covered thereby vesting
upon the first anniversary date, and an additional 20% each succeeding
anniversary date, with vesting to accelerate based on meeting certain sales
revenue growth targets and other events related to PEMS technologies and
products.
As part of the reorganization transactions, the Company entered into an
employment agreement with Krishna Jayaraman dated August 19, 1998, for a term
expiring on August 19, 2001 for Dr. Jayaraman's services as President and Chief
Executive Officer of the Gemini Biotech Division, a majority owned subsidiary of
the Company. This agreement provides for a base salary of $120,000 which has
increased to $150,000 and may increase further to $200,000 based on certain
corporate milestones and revenues of the Gemini Biotech Division. He is also
entitled to benefits, a term life contract, an automobile allowance and four
weeks' vacation per year. The agreement also provides that the Company will
grant to Dr. Jayaraman on the date of the agreement an option to purchase
250,000 shares of Common Stock, with 30,000 of the shares covered thereby
vesting immediately, 62,500 of the shares covered thereby vesting on each of the
first and second anniversaries of the agreement and an additional 75,000 of the
shares covered thereby vesting on the third anniversary of the date of the
agreement. The agreement also provides that if Dr. Jayaraman's employment is
terminated by him by permitted resignation or by the Company other than for
"cause", Dr. Jayaraman will receive an amount equal to 85% of the remaining
portion of the base salary due him under the term of the agreement, unless there
is a permitted resignation following a relocation of Dr. Jayaraman due to a
change in control not proposed or recommended by Dr. Jayaraman. In such case,
Dr. Jayaraman would receive the sum of his annual base salary and the average
annual bonus received by him during the previous two-year period. In the event
of termination with out "cause" or by permitted resignation, Dr. Jayaraman will
continue to receive benefits pursuant to the Company's welfare programs and
perquisite plans until the earliest of one year after his termination, the end
of the term of the agreement, or until Dr. Jayaraman in reemployed. In addition,
all of Dr. Jayaraman's options will immediately vest and be exercisable for the
full term of the option. Dr. Jayaraman is also subject to a non-compete
agreement as part of his employment agreement.
14
<PAGE>
Notes to the Financial Statements(Unaudited)
(5) Contingencies and Litigation
In February 1993, Diapulse Corporation of America, Inc. ("Diapulse")
filed a citizen's petition requesting that the FDA revoke the substantial
equivalence finding for the SofPulse and prevent the Company from making certain
labeling claims. The Company responded to the petition. The Company made
revisions in its promotional materials relating to its SofPulse device to
obviate any claim that such material is inconsistent with FDA regulations. In
October 1993, Diapulse submitted additional information to the FDA in support of
its petition and the Company responded. As of the date hereof, the FDA has not
notified the Company as to any action with respect to the aforementioned
petition. The Company believes that Diapulse's petition is lacking in merit and
that it is highly unlikely that the FDA will grant the petition. Even in the
event that the FDA were to grant the petition, the Company believes that its
future business is not likely to be materially adversely affected.
In August 1994, Diapulse filed a lawsuit in the Supreme Court of the
State of New York, Nassau County ("The Court"), captioned Diapulse Corporation
of America V. Magnetic Resonance Therapeutics, Inc. et al., alleging that the
Company, Magnetic Resonance Therapeutics, Inc. (a legal predecessor to the
Company) Bio-Sales, Inc., and certain of the Company's present and former
directors and officers, including Joshua Barnum ("Barnum"), David Mills
("Mills"), Arthur Pilla ("Pilla"), David Saloff ("Saloff"), and David Winter
("Winer"), (collectively, the defendants) engaged in deceptive acts and
practices, false advertising and unfair competition in the marketing of a
medical device. The complaint also alleges that Barnum and Mills breached
confidentiality and noncompetition agreements with Diapulse and that the
Company, Barnum and Pilla aided in the alleged tortious breach of the
agreements. Diapulse seeks unspecified compensatory damages, disgorgement of
profits realized by the defendants as a result of their alleged acts, treble
damages, punitive damages and reasonable attorneys' fees. Diapulse also seeks
unspecified injunctive relief prohibiting the defendants from engaging in the
alleged acts and ordering the defendants to take remedial action to rectify the
effects on consumers and Diapulse caused by the defendants' alleged acts. The
defendants jointly moved to dismiss the complaint on jurisdictional and
substantive grounds. The Court dismissed Winer from the case based on lack of
personal jurisdiction. The Court also dismissed certain claims, as to the
remaining individual defendants, including deceptive acts and practices, false
advertising and unfair competition. As to the claims remaining against the
individual defendants, certain of such claims may be indemnified by the Company.
As to the Company, the Court denied the motion to dismiss. The Company answered
the complaint, denied all material allegations, asserted various affirmative
defenses and counterclaimed against Diapulse and Jesse Ross, Diapulse's
President and Founder, individually. The counterclaims allege causes of action
against Diapulse and Jesse Ross for federal unfair competition and tortious
interference of existing and contractual business relations. In addition, the
Company has asserted claims against
15
<PAGE>
Notes to the Financial Statements(Unaudited)
Diapulse for deceptive acts and unfair trade practices, and trade disparagement.
In its counterclaims, the Company seeks compensatory and punitive damages in an
amount to be proved at trial. This lawsuit is in a preliminary stage and its
outcome is uncertain. Although the Company believes that it has meritorious
defenses that it will vigorously pursue and that its ability to develop its
future technologies and products does not materially depend on the outcome of
this litigation, there can be no assurance that the outcome of such action will
be resolved favorably to the Company or that such litigation will not have an
adverse effect on the Company's liquidity, financial condition and results of
operations.
On August 28, 1997, Michelle O'Connell, formerly employed by Kinetech
Medical, Inc. ("Kinetech") as the Company's sales representative, filed a
complaint entitled O'Connell v. Kinetech Medical, Inc. and Electropharmacology,
Inc. in the County Court in Dallas County, Texas. The complaint alleged that
Kinetech and the Company were jointly and severally liable for an unspecified
amount of commissions earned by O'Connell from Kinetech, but unpaid, and
asserted a cause of action quantum meruit against the Company. O'Connell
dismissed the complaint against the Company in May 1998 and Kinetech immediately
filed a cross-complaint against the Company for breach of the agreement between
the Company and Kinetech for failing to pay commissions owed in excess of
$30,000. In August 1998, Kinetech joined National Patient Care Systems, Inc. as
an additional defendant for its share of the commissions owed. The Company
answered the cross- complaint and asserted several affirmative defenses. The
case has not yet been set for trial and no discovery between the Company and
Kinetech has taken place.
On July 14, 1998, Jack Baxter ("Baxter"), a former employee of the
Company, filed a complaint entitled Baxter v. Electropharmacology, Inc. in the
Circuit Court in Broward County, Florida. The complaint alleges the failure by
the Company to make payments of $20,000 due to Baxter under an agreement
pursuant to which Baxter and the Company had agreed to the terms of the
termination of their employer-employee relationship. The Company answered the
complaint and asserted several affirmative defenses. The case has not yet been
set for trial and no discovery between the Company and Baxter has taken place.
(6) Recent Corporate Reorganization and Elan Transaction
Overview
The Company consummated a corporate reorganization, consisting of five
steps, on August 18, 1998. First, the Company contributed all of its assets and
liabilities (other than those assets and liabilities related to its business of
manufacturing and distributing the SofPulse device (the "SofPulse Business")) to
its wholly-owned subsidiary, EPi HealthTech Inc., a Delaware corporation (EPi
Sub") in exchange for 100 shares of EPi Sub Common Stock. Second, HTD, a
privately held Company,
16
<PAGE>
Notes to the Financial Statements(Unaudited)
was merged into EPi Sub, with the shareholders of HTD receiving an aggregate of
6,172,095 shares of the Company's Common Stock (such number of shares being
substantially equivalent to the number of shares of the Company's Common Stock
outstanding at such time, or 6,333,385 shares). Third, EPi Sub contributed all
of its assets and liabilities (including both the assets and liabilities
contributed to it by the Company and the assets and liabilities of HTD) to
Gemini Health Technologies L.P., a newly-formed Delaware limited partnership
(the "Partnership") in exchange for 12,505,480 partnership units of the
Partnership (such number of partnership units corresponding to the number of
shares of the Company's Common Stock issued and outstanding following the
issuance of shares of the Company's Common Stock to the shareholders of HTD).
Simultaneously with contribution of EPi Sub's assets and liabilities to the
Partnership, Krishna and Shashikala Jayaraman (the "Jayaramans") transferred all
the limited partnership interests in Gemini, a privately held Texas limited
partnership and all the stock of its general partner, Gemini Biotech, Inc.
("GBI"), to the Partnership in exchange for 6,000,000 partnership units in the
Partnership, which partnership units are exchangeable, subject to certain
restrictions, for shares of the Company's Common Stock, on the basis of one
share of the Company's Common Stock for each partnership unit (subject to
adjustment in the case of certain events concerning the Company and/or the
Partnership). Fourth, the Company issued 1,872,000 shares of its Common Stock to
the holders of certain warrants and all outstanding Preferred Stock of the
Company in exchange for such warrants and Preferred Stock. Fifth, the Company
sold all of its assets and liabilities relating to the SofPulse Business to a
wholly-owned subsidiary of ADM Tronics Unlimited, Inc. ("ADMT"), a publicly
traded Company, in exchange for a combination of $150,000 in cash, 1,400,000
shares of ADMT Common Stock issued to the Company, an additional 1,525,000
shares of ADMT Common Stock issued to pay approximately $650,000 of the
Company's payable and a warrant to purchase additional shares of ADMT Common
Stock if ADMT achieves certain sales objectives with respect to its conduct of
the SofPulse Business.
The effect of the corporate reorganization is that the businesses
previously conducted by the Company (other than the SofPulse Business), HTD and
Gemini are now being conducted by the Partnership and Gemini, with EPi Sub being
the general partner of the Partnership and the Jayaramans being the limited
partner of the Partnership, and the Partnership being the limited partner of
Gemini and Gemini Biotech, Inc. remaining as the limited partner of the
Partnership. At such time as the Jayaramans exchange all of their partnership
units in the Partnership for shares of the Company's Common Stock, it is
expected that the Partnership and Gemini will be dissolved, EPi Sub will be
dissolved and all of such businesses will be conducted by the Company under the
new corporate name of Gemini Health Technologies Inc.
17
<PAGE>
Notes to the Financial Statements(Unaudited)
Determination of Purchase Price for HTD and GBLP
The purchase price for both HealthTech Development, Inc., a development
stage company ("HTD") and Gemini Biotech L.P. ("GBLP") was determined by the
Company's management in accordance with APB 16 and was based upon a number of
objective and subjective factors including but not limited to (a) reference to
the market price of the Company's Common Stock during the negotiation period and
leading up to the execution of the acquisition agreements; (b) the Company's
management's estimation that the outstanding liabilities, transaction costs and
ongoing operation costs of HTD through the closing of its merger into the
Company would generally offset the realizable value of tangible assets, such
that the only material assets of HTD remaining as of the effective time of the
merger would be intangible assets consisting of technology rights and license
agreements; (c) the Company's management's assessment of the synergistic value
of (i) HTD's various technologies (ii) GBLP's various technologies and (iii) the
technologies licensed through the licensing agreement with Elan Pharma
International Limited, as well as the investment by Elan International Services,
Ltd in Common Stock of the Company in combination with the Company's own drug
delivery technologies in attracting corporate sponsors, facilitating technology
licenses and other fund raising activities, and providing a greater balance to
the Company's stock holders.
APB 16 states that the cost of an acquired company is measured by the
fair value of the consideration received. Since at the time of the foregoing
transactions there was no active trading market for the Company's Common Stock,
an objective measurement of its fair value is difficult. The Company utilized
various valuation methodologies including the income approach, stock price
approach and company comparable approach. Based on these methodologies, the
Company determined that the 20-day average stock price preceding each
transaction represented the most logical valuation methodology and has accounted
for the valuation of the respective technologies accordingly. This methodology
indicated a value of approximately $2,000,000 for HTD and $2,730,000 for GBLP
and their related developed technology (as defined below), which were the
primary assets being acquired by the Company given its current business
strategy. Since the technologies, chemical compounds, gene databases,
intellectual property rights and other intangible assets so acquired are not at
this time susceptible to precise valuation, the Company has used valuations that
it believes are reasonable based on its significant knowledge of such assets but
there can be no assurance that such valuations are accurate or reliable.
Accounting for Acquisitions and Allocation of Purchase Price
The HTD and GBLP acquisitions will be accounted for as purchase
transactions with the Company as the acquiring company. The total estimated
purchase price of $2,000,000 for HTD and
18
<PAGE>
Notes to the Financial Statements(Unaudited)
$2,730,000 for GBLP has been allocated to the fair market values of the assets
acquired and the liabilities assumed. The allocation of the purchase price is
based upon information that was available at the date of preparation of the
September 30, 1998 financial statements and is subject to change, although this
preliminary allocation is not expected to materially differ from the final
allocation.
In accordance with the provisions of APB Nos. 16 and 17, all
identifiable assets acquired, including identifiable intangible assets, were
assigned a portion of the purchase price on the basis of their fair values. To
this end, the Company performed a detailed analysis to determine the fair values
of the identifiable assets in allocating the purchase price among the Acquired
Assets.
The income, stock valuation, and comparable market approaches were used
to value the Acquired Assets. Standard valuation procedures indicate that these
are appropriate methodologies for valuing intangible assets such as patents and
patent applications, licenses, employment agreements, noncompete agreements,
chemical compounds, genetic databases, and various other intellectual property.
In the case of HTD, the base technologies (the "Developed Technology")
have various ascertainable development timelines with additional human or
financial resources still required for further development in order to realize
economic benefits. These base technologies include intellectual property in the
application of cancer drugs, new drug targets, and immune system booster
technologies. Since the technology is not well defined and understood by the
biotechnology community, management of the Company has determined that a
combination of the various valuation methodologies would provide the most
reliable valuation. Other intangibles considered included license agreements,
patents issued and patent applications pending, reputation and associated
goodwill, as well as the potential for incomplete research and development
projects. A review of the assets and liabilities carried on HTD's balance sheet
as of the acquisition date (August 24, 1998) indicated that the carrying value
of such assets and liabilities did not approximate their fair values at that
date and, accordingly, various intangible assets of $2,000,000 have been
recorded. As a result of the acquired technologies development timeline,
substantial development costs, technological feasibility, and various other
uncertainties involved related to the commercialization of these technologies,
the Company has classified the acquired intangible assets as in-process research
and development in the allocation of the purchase price and accordingly has
expensed this amount as a one-time charge in the statement of operations.
Although we have used our experience and observation in the industry, the
results are estimates only. We are not sure if the valuation and the respective
allocation of the purchase price and the corresponding accounting treatment as
in-process research and development in the financial statements is correct since
we can not predict the outcome of any technology at this early stage of
development.
19
<PAGE>
Notes to the Financial Statements(Unaudited)
<TABLE>
<CAPTION>
The calculation of the estimated purchase price is as follows:
<S> <C>
NET LIABILITIES:
Net liabilities (less fair value of assets)................... $ 43,486
EQUITY:
Common Stock issued (6,172,000 shares valued
At $0.317 per share)...................................... 1,956,514
------------
Estimated Total Purchase Price......................................... $ 2,000,000
</TABLE>
As a condition to the HTD merger agreement, up to an additional
1,650,000 shares of Common Stock of the Company may be issued to the former
shareholders of HTD based on certain minimum net revenues amounts, certain net
pretax profit percentages, and the certain development milestones.
The estimated allocation of the purchase price is as follows:
In-Process Research and Development charged to expense..$ 2,000,000
In the case of GBLP, the base technologies (the "Developed Technology")
have various ascertainable development timelines with additional human or
financial resources still required to be expended for further development in
order to realize economic benefits. These base technologies include intellectual
property in the application of cancer and inflammation drugs. Management of the
Company has determined that a combination of the various valuation methodologies
would provide the most reliable valuation. Other intangibles considered include
license agreements, patents issued and patent applications pending, reputation
and associated goodwill, as well as the potential for incomplete research and
development projects. A review of the assets and liabilities carried on GBLP's
balance sheet as of the acquisition date (August 24, 1998) indicated that the
carrying value of such assets and liabilities did not approximate their fair
values at that date and accordingly, various intangible assets of $2,730,000
have been recorded and classified as inventory ($730,000) and in-process
research and development ($2,000,000) in the allocation of the purchase price
and accordingly has expensed the acquired in-process research development as a
one-time charge in the statement of operations. As a result of the acquired
technologies development timeline, substantial development costs, technological
feasibility, and various other uncertainties involved related to the
commercialization of these technologies, the Company has classified the majority
of the acquired intangible assets as in-process research and development in the
allocation of the purchase price. Although we have used our experience and
observation in the industry, the results are estimates only. We are not sure if
the valuation and the respective allocation of the purchase price and the
corresponding accounting treatment as in-process research and development in the
financial
20
<PAGE>
Notes to the Financial Statements(Unaudited)
statements is correct since we can not predict the outcome of any technology at
this early stage of development.
The calculation of the estimated purchase price is as follows:
<TABLE>
<CAPTION>
<S> <C>
NET LIABILITIES:
Net liabilities (less fair value of assets)................... $ 416,968
EQUITY:
Partnership Units issued (6,000,000 units convertible Into
6,000,000 shares of Common Stock of the Company after 12
months, valued at
$0.3855 per unit)............................................. 2,313,032
--------------
Estimated Total Purchase Price......................................... 2,730,000
</TABLE>
As a condition to the GBLP merger agreement, additional partnership
units of up to 1,050,000 (convertible into 1,050,000 shares of Common Stock of
the Company) may be issued to the former partners of GBLP based on certain
development milestones.
<TABLE>
<CAPTION>
The estimated allocation of the purchase price is as follows:
<S> <C>
Inventory.............................................................. $ 730,000
In-Process Research and Development charged to expense................. $ 2,000,000
</TABLE>
GBLP has been consolidated as of September 30, 1998 and accordingly the
Company has recorded a Minority Interest in Limited Partnership of approximately
$2,075,000.
Elan License Agreement and Investment in the Company
On September 30, 1998, the Company acquired a worldwide license to the
flexible iontophoretic patch technology for non-cosmetic dermatology and wound
care applications from Elan Pharma International Limited ("Elan Pharma"). The
Company made a cumulative up-front payment of $7,500,000 to Elan Pharma for
in-process research and development price and accordingly has expensed the
acquired in-process research development as a one-time charge in the statement
of operations. In addition to this payment, the Company will pay prescribed
royalties and license fees to Elan Pharma based on the Company's future revenues
from the commercialization of the technology.
21
<PAGE>
Notes to the Financial Statements(Unaudited)
Management has determined that the licensed technology has various
ascertainable development timelines with additional human or financial resources
still required to be expended for further development in order to realize
economic benefits. As a result of the acquired technology's development
timeline, substantial development costs, technological feasibility, and various
other uncertainties involved related to the commercialization of these
technologies, the Company has classified the licensed intangible assets as
in-process research and development.
Separately, Elan International Services, Ltd. ("Elan International")
invested $7,500,000 in the Company to acquire 7,500 shares of Convertible
Preferred Stock and warrants to acquire up to 1,000,000 shares of Common Stock
of the Company at an exercise price of $2.50 per share and also committed to
invest an additional $2,000,000 to acquire shares of Common Stock at the
election of the Company at the 20- day average closing price preceding the
close, not exceeding $1.375
On October 30, 1998, Elan International acquired 777,202 shares of
Common Stock of the Company at $0.77 per share, or an aggregate of $600,000. In
December 1998, Elan International will acquire additional shares of the Company
for an aggregate of $1,400,000 at the 20- day average stock price preceding the
close.
Divestiture of Company's SofPulse Business and Settlement of Certain Legal
Expenses
On August 18, 1998, the Company sold substantially all of the assets of
its SofPulse medical device business to a wholly-owned subsidiary of ADM Tronics
Unlimited, Inc. ("ADM"), a publicly traded company, in exchange for a
combination of $150,000 in cash, 1,400,000 shares of ADM common stock issued to
the Company, and additional 1,540,000 shares of ADM common stock issued to pay
approximately $650,000 of the Company's note payables and a warrant to purchase
additional shares of ADM common stock if ADM achieves certain sales objectives
with respect to its conduct of the SofPulse business. The Company recorded a net
Investment in ADM Tronics of approximately $597,000 and a net gain on the
disposition of assets of approximately $780,000 as a result of this divestiture.
On August 24, 1998, in conjunction with the merger of HTD the Company
issued 322,581 common shares at a price of $0.31 per share in settlement of a
portion of a secured note payable and other unsecured payables for legal
expenses totaling approximately $100,000 with the Company's previous corporate
counsel.
Conversion of Preferred Stock and Exchange of Warrants
On August 24, 1998, in conjunction with the merger of HTD the Company
issued 1,872,000 common shares for the conversion of the outstanding preferred
stock and in exchange for certain
22
<PAGE>
Notes to the Financial Statements(Unaudited)
outstanding warrants. As a result of these issuances the Company recorded a
dividend for approximately $627,000 and additional consulting expense of
approximately $119,000.
(7) Pro Forma
The accompanying Pro Forma Condensed Combined Statement of Operations
for the third quarter and nine months ended September 30, 1998 reflects
adjustments for: (i) the acquisitions by the Company of HTD and Gemini,
development stage companies; (ii) the sale of the Company's medical device
business to AA Northvale Medical Associates, Inc., a subsidiary of ADMT; and
(iii) the acquisition of a worldwide license to Elan's flexible iontophoretic
patch technology for non-cosmetic dermatology and wound care application.
The pro forma adjustments assume that these transactions has occurred
as of January 1, 1998.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ------------------
<S> <C> <C>
Total Revenue $ 153,108 $ 570,070
=============== ===============
Pro Forma Net Losses Applicable to Common
Share Owners (712,332) (13,179,287)
=============== ===============
Pro Forma Basic and Diluted Net Losses Per
Share Applicable to Common Share Owners $ (0.11) $ (1.10)
=============== ===============
</TABLE>
23
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following Management's Discussion and Analysis of Financial
Condition and Results of Operations contains forward-looking statements about
the plans and business of Electropharmacology, Inc. (the "Company"). Actual
events and results may differ materially from those anticipated in these forward
looking statements. The Company's ability to achieve its projections and
business objectives is dependent on a variety of factors, many of which are
outside of management's control. Some of the most significant factors, alone or
in combination, would be the failure to integrate the businesses acquired by the
Company successfully, unanticipated disagreements with prospective corporate
partners, if any, an unanticipated slowdown in the health care industry (as a
result of cost containment measures, changes in governmental regulation or other
factors), or an unanticipated failure in the commercialization of the company's
technologies and potential products developed therefrom. Accordingly, there can
be no assurances that the Company will achieve its business objectives.
General
Electropharmacology (the "Company") recently completed restructuring
its business through a series of transactions with the goal to create a unique
biotechnology company developing proprietary products for complex diseases that
are not effectively treated by available drugs or treatment methods. Our
business is to develop: (i) drug delivery technologies to better deliver
pharmaceutical drugs to diseased tissues and (ii) drug design technologies to
create new drugs aimed at the genes and proteins being discovered by scientists
as the underlying causes of complex diseases. We are focusing on the use of our
technologies to create products for complex diseases such as cancer, chronic
tissue damage and inflammation.
Our two drug delivery technologies take advantage of the ability of
mild electrical currents to travel across and through the skin and of radio
frequency electromagnetic signals to be broadcast through superficial soft
tissues:
o We acquired a worldwide license to a flexible iontophoresis patch
technology developed by Elan, plc., a world leader in the
development of drug delivery products, to increase the local
delivery of drugs across the skin by the application of a mild
electrical current. This technology has promising applications in
improving the effects of drugs in a wide range of skin disorders
and wounds.
o During the past six years, we developed and demonstrated the use
of broadcasting pulses of electromagnetic signals ("PEMS") to
increase the local blood flow in superficial tissues. This
technology holds significant potential in increasing the delivery
of diagnostic agents or therapeutic drugs, taken by injection or
orally, carried by the bloodstream to superficial organs (such as
the breast, brain and prostate).
24
<PAGE>
Our drug delivery product development programs will focus on clinical
studies of iontophoresis for dermatology drugs (such as for psoriasis) and PEMS
for agents to treat or image breast or brain cancers. We expect that these
studies will also help us quantify the extent of improvement in the delivery of
topical drugs by iontophoresis and injectable drugs by PEMS. We intend to use
this information to form licensing and joint development agreements with
companies developing biopharmaceutical drugs. In our partnership with Elan, we
intend to combine iontophoresis with PEMS in a flexible patch system. This novel
product will be used to enhance the delivery and the activity of drugs in wound
care and the healing of tissues such as arthritis-damaged cartilage.
For long-term applications of our drug delivery technologies, our
scientists are researching the molecular changes associated with the various
clinical effects reported with PEMS and electrical fields. The results are
expected to lead to applications of PEMS and iontophoresis in "drug
enhancement", which is increasing the sensitivity of treated tissues to drugs.
Drug enhancement should be synergistic with the initial applications of PEMS and
iontophoresis in improving the delivery of drugs.
Our drug design technology focuses on creating a library of proprietary
small molecule drugs targeted at proteins encoded by genes implicated in complex
diseases such as cancer, inflammation and chronic degenerative diseases of
tissues. We have licensed a family of small molecule drugs and related design
technology from Aronex Pharmaceutical ("Aronex"), a biotechnology company in
Texas, that is developing novel formulations of drugs to treat cancer and
infection. Our drug design program has been funded in part by three Small
Business Innovations Research ("SBIR") grants. We also have used our drug design
expertise to generate revenues by providing contract services to produce
specialized molecular reagents for academic researchers and biopharmaceutical
companies. These revenues have provided additional resources to grow our small
molecule drug library.
We have two primary objectives in our drug design program:
o Continue to grow our small molecule drug library and
collaborations with researchers that identify protein or gene
targets for these drugs through additional grants or other
funding; and upon identifying potential targets, form licensing
and co-development agreements with corporate partners to screen
our library for various clinical market applications in different
territories of the world.
o Grow our service business to leverage the growing needs in gene
sequencing and other genetic research, novel genetic diagnostics
and new drug discovery and evaluation programs.
Our initial focus in drug design is on two small molecule drugs from
our library that target proteins implicated in malignant cancers and
inflammation. We intend to expand our small molecule drug library to target
clinically relevant proteins or genes for which we can establish high throughput
screening methods that can determine the potential clinical value of drugs. Our
corporate
25
<PAGE>
partnerships will focus on larger companies so that we can exploit the market
potential for our small molecule drugs in degenerative diseases (such as
arthritis, Alzheimer's disease and osteoporosis), inflammation, metabolic
diseases (such as obesity and diabetes) and chronic infection-associated
complications. We will focus on growing our service business by capitalizing on
the following trends: (i) the rapid growth in gene sequencing needs in the Human
Genome Project; (ii) product development programs for new chips and microarrays
in the growing gene diagnostics industry; and (iii) the increasing need for
molecular reagents in research on genetic mechanisms of complex diseases. We may
expand our service business to include analyses of genetically engineered
animals, especially mice, that are emerging as models to study the genetics of
human diseases as well as to predict the safety and efficacy of pharmaceutical
products ("pharmacogenomics"). We intend to use the growing revenues from these
services to fund the growth of our small molecule drug library and acquire
know-how to be used by our scientists to identify new clinical market
applications of our drugs.
We have invested more than $16 million in conducting pre-clinical and
initial clinical evaluations. Unlike early development stage biotechnology
companies, we have functioning operations as well as academic collaborations
that we believe to be a cost-effective means to create value through the
translation of emerging technologies into product prototypes for defined unmet
clinical needs. We believe that our strength is in rapidly converting new
technical ideas into product prototypes or new methods of treatment or
diagnosis. Once we prove the clinical use and define the patients for whom our
products or methods will have real benefit, we intend to form partnerships with
larger companies for the future development, large scale manufacturing and
worldwide marketing and sales of the final products. Our drug delivery
technology can be used with many different drugs and our small molecule drug
design technology can create drugs to target many different proteins and genes.
Therefore, our strategy is to form partnerships with many companies and achieve
broad penetration in both the diagnostic and the therapeutic product markets.
We are a development stage company and all of our technologies are
under development and not commercially marketed. Our Company was originally
incorporated under the laws of the State of California in August 1990 under the
name Magnetic Resonance Therapeutics, Inc. We reorganized through a merger with
and into Electropharmacology, Inc., a Delaware corporation, in February 1995.
Our executive offices are located at 1109 NW 13th Street, Gainesville, Florida
32601 and our telephone number is (352) 367-9088.
Recent Change of Business - Discontinued Business; Recent Acquisition and
Corporate Reorganization
From 1990 to August 1998, our Company was engaged in the business of
developing medical device applications for its proprietary PEMS technology and,
more specifically, the manufacturing and marketing of a PEMS device called
SofPulse. On August 24, 1998, we sold our SofPulse business, restructured our
business and completed two acquisitions that transformed us into a biotechnology
development company. The transactions we closed are summarized as follows:
26
<PAGE>
o We contributed all of the assets and liabilities (other than those
assets and liabilities related to our previous business of
manufacturing and distributing the SofPulse device for its
currently approved medical uses (the "SofPulse Business")) of our
company to a newly created wholly-owned subsidiary, EPi HealthTech
Inc., a Delaware corporation ("EPi Sub"), in exchange for 100
shares of EPi Sub common stock.
o We merged HealthTech Development Inc. ("HTD") into EPi Sub. HTD
was a privately held biotechnology company engaged in the
commercialization of emerging medical technologies. We issued an
aggregate of 6,172,095 shares of Common Stock of our Company to
the shareholders of HTD. The number of shares was calculated to be
approximately equal to the number of our shares of Common Stock
outstanding (6,333,385 shares) on the date of closing, including
the 1,872,000 shares that we issued to some of our shareholders in
exchange for their warrants, as described below. We also gave the
HTD shareholders the right to earn up to an additional 1,650,000
shares of Common Stock in the future if the business previously
conducted by HTD achieves certain milestones. The total number of
our shares outstanding after this acquisition was 12,505,480.
o We acquired Gemini through a complex transaction. Gemini is a
privately held biotechnology Company with special expertise in
small molecule drug design. Gemini had been organized as a Texas
limited partnership with Gemini Biotech, Inc. ("GBI"), a Delaware
corporation, serving as the general partner. All shares of GBI
were owned by Dr. Krishna and Ms. Shashikala Jayaraman. EPi Sub
contributed all of its assets and liabilities (both the ones it
received from us as described above and the assets and liabilities
of HTD acquired as described above) to Gemini Health Technologies
L.P., a newly-formed Delaware limited partnership (the
"Partnership"). EPi Sub received 12,505,480 partnership units of
the Partnership. This number of partnership units equaled the
total number of our outstanding shares of our Common Stock after
issuing the 6,172,095 shares to the shareholders of HTD.
Simultaneously, the Jayaramans contributed all of their
partnership units of Gemini and all GBI stock to the Partnership.
The Jayaramans received 6,000,000 partnership units in the
Partnership. We also gave the Jayaramans the right to earn up to
2,050,000 additional partnership units in the future if the
business conducted by Gemini achieves certain milestones. These
partnership units are exchangeable, subject to certain
restrictions, for shares of our Common Stock on a one-for-one
basis (subject to adjustments in the case of some material events
concerning either our Company and/or the Partnership).
o We issued 1,872,000 new shares of Common Stock of our Company to
the holders of most of our outstanding warrants and all of our
outstanding preferred stock in exchange for these warrants and
preferred stock.
27
<PAGE>
o We sold all of our assets and liabilities relating to the SofPulse
Business (which were not transferred to EPi Sub) to AA Northvale
Medical Associates, a wholly- owned subsidiary of ADM Tronics
Unlimited, Inc. ("ADMT"), a publicly traded Nasdaq Small Cap
company. ADMT develops and markets therapeutic medical devices
that utilize electrical and ultrasonic energy. ADMT paid our
Company $150,000 in cash, issued 1,400,000 shares of ADMT common
stock directly to us and issued an additional 1,525,000 shares of
ADMT common stock to pay approximately $650,000 of our past due
payables. ADMT also granted us a warrant to purchase additional
shares of ADMT common stock if their revenue from the SofPulse
business during the next twelve months reaches specified levels.
ADMT has agreed to register their shares issued to us and we have
the right to sell these shares with some restrictions on the
volume we sell during any month.
The effect of the corporate reorganization is that all of the
businesses previously conducted by our Company (other than the SofPulse
Business), HTD and Gemini are now being conducted by the Partnership and Gemini.
EPi Sub is the general partner of the Partnership and the Jayaramans are the
limited partners of the Partnership. Gemini will remain a Texas partnership
focused on Gemini's small molecule drug business. The Partnership will be the
general partner of Gemini and GBI will remain as the limited partner. The
Jayaramans are expected to exchange all of their partnership units in the
Partnership for shares of our Company Common Stock on or about year from the
close of these reorganization transactions. At that time the Partnership and
Gemini will be liquidated, EPi Sub will be dissolved and all the businesses will
be consolidated into our Company which by then will be named Gemini Health
Technologies Inc.
Each of HTD and Gemini brought to our Company significant intellectual
property assets that we expect to use in the development of new small molecule
drugs. HTD is primarily developing two technologies - one for drugs designed to
treat the spread of cancer without toxic side effects and the other to create
proprietary genetic databases to identify novel protein and gene targets for our
future small molecule drugs for complex diseases such as cancer, arthritis and
heart disease. Gemini is a leader in the design and chemical synthesis of
therapeutic drugs and diagnostic agents created using "nucleobases", the
building blocks of genes. Gemini has a library of proprietary and exclusively
licensed small molecule drugs for the treatment of cancer and rheumatoid
arthritis. The assets being acquired from Gemini also include an inventory of
research reagents for product development and resale, laboratory equipment and
other fixed assets.
Recent Elan Transactions
Soon after the closing of our corporate reorganization, on September
30, 1998 we entered into agreements with two different subsidiaries of Elan
Corporation, plc ("Elan"). Elan is an international leader in the development of
novel drug delivery technologies for pharmaceutical and biotechnology drugs.
Elan is publicly traded on the New York Stock Exchange (NYSE: ELN). We
28
<PAGE>
acquired from Elan Pharma International Limited a worldwide license to a novel
flexible iontophoresis patch technology. Elan scientists have been engaged in
developing product prototypes to increase drug delivery by the application of a
mild electrical current - a method called iontophoresis that has been recognized
for three decades. One outcome of Elan's efforts over the past decade has been
the development of a flexible patch for iontophoresis. The patch system is
uniquely suitable for the topical application of dermatology drugs locally at
sites of skin disorders regardless of the location, shape or size of the
diseased skin site. We acquired a license to use this flexible patch technology
for non-cosmetic skin diseases and wound care. Elan also agreed to collaborate
with us to develop a flexible patch system for our PEMS technology and a patch
system that combines our PEMS and their iontophoresis technologies. We intend to
pursue the application of iontophoresis and PEMS in enhancing the delivery of
drugs and biologics to diseased tissues and promoting the regeneration of cells
in tissues damaged by trauma or chronic diseases. We made an up-front payment of
$7,500,000 for the acquisition and transfer of the Elan technology and will make
future payments of prescribed license fees and royalties payable from the
revenues from product sales and/or sublicensing to future corporate partners.
Separately, Elan International Services ("EIS") invested $7,500,000 to
buy preferred stock and warrants in our Company. The preferred stock consists of
7,500 shares of our 10% convertible preferred stock ("Preferred Stock") that are
convertible into our Common Stock at a conversion ratio of one share of Common
Stock for each $1.20 of Preferred Stock investment and the warrants can be
exercised to purchase 1,000,000 shares of our Common Stock at an exercise price
of $2.50 per share for a term of seven years. The Preferred Stock accrues 10%
per year dividends paid semi-annually in cash or in kind, at the Company's
option, and mandatory redemption after a seven year period, unless the Company
has insufficient funds. In such case, EIS must elect to extend the redemption
date to a date acceptable to the Company or accept Common Stock in lieu of
redemption. EIS also agreed to invest an additional $2,000,000 to buy our Common
Stock at a share price to EIS calculated as one of the following: (i) the
average price for twenty trading days prior to the date of sale of our shares to
EIS or (ii) the price paid by other investors in the offering contemplated in
our recently filed registration statement, up to a maximum price to be paid by
EIS of $1.375 per share. On October 30, 1998 we issued 777,202 shares of our
common stock to EIS at $.772 per share for a total of $600,000, which
represented our first draw down on EIS's $2,000,000 commitment. EIS also has the
right to nominate one member to our Company's Board of Directors.
Background
The Company commenced commercially marketing the first embodiment of
its PEMS technology as the SofPulse device in early 1992. SofPulse was cleared
for commercial marketing in January 1991 by the United States Food and Drug
Administration pursuant to a Section 510(k) premarket notification. SofPulse
broadcasts PEMS in the radio frequency range at 27.1 MHZ ("PEMSRF") and is used
as an adjunct in the palliative treatment of pain and edema associated with
various medical conditions that involve superficial soft tissue injury. The
Company's principal sources of revenue from SofPulse devices had been rental
fees charged to nursing homes and hospitals and sales to certain distributors
and cosmetic surgeons. Until the sale in August 1998, the
29
<PAGE>
Company had generated only modest revenue from sales and rentals of the
SofPulse, which had achieved only limited market acceptance. As of May 27, 1998,
when the Company entered into a definitive agreement to sell its SofPulse device
business and most of its inventory, the Company had 98 SofPulse devices under
rental agreements at nursing homes. Since inception, the Company's expenses have
exceeded its revenues, resulting in net losses of $3,069,586 and $2,927,990
respectively, for the years ended December 31, 1996 and 1997. As of September
30, 1998, the Company had an accumulated deficit of $15,305,311. Losses incurred
since inception have been primarily attributable to costs incurred in connection
with the design and development of the Company's products, research and clinical
studies on the SofPulse, manufacturing, marketing literature and advertisement
for the SofPulse, and the hiring of personnel necessary to support the Company's
operations. The Company continues to have high levels of operating expenses
(including salaries of management and marketing personnel) and will be required
to incur significant expenses in connection with research and clinical studies.
During 1997, the Company's management concluded that it could not
create shareholder value by pursuing on its own both the growth of the SofPulse
device business and the PEMS technology business focused upon drug delivery
devices. Accordingly, we implemented a strategy to create value from each of the
two lines of businesses under separate business structures. On August 24, 1998,
as described above, the Company completed an asset sale pursuant to which ADMT
acquired on August 24, 1998 most of the Company's SofPulse device units and
certain other assets specifically related to the business of SofPulse device
manufacturing and marketing. On August 24, 1998, we also consummated agreements
to acquire HTD and Gemini, two privately held companies engaged in the design
and development of small molecule drugs. As a result of the consummation of
these acquisitions, the Company combined its PEMS technology development
business with a broad portfolio of biotechnologies, collaborative affiliations
with major medical institutions and relationships with internationally
recognized scientists.
30
<PAGE>
Results of Operations
Three Months Ended September 30, 1998 Compared to the Three Months Ended
September 30, 1997
Revenue for the three months ended September 30, 1998 decreased to
$60,548, as compared to $470,912 for the three months ended September 30, 1997,
or a decrease of $410,364. This decrease was primarily attributable to the
absence of rental or sales revenue from the SofPulse device in the third quarter
of 1998 due to the sale of such devices and related revenues to ADMT on May 27,
1998. Revenues of $60,548 during the three months ended September 30, 1998 were
attributable to the sale of small molecule products, the provision of custom
synthesis services, and receipt of research grants by Gemini during the period
from August 24, 1998 to September 30, 1998.
The Company has no assurance, however, that any additional grant funds will be
received or that there will be any significant increase in revenue from the
small molecule service business
Cost of revenue for the three months ended September 30, 1998 decreased
to $60,650, as compared to $128,204 for the three months ended September 30,
1997. The Company had no cost of revenue associated with its Sofpulse devices
during the third quarter of 1998 due to the transfer of the SofPulse devices and
revenues to ADMT in the second quarter of 1998. All cost of revenue incurred in
the quarter ended September 30, 1998 relates to the cost of materials associated
with Gemini's products and services. Cost of revenue during the quarter ended
September 30, 1997, represented primarily depreciation on the rental fleet and
cost of the 17 devices sold during the quarter.
Selling, general and administrative expenses decreased $422,237for the
three months ended September 30, 1998, as compared to $604,805 for the three
months ended September 30, 1997, a decrease of $182,568, or 43.2%. This cost
decrease reflects a reduction in salaries and related benefits associated with
personnel reductions in the sales and marketing, administrative services and
manufacturing departments, in addition to a reduction in outside legal expenses
and sales commissions, offset in part by general and administrative expenses of
$39,012 relating to Gemini's operations for the period from August 24, 1998 to
September 30, 1998.
The Company incurred $11.5 million in research and development expenses
for the three months ended September 30, 1998, as compared to $37,809 for the
three months ended September 30, 1997. The significant increase in this expense
is attributable to one-time write-offs of purchased research and development in
connection with the acquisitions of HTD ($2 million) and Gemini ($2 million),
and a one- time payment to Elan ($7.5 million) totaling $11.5 million.
The Company expects that the Company's operating expenses going
forward, will increase as a result of (i) the expected additional research and
development expenses related to the small molecule drugs for cancer and
inflammation, (ii) the increased cost of growing the small molecule and related
special service business, and (iii) research and development programs planned
31
<PAGE>
for the drug delivery technologies. and the Company does not expect significant
savings from the elimination of duplicative expenses. There also can be no
assurance that future expenses will be consistent with historical expenses for
either the technology development business of the Company or the businesses of
HTD and Gemini.
Interest and other income (expense) for the three months ended
September 30, 1998, increased by $733,324 to $703,370, as compared to $(29,954)
for the three months ended September 30, 1997, primarily due to a $780,000 gain
on sale of the Sofpulse assets to ADMT, offset in part by an approximate $65,000
loss on disposal of office equipment during the third quarter of 1998, and a
$13,700 increase in interest expense due to recordation of interest expense on
Gemini's note payable in the principal amount of $1,241,410 at September 30,
1998. The Company incurred a $29,161 loss on disposal of equipment in the
quarter ended September 30, 1997.
The above resulted in a net loss of $(11,218,968) for the three
months ended September 30, 1998, compared to a net loss of $(329,860) for the
three months ended September 30, 1997.
Nine Months Ended September 30, 1998 Compared to the Nine Months Ended
September 30, 1997
The Company's revenue for the nine months ended September 30, 1998
was $495,551, as compared to $1,985,663 for the nine months ended September 30,
1997, or a decrease of $1,490,112. This 75.0% decrease was primarily
attributable to a $1,196,470, or 77.0 %, decrease in SofPulse rental revenues in
the nine months ended September 30, 1998, as compared to the same period in
1997. The Company's rental revenues were materially adversely affected as a
consequence of the issuance on July 18, 1997 by the Health Care Financing
Administration ("HCFA") of a national policy of non-reimbursement by Medicare
for all forms of electrotherapy for wound healing. HCFA was enjoined from
implementing this national policy under a ruling by a U.S. District Court in
Massachusetts on November 18, 1997; however, monthly rental revenues declined
substantially. At May 27, 1998, the effective date of the transfer of the
SofPulse rental and sales revenue to a wholly owned subsidiary of ADMT, there
were 98 units under rental contracts or monthly fixed fee arrangements, as
compared to 391 units at May 1, 1997. Accordingly, rental revenues in May 1998
were $68,418, as compared to $259,437 in May 1997.In addition, the Company had
no SofPulse rental or sale revenues in the last four months of the nine-month
period ended September 30, 1998.
Revenue from the sales of units also decreased from $430,050 in the nine months
ended September 30, 1997 to $75,860 in the comparable period in 1998. During the
nine months ended September 30, 1998, the Company sold 12 used SofPulse devices
as compared to 43 new and used devices in the first nine months of 1997, most of
which were sold to National Patient Care Systems ("NECS") to fulfill NECS'
obligation to purchase specific minimum monthly quotas pursuant to a strategic
alliance agreement. Revenues of $60,548 during the nine months ended September
30, 1998 were attributable to the sale of small molecule products, the provision
of custom synthesis services, and receipt of research grants by Gemini during
the period from August 24, 1998 to September 30, 1998
Cost of revenue for the nine months ended September 30, 1998 was
$199,249, compared to $330,853 for the nine months ended September 30, 1997, a
decrease of $131,604. This 39.8%
32
<PAGE>
decrease reflects the decreased number of SofPulse devices sold during the nine
months ended September 30, 1998, as compared to the same period in the prior
year, as well as the Company recording no depreciation expense on rental units
after May 27, 1998, the date of the transfer of the rental units and revenues to
ADMT.
Selling, general and administrative expenses were $1,205,774 for the
nine months ended September 30, 1998, compared to $2,454,806 for the nine months
ended September 30, 1997, a decrease of $1,249,032, or 50.9 %. This cost
decrease is primarily due to a $424,000 reduction in the salaries and related
benefits associated with personnel reductions in the sales and marketing,
clinical support services and manufacturing departments, a $340,000 reduction in
outside legal, accounting and consulting expenses, and a $242,000 reduction in
sales commissions, as well as reductions in public relations, travel and
marketing expenses. As a consequence of the Company's deteriorating cash
position and its recent sale of assets, the Company underwent a reduction in
personnel from 27 employees in March 1997 to six employees by June 30, 1998. The
Company currently has 17 full-time employees.
Research and development expenses decreased to $11,537,974 for the nine
months ended September 30, 1998, as compared to $220,982 for the nine months
ended September 30, 1997. The significant increase in this expense is
attributable to one-time write-offs of purchased research and development in
connection with the acquisitions of HTD ($2 million) and Gemini ($2 million),
and an up-front license fee payment to Elan ($7.5 million) totaling $11.5
million, offset in part by a reduction in 1998 of basic scientific research
involving PEMS technologies due to the lack of funds available for such
research.
Interest expense for the nine months ended September 30, 1998,
increased to $55,083 compared to $28,385 for the nine months ended September 30,
1997, primarily due to a an increase in the amount of outstanding debt. With the
exception of obligations under capital equipment leases, the Company had
outstanding at September 30, 1997, two notes payable in the aggregate amount of
$169,472 to finance the Company's directors and officers' and general liability
policies.. On September 30, 1998, due to its cash flow deficit, the Company had
debt outstanding to directors of the Company in the aggregate amount of $73,926
representing advances and foregone salary and two notes payable in the aggregate
amount of $127,132 to finance the Company's insurance policies. The Company also
had outstanding a $1,241,410 note payable to finance Gemini's operations and a
financing lease in the amount of $53,164 for laboratory equipment.
In the nine months ended September 30, 1998, the Company recognized a
one-time $780,000 gain on sale of the Sofpulse assets to DMT, offset in part by
an approximate $65,000 loss on disposal of office equipment during the third
quarter of 1998 when the Company relocated its corporate headquarters and
administrative operations to Gainesville, Florida. In comparison, in the
comparable period in 1997, the Company recorded a loss on the disposal of
equipment of $29,161.
33
<PAGE>
Interest income for the nine months ended September 30, 1998 decreased
to $5,671 compared to $9,625 for the nine months ended September 30, 1997 due to
the decrease in funds of the Company available for short term investment in the
nine months ended September 30, 1998.
The above resulted in a net loss of $(11,778,994) for the nine months
ended September 30, 1998, compared to a net loss of $(1,049,361) for the nine
months ended September 30, 1997.
Liquidity and Capital Resources
The Company's cash requirements have been and will continue to be
significant. Since its inception, the Company has satisfied its operating
requirements primarily through the issuance of equity and debt securities and
loans from stockholders. At December 31, 1997, the Company had a working capital
deficit of ($899,573) and a deficiency in capital of ($74,938). At September 30,
1998, the Company had working capital of $110,019 and a deficiency in capital of
($2,099,612) . The working capital consists primarily of a $730,000 inventory of
molecular reagents acquired in the Gemini acquisition, which was recorded by the
Company at its fair realizable market value. To date, none of the reagent
inventory has been sold. Net cash used in operating activities for the nine
months ended September 30, 1998 was $(117,481), as compared to net cash provided
by operating activities of $26,469 for the nine months ended September 30, 1997.
Net cash was used primarily to fund the losses from operations. Net cash used in
financing activities was $(99,277) for the nine months ended September 30, 1998,
as compared to $(129,836) for the nine months ended September 30, 1997. At
September 30, 1998, the Company had unrestricted cash of $59,060 and restricted
cash of $148,365. Under the terms of Gemini's loan agreement, the restricted
cash can only be disbursed to Gemini for leasehold improvements and certain
fixed asset acquisitions. Gemini is in the process of requesting a loan
modification which would allow Gemini to reallocate the loan proceeds for use as
working capital.
On October 30, 1998, the Company issued 777,202 shares of the Common
Stock to Elan at $.772 per share for a total of $600,000, which represented the
Company's first draw down on Elan's $2,000,000 commitment. Elan has agreed to
invest the remaining $1,400,000 in December 1998. Under the Agreement with Elan,
a portion of the proceeds from Elan's investment must be used by the company to
fund further development of iontophoresis products.
The Company on November 9, 1998, filed with the Securities and Exchange
Commission a registration statement to register for public sale approximately
5,000,000 shares of its common stock ("Common Stock") in order to raise
approximately $4,000,000, which would include the sale of $2,000,000 of the
Common Stock to a subsidiary of Elan, plc., which has committed to purchase up
to $2,000,000 of our Common Stock. The funds will supplement the Company's
current grant funds and sales revenues from services using the Company's drug
design expertise. The funds will be used to advance the Company's core
technologies through validation in the initial target areas of application. The
Company intends to seek additional SBIR grants, including Phase II grants
(common average funding at about $500,000 for each grant), and Federal Advanced
Technology Program grants. The Company believes that upon a successful
implementation of its strategic plan
34
<PAGE>
the Company will be able to obtain additional capital through a combination of
larger government grants, corporate strategic alliances and an additional public
financing. The proceeds from the sale of Common Stock will be used by the
Company to pursue the development of the technologies acquired from HTD and
Gemini in large therapeutic markets such as cancer and inflammation, and for
development of the drug delivery technologies in tissue repair/regeneration
However, there can be no assurance that the Company will be able to conclude the
contemplated financing or obtain sufficient funds to pursue all of its intended
product development programs.
At December 31, 1997, the Company had a net operating loss ("NOL")
carry forward of $10,719,000 available to offset future taxable income, if any,
through the year 2012. During 1993 and 1995, changes in ownership of greater
than 50% occurred as a result of the Company issuing equity securities.
Accordingly, a substantial limitation will be imposed upon the future
utilization of approximately $2,450,000 of its net operating loss carryforwards.
The Company expects that its cash needs will continue to increase in
the future periods, primarily because it will incur additional expenses related
to the development of small molecule drugs and the iontophoresis flexible patch
technology licensed from Elan, in addition to its efforts to develop novel
medical applications for its core PEMS technology. Accordingly, the Company will
need to raise substantial additional funds to continue the development and
commercialization of its technologies and products. The future cash needs of the
Company will depend significantly on many factors that relate to the development
of drug delivery and small molecule drug products, including but not limited to,
continued scientific progress in the research and development programs; the
results of research and development; preclinical studies and clinical trials;
acquisition of products and technologies, if any; relationships with corporate
partners, if any; competing technological and market developments; the time and
costs involved in obtaining regulatory approvals; the costs involved in filing,
prosecuting and enforcing patent claims; the time and costs of manufacturing
scale-up and commercialization activities and other factors.
Under the present circumstances, the Company's ability to continue as a
going concern depends on its ability to restructure, improve its operations, and
ultimately, to obtain additional financing. The Company is exploring alternative
sources of additional financing. Other than the proposed sale of $2,000,000 of
the Company's Common Stock to EIS, no definitive sources of additional financing
have been identified at this time, nor can there be any assurance that
additional financing will be obtained on favorable terms. The Company's ability
to obtain additional financing through issuance of its Common Stock was
negatively affected when Nasdaq notified the Company on September 23, 1997 that
the Company's stock would be delisted from the Nasdaq SmallCap Market as of the
close of business on September 23, 1997 due to noncompliance with the minimum
capital, surplus and public float requirements. The Company is now quoted on the
OTC Bulletin Board, but there can be no assurance that a public trading market
for the Company's Common Stock will continue to exist.
35
<PAGE>
The Company cannot predict whether the operating and financing
strategies described above will be successful. If the Company is unable to
restructure and improve its operations and is unable to ultimately obtain
additional financing, it may not be able to continue as a going concern.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In February 1993, Diapulse Corporation of America, Inc. ("Diapulse")
filed a citizen's petition requesting that the FDA revoke the substantial
equivalence finding for the SofPulse and prevent the Company from making certain
labeling claims. The Company believes, based upon the advice of regulatory
counsel, that Diapulse's petition is without merit. The Company responded to the
petition. The Company, however, made revisions in its promotional materials to
obviate any claim that such material was inconsistent with FDA regulations. The
Company believes that Diapulse's petition is lacking in merit and that it is
highly unlikely that the FDA will grant the petition. Even in the event that the
FDA were to grant the petition, the Company believes that its future business is
not likely to be materially adversely affected. In October 1993, Diapulse
submitted additional information to the FDA in support of its petition and the
Company responded. As of the date hereof, the FDA has not notified the Company
as to any action with respect to the aforementioned petition.
In August 1994, Diapulse filed a lawsuit in the Supreme Court of the
State of New York, Nassau County ("The Court"), captioned Diapulse Corporation
of America V. Magnetic Resonance Therapeutics, Inc. et al., alleging that the
defendants, Magnetic Resonance Therapeutics, Inc., a legal predecessor to the
Company, Bio-Sales, Inc., the Company, and certain of the Company's present and
former directors and officers, including Joshua Barnum ("Barnum"), David Mills
("Mills"), Arthur Pilla ("Pilla"), David Saloff ("Saloff"), and David Winter
("Winer"), engaged in deceptive acts and practices, false advertising and unfair
competition in the marketing of a medical device. The complaint also alleges
that Barnum and Mills breached confidentiality and noncompetition agreements
with Diapulse and that the Company, Barnum and Pilla aided in the alleged
tortious breach of the agreements. Diapulse seeks unspecified compensatory
damages, disgorgement of profits realized by the defendants as a result of their
alleged acts, treble damages, punitive damages and reasonable attorneys' fees.
Diapulse also seeks unspecified injunctive relief prohibiting the defendants
from engaging in the alleged acts and ordering the defendants to take remedial
action to rectify the effects on consumers and Diapulse caused by the
defendants' alleged acts. The defendants jointly moved to dismiss the complaint
on jurisdictional and substantive grounds. The Court dismissed Winer from the
case based on lack of personal jurisdiction. The Court also dismissed certain
claims, as to the remaining individual defendants, including deceptive acts and
practices, false advertising and unfair competition. As to the claims remaining
against the individual defendants, certain of such claims may be indemnified by
the Company. As to the Company, the Court denied the motion to dismiss. The
Company answered the complaint, denied all material
36
<PAGE>
allegations, asserted various affirmative defenses and counterclaimed against
Diapulse and Jesse Ross, individually. The counterclaims allege causes of action
against Diapulse and Jesse Ross for federal unfair competition and tortious
interference of existing and contractual business relations. In addition, the
Company has asserted claims against Diapulse for deceptive acts and unfair trade
practices, and trade disparagement. In its counterclaims, the Company seeks
compensatory and punitive damages in an amount to be proved at trial. This
lawsuit is in a preliminary stage and its outcome is uncertain. Although the
Company believes that it has meritorious defenses that it will vigorously pursue
and that its ability to develop its future technologies and products does not
materially depend on the outcome of this litigation, there can be no assurance
that the outcome of such action will be resolved favorably to the Company or
that such litigation will not have an adverse effect on the Company's liquidity,
financial condition and results of operations.
On August 28, 1997, Michelle O'Connell, formerly employed by Kinetech
Medical, Inc. ("Kinetech") as the Company's representative, filed a complaint
entitled O'Connell v. Kinetech Medical, Inc. and Electropharmacology, Inc. in
the County Court in Dallas County, Texas. The complaint alleges that Kinetech
and the Company are jointly and severally liable for an unspecified amount of
commissions earned by O'Connell from Kinetech, but unpaid, and asserts a cause
of action quantum meruit against the Company. O'Connell dismissed the complaint
against the Company in May, 1998 and Kinetech immediately filed a
cross-complaint against the Company for breach of the agreement between the
Company and Kinetech for failing to pay commissions owed in excess of $30,000.
The Company answered the cross-complaint and asserted several affirmative
defenses. The case has not yet been set for trial and no discovery between the
Company and Kinetech has taken place.
On July 14, 1998, Jack Baxter ("Baxter"), a former employee of the
Company filed a complaint entitled Baxter v. Electropharmacology, Inc. in the
Circuit Court in Broward County, Florida. The complaint alleges the failure by
the Company to make payments of $20,000 due Baxter under an agreement pursuant
to which Baxter and the Company had agreed to the terms of the termination of
their employer-employee relationship. The Company answered the complaint and
asserted several affirmative defenses. The case has not yet been set for trial
and no discovery between the Company and Baxter has taken place.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this Quarterly Report
on form 10-Q:
(27) -- Financial Data Schedule
(b) The following reports on Form 8-K were filed during the
quarter ended September 30, 1998:
37
<PAGE>
* Form 8-K dated July 6, 1998 - Item 2 - regarding the
execution of an agreement to acquire Gemini Biotech, Ltd.
* Form 8-K dated September 3, 1998 - Item 1 - regarding the
change in control of the Company due to the reorganization
of the Company and the acquisition of Gemini Biotech, Ltd.
And HealthTech Development, Inc.
* Form 8-K dated September 4, 1998 - Item 5 - regarding the
execution of a binding Letter of Intent with subsidiaries
of Elan, plc.
SIGNATURES
In accordance with the requirements of the Securities and Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto authorized.
ELECTROPHARMACOLOGY, INC.
Registrant
Dated November 18, 1998 /s/ Arup Sen
--------------------------------------
Arup Sen
President and Chief Executive Officer
Dated November 18, 1998 /s/ David Saloff
--------------------------------------
David Saloff
Chief Financial Officer
38
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
FORM 10-QSB AT SEPTEMBER 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 207,425
<SECURITIES> 0
<RECEIVABLES> 157,066
<ALLOWANCES> 26,367
<INVENTORY> 742,172
<CURRENT-ASSETS> 1,249,758
<PP&E> 286,323
<DEPRECIATION> 0
<TOTAL-ASSETS> 2,284,286
<CURRENT-LIABILITIES> 1,203,393
<BONDS> 0
<COMMON> 125,054
0
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<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 2,284,286
<SALES> 136,408
<TOTAL-REVENUES> 495,551
<CGS> 199,249
<TOTAL-COSTS> 199,249
<OTHER-EXPENSES> 12,807,402
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 55,083
<INCOME-PRETAX> (11,842,648)
<INCOME-TAX> 0
<INCOME-CONTINUING> (11,842,648)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,842,648)
<EPS-PRIMARY> (2.52)
<EPS-DILUTED> (2.52)
</TABLE>
