UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
Commission file number 0-13092
SPECTRASCIENCE, INC.
(Exact name of registrant
as specified in its charter)
Minnesota | 41-1448837 |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
11568 Sorrento Valley Rd., Suite 11
San Diego, California 92121
(Address of principal executive offices, including zip code)
(858) 847-0200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. YESx NO¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registration was required to submit and post such files). YES x NO¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ |
Non-accelerated filer ¨ | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES¨ NOx
The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding on November 12, 2014 was 173,701,088.
SPECTRASCIENCE, INC.
FORM 10-Q
For the Nine Months Ended September 30, 2014
TABLE OF CONTENTS
PART I | FINANCIAL INFORMATION: | ||
Item 1. | Financial Statements (Unaudited) | 3 | |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 18 | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 24 | |
Item 4. | Controls and Procedures | 24 | |
PART II | OTHER INFORMATION | ||
Item 1. | Legal Proceedings | 24 | |
Item 1A. | Risk Factors | 24 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 25 | |
Item 3. | Defaults Upon Senior Securities | 25 | |
Item 4. | Mine Safety Disclosures | 25 | |
Item 5. | Other Information | 25 | |
Item 6. | Exhibits | 26 | |
SIGNATURES | 27 |
2 |
PART I FINANCIAL INFORMATION:
SpectraScience, Inc. and Subsidiary
Condensed Consolidated Balance Sheets
September 30, | December 31, | |||||||
2014 | 2013 | |||||||
(Unaudited) | (Audited) | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash | $ | 43,641 | $ | 236,597 | ||||
Accounts receivable, net | - | 60,000 | ||||||
Inventory | 316,680 | 247,433 | ||||||
Deferred debt issuance costs | 109,849 | 82,227 | ||||||
Prepaid expenses and other current assets | 201,819 | 174,852 | ||||||
Total current assets | 671,989 | 801,109 | ||||||
Fixed assets, net | 5,441 | 15,917 | ||||||
Patents, net | 1,389,255 | 1,513,340 | ||||||
$ | 2,066,685 | $ | 2,330,366 | |||||
LIABILITIES AND STOCKHOLDERS' DEFICIT | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 786,091 | $ | 1,009,018 | ||||
Note payable to an affiliate | - | 30,000 | ||||||
Convertible debt, net of discounts of $696,824 as of September 30, 2014 and | ||||||||
$644,518 as of December 31, 2013 | 3,946,854 | 2,307,111 | ||||||
Derivative liability | 1,082,557 | 1,104,423 | ||||||
Accrued expenses | 695,345 | 431,045 | ||||||
Total current liabilities | 6,510,847 | 4,881,597 | ||||||
COMMITMENTS AND CONTINGENCIES | ||||||||
Stockholders' deficit | ||||||||
Series A Convertible Preferred Stock, $.01 par value; | ||||||||
0 shares authorized, issued and outstanding as of September 30, 2014 and | ||||||||
December 31, 2013 | - | - | ||||||
Series B Convertible Preferred Stock, $.01 par value; | ||||||||
2,585,000 shares authorized, issued and outstanding as of September 30, 2014 and | ||||||||
December 31, 2013; liquidation value of $517,000 plus accumulated and | ||||||||
unpaid dividends of $106,931 as of September 30, 2014 and December 31, 2013 | 25,850 | 25,850 | ||||||
Series C Convertible Preferred Stock, $.01 par value; | ||||||||
1,000,000 shares authorized; 500,000 shares issued and outstanding as of | ||||||||
September 30, 2014 and December 31, 2013; liquidation value of $100,000 as of | ||||||||
September 30, 2014 and December 31, 2013 | 5,000 | 5,000 | ||||||
Common stock, $.01 par value; | ||||||||
746,415,000 shares authorized; 173,701,088 and 166,712,054 shares issued | ||||||||
and outstanding as of September 30, 2014 and December 31, 2013 | 1,737,011 | 1,667,120 | ||||||
Additional paid in capital | 38,625,792 | 37,126,602 | ||||||
Accumulated deficit | (44,837,815 | ) | (41,375,803 | ) | ||||
Total stockholders' deficit | (4,444,162 | ) | (2,551,231 | ) | ||||
$ | 2,066,685 | $ | 2,330,366 |
See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.
3 |
SpectraScience, Inc. and Subsidiary
Condensed Consolidated Statements of Operation
(Unaudited)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Revenue | $ | - | $ | 60,000 | $ | - | $ | 180,000 | ||||||||
Cost of revenue | - | 36,756 | (6,000 | ) | 110,269 | |||||||||||
Gross profit | - | 23,244 | 6,000 | 69,731 | ||||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 138,806 | 59,176 | 673,173 | 440,086 | ||||||||||||
General and administrative | 280,000 | 375,200 | 1,092,689 | 1,527,780 | ||||||||||||
Sales and marketing | 114,178 | 33,285 | 344,529 | 200,355 | ||||||||||||
532,984 | 467,661 | 2,110,391 | 2,168,221 | |||||||||||||
Loss from operations | (532,984 | ) | (444,417 | ) | (2,104,391 | ) | (2,098,490 | ) | ||||||||
Other income (expense) | ||||||||||||||||
Interest expense | (131,846 | ) | (79,260 | ) | (347,587 | ) | (202,352 | ) | ||||||||
Change in fair value of derivative and | ||||||||||||||||
warrant liabilities | 1,883,289 | 1,156,215 | (168,471 | ) | 1,073,017 | |||||||||||
Amortization of derivative and warrant | ||||||||||||||||
liabilities discount | (396,853 | ) | (308,484 | ) | (850,691 | ) | (1,328,849 | ) | ||||||||
Amortization of deferred debt issuance | ||||||||||||||||
costs and original issue discount | (85,034 | ) | (141,840 | ) | (197,608 | ) | (532,912 | ) | ||||||||
Gain (loss) on extinguishment of debt | 227,259 | - | 227,259 | (16,989 | ) | |||||||||||
Other income (expense), net | (5,343 | ) | (4,848 | ) | (20,523 | ) | (3,085 | ) | ||||||||
1,491,472 | 621,783 | (1,357,621 | ) | (1,011,170 | ) | |||||||||||
Net income (loss) before income taxes | 958,488 | 177,366 | (3,462,012 | ) | (3,109,660 | ) | ||||||||||
Provision for income taxex | - | - | - | - | ||||||||||||
Net income (loss) | $ | 958,488 | $ | 177,366 | $ | (3,462,012 | ) | $ | (3,109,660 | ) |
See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.
4 |
SpectraScience, Inc. and Subsidiary
Condensed Consolidated Statement of Shareholders' Deficit
For the nine months ended September 30, 2014
(unaudited)
Additional | Accumulated | Total | ||||||||||||||||||||||||||||||||||
Series B Preferred Stock | Series C Preferred Stock | Common Stock | Paid-In | Deficit | Shareholders' | |||||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Capital | Deficit | |||||||||||||||||||||||||||||
Balance December 31, 2013 | 2,585,000 | $ | 25,850 | 500,000 | $ | 5,000 | 166,712,054 | $ | 1,667,120 | $ | 37,126,602 | $ | (41,375,803 | ) | $ | (2,551,231 | ) | |||||||||||||||||||
Non cash issuance of stock options | - | - | - | - | - | - | 349,143 | - | 349,143 | |||||||||||||||||||||||||||
Common stock issued for cash on option exercise | - | - | - | - | 931,200 | 9,312 | 9,312 | - | 18,624 | |||||||||||||||||||||||||||
Common stock issued for debt offering costs | - | - | - | - | 1,000,000 | 10,000 | 40,000 | - | 50,000 | |||||||||||||||||||||||||||
Conversion of convertible debt | - | - | - | - | 5,057,834 | 50,579 | 202,313 | - | 252,892 | |||||||||||||||||||||||||||
Warrant valuation on issuance of convertible debt | - | - | - | - | - | - | 897,712 | - | 897,712 | |||||||||||||||||||||||||||
Warrant valuation on issuance of short term debt | - | - | - | - | - | - | 710 | - | 710 | |||||||||||||||||||||||||||
Net loss | - | - | - | - | - | - | - | (3,462,012 | ) | (3,462,012 | ) | |||||||||||||||||||||||||
Balance September 30, 2014 | 2,585,000 | $ | 25,850 | 500,000 | $ | 5,000 | 173,701,088 | $ | 1,737,011 | $ | 38,625,792 | $ | (44,837,815 | ) | $ | (4,444,162 | ) |
See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.
5 |
SpectraScience, Inc. and Subsidiary
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30, | ||||||||
2014 | 2013 | |||||||
Operating activities: | ||||||||
Net loss | $ | (3,462,012 | ) | $ | (3,109,660 | ) | ||
Adjustments to reconcile net loss | ||||||||
to cash used in operating activities: | ||||||||
Provision for uncollectable accounts receivable | - | 4,281 | ||||||
Amortization and depreciation | 140,836 | 179,308 | ||||||
Non-cash issuance of stock options | 349,143 | 287,338 | ||||||
Non-cash interest on issuance of warrant | 710 | - | ||||||
Amortization of derivative and warrant liabilities discount | 850,691 | 1,328,849 | ||||||
Amortization of deferred debt issuance costs and original issue discount | 197,608 | 532,912 | ||||||
Change in fair value of derivative and warrant liabilities | 168,471 | (1,073,017 | ) | |||||
(Gain) loss on extinguishment of debt | (227,259 | ) | 16,989 | |||||
Fair market value of common stock issued for debt offering costs | 50,000 | 244,500 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 60,000 | (34,281 | ) | |||||
Inventory | (69,247 | ) | 81,435 | |||||
Prepaid expenses and other current assets | (26,966 | ) | (32,301 | ) | ||||
Accounts payable | (222,927 | ) | 144,156 | |||||
Accrued expenses | 317,271 | 350,248 | ||||||
Net cash used in operating activities | (1,873,681 | ) | (1,079,243 | ) | ||||
Investing activities: | ||||||||
Purchases of fixed assets | (6,275 | ) | (1,600 | ) | ||||
Net cash used in investing activities | (6,275 | ) | (1,600 | ) | ||||
Financing activities: | ||||||||
Proceeds from issuance of convertible notes payable | 1,856,376 | 1,372,000 | ||||||
Proceeds from issuance of note payable to affiliate | - | 45,000 | ||||||
Payments against note payable to affiliate | (30,000 | ) | - | |||||
Proceeds from exercise of stock options | 18,624 | 9,375 | ||||||
Debt issuance costs | (158,000 | ) | (197,239 | ) | ||||
Net cash provided by financing activities | 1,687,000 | 1,229,136 | ||||||
Net increase (decrease) in cash | (192,956 | ) | 148,293 | |||||
Cash,beginning of year | 236,597 | 90,192 | ||||||
Cash,end of period | $ | 43,641 | $ | 238,485 | ||||
Supplemental Disclosure of Cash Flow Information: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | - | $ | 5,539 | ||||
Income taxes | $ | - | $ | - | ||||
Non Cash Investing and Financing Activities: | ||||||||
Conversion of convertible notes to common stock | $ | 236,842 | $ | 263,158 | ||||
Conversion of interest due on convertible notes to common stock | $ | 52,972 | $ | 33,988 | ||||
Exchange of interest due on convertible notes to new notes | $ | - | $ | 25,259 | ||||
Conversion of preferred stock to common stock | $ | - | $ | 5,000 | ||||
Warrant valuation on isuance of convertible debentures | $ | 897,712 | $ | - | ||||
Elimination of derivative liabilities on conversion | $ | 190,337 | $ | - |
See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.
6 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements
1. Nature of Business and Basis of Presentation
Description of Business
SpectraScience, Inc. was incorporated in the State of Minnesota on May 4, 1983 as GV Medical, Inc. In October 1992, GV Medical discontinued its prior business, refocused its development efforts and changed its name to SpectraScience, Inc. The “Company,” hereinafter, refers to SpectraScience, Inc. and its wholly owned subsidiaries Luma Imaging Corporation (“LUMA”), Spectra Science International, Inc. (“International”) and SpectraScience (UK) Limited (“SpectraUK”). Since 1996, the Company has focused primarily on developing the WavSTAT Optical Biopsy System (the “WavSTAT System”).
The Company has developed and received the European CE mark approval to market a proprietary, minimally invasive technology that optically illuminates tissue in real-time to distinguish between normal, pre-cancerous or cancerous cells without the need to remove the subject cell tissue from the body to make such determinations. The WavSTAT System operates by using cool, safe laser light to optically illuminate and analyze tissue, enabling the physician to make an instant diagnosis during endoscopy when screening for cancer, and if warranted, to begin immediate treatment during the same procedure. Beginning in December 2011, the WavSTAT 4 version of the product began to be sold in the European Union for colon cancer detection. In June 2012, the Company entered into a distribution agreement with PENTAX Europe, GmbH, for the sale of its systems internationally.
On November 6, 2007, the Company acquired the assets of LUMA in an equity transaction accounted for as an acquisition of assets and now operates LUMA as a wholly-owned subsidiary of the Company. LUMA had acquired the assets from a predecessor company that had developed, and received FDA approval for, a non-invasive diagnostic imaging system that can detect cervical cancer precursors and which utilizes an underlying technology that is similar to that of the WavSTAT System. The addition of the LUMA technology to the Company’s existing WavSTAT System technology provides the Company with a broad suite of fluorescence-based intellectual property and know-how. During the fiscal year ended December 31, 2010, the Company wrote off the remaining fair value of the LUMA inventory in order to focus on the continued development and marketing of the WavSTAT System. The Company retained the intellectual property of LUMA for use in the development of future generations of the WavSTAT System.
The transaction was accounted for as an acquisition of assets that included intellectual property, inventory and equipment. The intellectual property consisted of a total of 34 issued U.S. patents and 28 additional patent applications.
Basis of Presentation
The accompanying unaudited financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q as they are prescribed for smaller reporting companies. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the three and nine month periods ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These statements should be read in conjunction with the financial statements and related notes, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.
7 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
Going Concern
Historically, the Company’s sources of cash have come from the issuance and sales of equity securities and convertible debentures. The Company’s historical cash outflows have been primarily used for operating activities including research, development, administrative and sales activities. Fluctuations in the Company’s working capital due to timing differences of its cash receipts and cash disbursements also impact its cash flow. The Company expects to incur significant additional operating losses through at least the end of 2014, as it completes proof-of-concept trials, conducts outcome-based clinical studies and increases sales and marketing efforts to commercialize the WavSTAT4 Systems in Europe. If the Company does not receive sufficient funding, there is substantial doubt that the Company will be able to continue as a going concern. The Company may incur unknown expenses or may not be able to meet its revenue forecast, and one or more of these circumstances would require the Company to seek additional capital. The Company may not be able to obtain equity capital or debt funding on terms that are acceptable. Even if the Company receives additional funding, such proceeds may not be sufficient to allow the Company to sustain operations until it becomes profitable and begins to generate positive cash flows from operations.
As of September 30, 2014, the Company had a working capital deficit of $5,838,858 and cash of $43,641, compared to a working capital deficit of $4,080,488 and cash of $236,597 as of December 31, 2013. In December 2011, the Company entered into an Engagement Agreement with Laidlaw & Company (UK) Ltd., which Engagement Agreement was amended in July 2012. Under the Engagement Agreement, Laidlaw agreed to assist the Company in raising up to $20.0 million in capital over a two year period from the date of the Engagement Agreement. Subsequent to September 30, 2013, the Company has engaged other agents to assist the Company with raising capital and has commenced raising capital on its own. During the nine months ended September 30, 2014, The Company raised $1,856,376, net of transaction costs of $158,000, under these agreements. However, if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined in the Engagement Agreements occur as expected, or if the Company is otherwise able to raise a similar level of funds, such proceeds will be sufficient to allow the Company to sustain operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be able to meet its revenue expectations requiring it to seek additional capital. In such event, the Company may not be able to find capital or raise capital or debt on terms that are acceptable.
The holders of Convertible Debentures control the conversion of the Convertible Debentures and certain of the Convertible Debentures were not converted at their maturity constituting a potential default on the matured, but unconverted, Convertible Debentures. In the event of such default, principal, accrued interest and other related costs are immediately due and payable in cash. As of September 30, 2014, Convertible Debentures with a face value of $1,624,211 held by 32 individual investors are in default. None of these investors have served notice of default on the Convertible Debentures held by them.
The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.
8 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
2. Summary of Significant Accounting Policies
Revenue recognition
The Company recognizes revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Revenue from the sale of the Company’s products is generally recognized when title and risk of loss transfers to the customer, the terms of which are generally free on board shipping point. The Company
uses customer purchase orders to determine the existence of an arrangement. The Company uses shipping documents and third-party proof of delivery to verify that title has transferred. The Company assesses whether the price is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, the Company assesses a number of factors, including past transaction history with the customer and the creditworthiness of the customer.
Consolidation
The accompanying consolidated financial statements include the accounts of SpectraScience, Inc. and its wholly-owned subsidiaries LUMA, International and Spectra UK. All significant intercompany balances and transactions have been eliminated in consolidation.
Risks and Uncertainties
The Company operates in an industry that is subject to intense competition, government regulation and rapid technological change. The Company's operations are subject to significant risk and uncertainties, including financial, operational, technological, regulatory and other risks associated with a short history of product sales, including the potential risk of business failure.
Use of Estimates
The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. Significant estimates made by management include, among others, realization of long-lived assets including intangible assets, assumptions used to value stock options, assumptions used to value the common stock issued and assumptions related to the determination of the fair value of the derivative components associated with the Company’s Convertible Debentures. Actual results could differ from those estimates.
Inventory Valuation
The Company states its inventory at the lower of cost or market value, determined on a specific cost basis. The Company provides inventory allowances when conditions indicate that the selling price could be less than cost due to obsolescence and reductions in estimated future demand. The Company balances the need to maintain strategic inventory levels with the risk of obsolescence due to changing technology and customer demand levels. Unfavorable changes in market conditions may result in a need for additional inventory reserves that could adversely impact the Company’s gross margins. Conversely, favorable changes in demand could result in higher gross margins when the Company sells products.
Valuation of Long-lived Assets
The Company’s long-lived assets consist of property and equipment and intangible assets. Equipment is carried at cost and is depreciated over the estimated useful lives of the assets, which are generally two to three years, and leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the improvements. The straight-line method is used for depreciation and amortization. Intangible assets consist of patents, which are amortized using the straight-line method over the estimated useful lives of the patents. The Company does not capitalize external legal costs and filing fees associated with obtaining patents on its new discoveries. Acquired intellectual property is recorded at cost and is amortized over its estimated useful life. The Company believes the useful lives assigned to these assets are
reasonable. The Company assesses the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent in management’s estimate of future cash flows to determine recoverability of these assets. If management’s assumptions about these assets were to change as a result of events or circumstances, the Company may be required to record an impairment loss.
9 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
Stock-Based Compensation
The Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718,Compensation—Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company adopted ASC 718 on January 1, 2006. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option-pricing model (the “Black-Scholes Model”). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. The Company estimates forfeitures at the time of grant and revises its estimate in subsequent periods if actual forfeitures differ from those estimates.
The Company accounts for stock-based compensation awards to non-employees in accordance with FASB ASC Topic 505-50,Equity-Based Payments to Non-Employees (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.
All issuances of stock options or other equity instruments to employees and non-employees as the consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments issued. Any stock options issued to non-employees are recorded in expense and additional paid-in capital in shareholders’ equity over the applicable service periods using variable accounting through the vesting dates based on the fair value of the options at the end of each reporting period.
As of September 30, 2014, the Company had one stock-based employee compensation plan under which it makes grants, the 2011 Equity Incentive Plan (the “EIP”). The EIP provides for the grant of incentive stock options (“ISOs”), nonqualified stock options (“NQSOs”) and restricted stock awards to full-time employees (who may also be directors) and NQSOs and restricted stock awards to non-employee directors, consultants, customers, vendors or providers of services. The exercise price of any ISO may not be less than the fair market value of the common stock on the date of grant and the term shall not exceed ten years. The amount reserved under the 2011 EIP is 37,000,000 shares of common stock. At September 30, 2014, the Company had options outstanding exercisable into up to 35,168,800 shares of stock under the EIP and the Company’s prior Amended 2001 Stock Plan of which up to 13,780,397 shares were exercisable. Awards under the Company’s EIP generally vest over four years.
10 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
The fair value of options granted are estimated at the date of grant using a Black-Scholes Model which includes several variables including expected life, risk free interest rate, expected stock price volatility, stock option exercise patterns and expected dividend yield. The Company also must estimate forfeitures for employee stock options. Management used the following weighted average assumptions to value stock options granted during the three and nine month periods ended September 30, 2014 and 2013:
Three months ended September 30, | Nine months ended September 30, | |||||||||
2014 | 2013 | 2014 | 2013 | |||||||
Expected term of options | None | None | 5 years | None | ||||||
Exercise price | None | None | $ | 0.02 | None | |||||
Expected volatility | None | None | 187 | % | None | |||||
Expected dividends | None | None | None | None | ||||||
Risk-free interest rate | None | None | 1.64 | % | None | |||||
Forfeitures | None | None | None | None |
Earnings (Loss) Per Share
Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.
For the periods ended September 30, 2014 and 2013, the following common equivalent shares were excluded from the computation of loss per share since their effects are anti-dilutive.
September 30, | September 30, | |||||||
2014 | 2013 | |||||||
Preferred Stock | 3,085,000 | 3,085,000 | ||||||
Convertible debentures | 94,767,062 | 39,111,869 | ||||||
Options | 35,168,800 | 19,491,667 | ||||||
Warrants | 109,942,469 | 77,127,289 | ||||||
Total | 242,963,331 | 138,815,825 |
11 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
The following table sets forth the computation of basic and diluted loss per share for the three and nine month periods ended September 30, 2014 and 2013:
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2014 | 2013 | 2014 | 2013 | |||||||||||||
Numerator: | ||||||||||||||||
Net income (loss) for basic earnings per share | $ | 958,488 | $ | 177,366 | $ | (3,462,012 | ) | $ | (3,109,660 | ) | ||||||
Net income (loss) for diluted earnings per share | $ | 958,488 | $ | 177,366 | $ | (3,462,012 | ) | $ | (3,109,660 | ) | ||||||
Denominator: | ||||||||||||||||
Weighted average basic shares outstanding | 171,996,818 | 161,854,734 | 169,070,461 | 158,736,987 | ||||||||||||
Denominator for diluted earnings per share- | ||||||||||||||||
Adjusted weighted average shares | 186,965,778 | 161,854,734 | 169,070,461 | 158,736,987 | ||||||||||||
Loss per share | ||||||||||||||||
Basic | $ | 0.01 | $ | 0.00 | $ | (0.02 | ) | $ | (0.02 | ) | ||||||
Diluted | $ | 0.01 | $ | 0.00 | $ | (0.02 | ) | $ | (0.02 | ) |
Inventory
Inventory consisted of the following at September 30, 2014 and December 31, 2013:
September 30, | December 31, | |||||||
2014 | 2013 | |||||||
Raw materials | $ | 270,345 | $ | 201,098 | ||||
Finished goods | 46,335 | 46,335 | ||||||
316,680 | 247,433 | |||||||
Reserve for obsolescence | - | - | ||||||
$ | 316,680 | $ | 247,433 |
3. Liabilities
Note Payable to an Affiliate
In September 2013, the Company issued a nine month unsecured note with a face value of $45,000 and 500,000 restricted shares of common stock to an affiliate of the Company in exchange for $54,325 in cash. The imputed annual rate of interest was calculated to be 18.4% and was repaid in nine equal monthly installments. Of the 500,000 shares issued, 312,500 shares were issued for debt issuance costs in an amount of $15,625 which was amortized as interest expense over the life of the note and 187,500 shares were issued for cash in an amount of $9,375.
12 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
Convertible Debentures
As of September 30, 2014, the Company has issued and outstanding Convertible Debentures (“Debentures”) with original terms of six months to one year, an interest rate ranging from 10-20% per year and an original issue discount ranging from 5% to 10% which, at the option of the holder, may convert into common stock at an initial conversion price ranging from $0.045 to$0.099 per share. The Debentures were issued with detachable five year cashless Holders Warrants that allow the holders to purchase one share of stock for each two shares available under the converted Debentures at an exercise price ranging from $0.0745 to $0.1287 per share. In addition, the Company issued five year cashless Agent Warrants equal to 10% of the total number of shares issuable under the Debentures and Holders Warrants at an exercise price ranging from $0.0745 to $0.1287 per share. For debentures issued through September 30, 2013, at the option of the Debenture holder, the terms of the Debentures and Holders Warrants are subject to an exchange feature in the event that the Company issues securities with terms more favorable than those of the then outstanding Debentures and Holders Warrants. Debentures issued subsequent to September 30, 2013 do not contain such an exchange clause.
As of September 30, 2014 and December 31, 2013, the balances of the Debentures are as follows:
September 30, | December 31, | |||||||
2014 | 2013 | |||||||
Balance at beginning of period | $ | 2,951,629 | $ | 1,129,473 | ||||
Issuance of debentures for cash | 1,856,376 | 2,122,000 | ||||||
Original issue discount | 72,515 | 111,685 | ||||||
Debentures surrendered in exchange transactions | - | (564,213 | ) | |||||
Debentures issued in exchange transactions | - | 626,368 | ||||||
Debentures converted to common stock | (236,842 | ) | (473,684 | ) | ||||
Convertible debt | 4,643,678 | 2,951,629 | ||||||
Less unamortized costs of financing | 696,824 | 644,518 | ||||||
Convertible debt, net of unamortized costs | $ | 3,946,854 | $ | 2,307,111 | ||||
Convertible debt in default | $ | 1,624,211 | $ | 1,324,212 |
Derivative Liability
Since the Company issued Convertible Debentures which included Holders Warrants, Agent Warrants and a conversion option that includes a possible exchange feature in the event of a future financing on terms more favorable than those of the existing warrants and debentures, this results in the warrants and conversion feature of the debentures being recorded as a liability and measured at fair value. The Company measures these warrants and conversion feature using a combination of Black-Scholes option valuation models and Binomial Lattice option valuation models using similar assumptions to those described under “Stock-Based Compensation.” The time period over which the Company will be required to evaluate the fair value of the warrants is approximately five years and the time period over which the Company will be required to evaluate the fair value of the conversion feature is the lesser of six to twelve months or conversion.
The assumptions used in determining fair value represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change, including changes in the market value of the Company’s common stock, managements’ assessment of the probability of a more favorably priced future financing or significant fluctuations in the volatility of the trading market for the Company’s common stock, the Company’s fair value estimates could be materially different in the future.
13 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
The Company computes the fair value of the derivative liability at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component in the value of the derivative liability is the Company’s stock price, which is subject to significant fluctuation and is not under its control. The resulting effect on net loss is therefore subject to significant fluctuation and will continue to be so until the Company’s Debentures, which the convertible feature is associated with, are converted into common stock or paid in full with cash. Assuming all other fair value inputs remain constant, the Company will record non-cash expense when its stock price increases and non-cash income when its stock price decreases.
As of September 30, 2014 and December 31, 2013, the balances of the Derivative Liability are as follows:
Conversion | ||||||||||||
Warrants | Feature | Total | ||||||||||
Balance at December 31, 2012 | $ | 1,730,044 | $ | 605,516 | $ | 2,335,560 | ||||||
Liability on issuance of debt and warrants | 762,111 | 929,156 | 1,691,267 | |||||||||
Change in fair value at year end | (1,688,671 | ) | (1,233,733 | ) | (2,922,404 | ) | ||||||
Balance at December 31, 2013 | 803,484 | 300,939 | 1,104,423 | |||||||||
Liability on issuance of debt and warrants | - | - | - | |||||||||
Elimination of liability on conversion | - | (190,337 | ) | (190,337 | ) | |||||||
Change in fair value at period end | (36,710 | ) | 205,181 | 168,471 | ||||||||
Balance at September 30, 2014 | $ | 766,774 | $ | 315,783 | $ | 1,082,557 |
Debentures issued subsequent to September 30, 2013 did not contain an exchange provision and were accounted for using the equity method of valuing the note and warrant. For the nine months ended September 30, 2014, $897,712 was recorded as additional paid-in capital.
4. Shareholders’ Deficit
Common Stock
In February 2014, an affiliate of the Company exercised a portion of his stock options into 931,200 shares of restricted common stock at an exercise price of $0.02 for proceeds to the Company of $18,624.
In March 2014, the Company issued 310,000 shares of restricted common stock to one consultant at a price of $0.05 per share related to the issuance of convertible debentures.
In June 2014, the Company issued 690,000 shares of restricted common stock to one consultant at a price of $0.05 per share related to the issuance of convertible debentures.
During the nine months ended September 30, 2014, holders of Convertible Debentures with a face value of $236,842 converted their debentures into 4,133,369 shares of restricted common stock. In addition, associated with these debentures, the Company paid $52,972 in accrued interest by issuing 924,465 shares of restricted common stock
Warrants
During the three and nine months ended September 30, 2014, in conjunction with the sale of Convertible Debentures, the Company issued five year common stock purchase warrants to acquire up to 4,222,530 and 22,012,675 shares to holders of the Debentures and as compensation to Agents. These warrants have an exercise price of $0.09 per share.
14 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
The balance of all warrants outstanding as of September 30, 2014 is as follows:
Weighted | ||||||||
Average | ||||||||
Exercise | ||||||||
Warrants | Shares | Price | ||||||
Outstanding at January 1, 2014 | 87,929,794 | $ | 0.15 | |||||
Granted | 22,012,675 | $ | 0.09 | |||||
Exchanged cancelled | - | $ | - | |||||
Exchanged issued | - | $ | - | |||||
Cancelled | - | $ | - | |||||
Exercised | - | $ | - | |||||
Outstanding at September 30, 2014 | 109,942,469 | $ | 0.13 | |||||
Exercisable at September 30, 2014 | 109,942,469 | $ | 0.13 |
Stock Options
Options outstanding as of September 30, 2014 are as follows:
Outstanding Options | ||||||||||||||||
Weighted Average | Weighted Average | Aggregate | ||||||||||||||
Exercise Price | Remaining Contractual | Intrinsic | ||||||||||||||
Shares | Per Share | Term (years) | Value (1) | |||||||||||||
Outstanding at January 1, 2014 | 15,075,000 | $ | 0.14 | 6.94 | ||||||||||||
Granted | 35,550,000 | $ | 0.02 | - | ||||||||||||
Cancelled | (14,525,000 | ) | $ | 0.14 | - | |||||||||||
Exercised | (931,200 | ) | $ | 0.02 | - | |||||||||||
Outstanding at September 30, 2014 | 35,168,800 | $ | 0.02 | 9.21 | $ | - | ||||||||||
Exercisable at September 30, 2014 | 13,780,397 | $ | 0.03 | 9.11 | $ | - | ||||||||||
Weighted average fair value of options | ||||||||||||||||
granted during the period | 35,550,000 | $ | 0.02 |
(1) | These amounts represent the excess, if any, between the exercise price and $0.02, the closing market price of the Company’s common stock on September 30, 2014 as quoted on the Over-the-Counter Bulletin Board under the symbol “SCIE”. |
In January 2014, the Company’s Board of Directors authorized the issuance of stock options exercisable into up to 35,550,000 shares of common stock at an exercise price of $0.02 per share to a group of employees, directors and consultants in exchange for the cancelation of stock options exercisable into up to 14,225,000 shares of common stock with average exercise prices of $0.14 per share held by the same group.
15 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
There was one option exercised for 931,200 shares during the nine month period ended September 30, 2014. At September 30, 2014, total unrecognized estimated employee compensation cost related to non-vested stock options granted prior to that date is $538,067, which we expect to be recognized over the next four years.
5. Fair Value Measurements
Accounting guidance on fair value measurements and disclosures defines fair value, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system, and defines
required disclosures. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business.
The Company's balance sheet contains derivative and warrant liabilities that are recorded at fair value on a recurring basis. The three-level valuation hierarchy for disclosure of fair value is as follows:
Level 1: uses quoted market prices in active markets for identical assets or liabilities.
Level 2: uses observable market-based inputs or unobservable inputs that are corroborated by market data.
Level 3: uses unobservable inputs that are not corroborated by market data.
The fair value of the Company’s recorded derivative and warrant liabilities is determined based on unobservable inputs that are not corroborated by market data, which require a Level 3 classification. A Binomial Lattice option valuation model was used to determine the fair value with similar assumptions to those described under “Stock-Based Compensation”. The Company records derivative and warrant liabilities on the condensed consolidated balance sheets at fair value with changes in fair value recorded in the condensed consolidated statements of operation.
The following table presents the balances of liabilities measured at fair value on a recurring basis by level as of September 30, 2014:
Fair Value Measurements Using | ||||||||||||||||
Quoted Prices in | Significant Other | Significant | ||||||||||||||
Active Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | |||||||||||||
As of September 30, 2014 | ||||||||||||||||
Derivative liability | $ | - | $ | - | $ | 315,783 | $ | 315,783 | ||||||||
Warrant liability | - | - | 766,774 | 766,774 | ||||||||||||
Total | $ | - | $ | - | $ | 1,082,557 | $ | 1,082,557 |
16 |
SpectraScience, Inc.
Notes to Unaudited Condensed Financial Statements (continued)
The following table presents changes in the liabilities with significant unobservable inputs (Level 3) for the nine months ended September 30, 2014:
Warrant | Derivative | Total | ||||||||||
Liability | Liability | Liability | ||||||||||
Balance December 31, 2013 | $ | 803,484 | $ | 300,939 | $ | 1,104,423 | ||||||
Liability on issuance of debt and warrants | - | - | - | |||||||||
Change in estimated fair value (1) | (36,710 | ) | 205,181 | 168,471 | ||||||||
Elimination of liability on conversion | - | (190,337 | ) | (190,337 | ) | |||||||
Balance September 30, 2014 | $ | 766,774 | $ | 315,783 | $ | 1,082,557 |
(1) Included in the Condensed Statements of Operation on the line “Change in fair value of derivative and warrant liabilities.”
Management used the following inputs to value the Derivative and Warrant Liabilities for the nine months ended September 30, 2014:
Derivative Liability | Warrant Liability | |||
Expected term | 6 months - 1 year | 5 years | ||
Exercise price | $0.045 - $0.099 | $0.075 - $0.1287 | ||
Expected volatility | 232% to 242% | 189% to 193% | ||
Expected dividends | None | None | ||
Risk-free interest rate | 0.10% to 0.13% | 1.62% to 1.78% | ||
Forfeitures | None | None |
In computing the fair value of the derivative and warrant liability at September 30, 2014 for instruments under the Binomial Lattice option-pricing model, management estimated a 60% probability of a down round financing event at a price of $0.036 and a 18% to 75% probability that existing note holders with exchange privileges would exchange their existing debentures and warrants for new debentures and warrants.
6. Contingencies
None
7. Subsequent Events
Convertible Debentures and Warrants
During October and November 2014, the Company sold $427,778 of Unsecured Convertible Debentures (the “Debentures”) to accredited investors for aggregate consideration of $400,000. The Debentures mature in twelve months, carry a fixed conversion price of $.045, an annual interest rate of 10% and are convertible into 8,947,368 shares of common stock at maturity. The Company received net cash proceeds of approximately $368,000 after payment of fees and expenses of $32,000. In addition, the Company issued the holders of the Debentures detachable five-year warrants to purchase 4,473,684 additional shares of common stock at an exercise price of $0.090 per share.
Subsequent events have been evaluated through the date financial statements are filed with the Securities and Exchange Commission.
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Forward-Looking Statements
This quarterly report on Form 10-Q (the “Report”) contains forward-looking statements that are not related to historical results, including, without limitation, statements regarding our business strategy and objectives, our anticipated duration of periods of net loss, our near term operating goals, our expectations regarding the market for our products, the introduction of our products in new international markets and our beliefs with respect to opportunities and industry conditions in those markets, our beliefs about our products, product development, acquisition or licensing of complementary technologies and expectations with respect to our products’ performance and acceptance, the results of and our intentions with respect to our distribution agreement with PENTAX Europe GmbH, our beliefs about the strengths of our intellectual property portfolio, our regulatory goals and developments, anticipated clinical trials and research, our agreements with Laidlaw and other agents and their effect on our future capital resources and future financial position, our expectations with respect to stock option expense recognition, our future cash needs, the sufficiency of our working capital and our operating losses for the remainder of the current fiscal year. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, there can be no assurance that such assumptions will prove to be accurate and actual results could differ materially from those discussed in the forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause or contribute to such differences, including, but not limited to, changes in law or regulatory policies, unanticipated competition from other similar businesses, adverse outcomes from litigation, unexpected employee departures or disruptions, adverse market and general economic factors and other factors described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. Such forward-looking statements are qualified in their entirety by the cautions and risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.
Business
SpectraScience, Inc. (the “Company,” “SpectraScience,” “we,” “our,” or “us”) develops and manufactures innovative Laser Induced Fluorescence spectrophotometry systems capable of determining whether tissue is normal, pre-cancerous or cancerous without removing tissue from the body. The WavSTAT Optical Biopsy System (the “WavSTAT System”) is SpectraScience's first product to incorporate its proprietary fluorescence technology for clinical use. The WavSTAT System carries the CE mark designation which allows for the sale and marketing in the European Union for the diagnosis of cancer. We are developing light-based diagnostics for additional indications including inflammatory bowel disease and esophageal cancer. Once these additional applications are developed we plan to self-certify for CE mark approval for sale in the European Union and then file an application with the FDA seeking permission to begin marketing for that indication for use in the United States. We believe we have a strong intellectual property portfolio that will allow us to continue to expand our WavSTAT cancer diagnosis platform to address the diagnosis of multiple cancers, utilize additional proprietary bio-photonic techniques to improve the WavSTAT’s overall diagnostic performance and ultimately allow for the detection of cancer and pre-cancer over a relatively large area of examined tissue.
Our principal executive offices are located at 11568 Sorrento Valley Rd., Suite 11, San Diego, CA 92121. We can be reached by telephone at (858) 847-0200; by fax at (858) 847-0880; or by email at info@spectrascience.com. We have a Web site at http://www.spectrascience.com. The information contained on our Web site shall not be deemed to be a part of this Report.
Plan of Operation
During the three and nine month periods ended September 30, 2014, SpectraScience carried forward on the improvements made to the WavSTAT4 in fiscal 2011 and continued working with PENTAX Europe, GmbH (“PENTAX”), for distribution of its products in Europe, the Middle East and Africa.
18 |
Over the next 12 months, SpectraScience intends to:
· | Market and sell the WavSTAT4 Optical Biopsy System colon cancer diagnostic application through PENTAX in the European Union; |
· | Conduct country-specific evaluation trials to demonstrate the effectiveness and cost benefit of the WavSTAT4 Optical Biopsy System in each relevant European jurisdiction; |
· | Coordinate the creation and publication of scientific papers and presentations related to the country-specific evaluation trials to support widespread education and adoption of the WavSTAT4 ; |
· | Pursue the introduction of the WavSTAT4 colon cancer application in other international markets, in particular Saudi Arabia, Russia and India; |
· | Begin meeting with the FDA towards the preparation and submission of a Supplemental PMA filing with the FDA for the WavSTAT4 and plan for additional clinical trials to support eventual approval for sale in the United States; |
· | Begin the design and planning for the next generation of multi-modal fluorescence and broadband spectroscopy systems at our facility in San Diego, California; and |
· | Continue to expand and refine our intellectual property portfolio. |
Results of Operations
Comparison of the Three Months Ended September 30, 2014 and 2013
Three Months Ended September 30, | Favorable | |||||||||||||||
2014 | 2013 | (Unfavorable) | % | |||||||||||||
Revenue | $ | - | $ | 60,000 | $ | (60,000 | ) | NM | ||||||||
Cost of revenue | - | 36,756 | 36,756 | NM | ||||||||||||
Gross profit | - | 23,244 | (23,244 | ) | NM | |||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 138,806 | 59,176 | (79,630 | ) | 134.6 | % | ||||||||||
General and administrative | 280,000 | 375,200 | 95,200 | 25.4 | % | |||||||||||
Sales and marketing | 114,178 | 33,285 | (80,893 | ) | 243.0 | % | ||||||||||
532,984 | 467,661 | (65,323 | ) | -14.0 | % | |||||||||||
Loss from operations | (532,984 | ) | (444,417 | ) | (88,567 | ) | -19.9 | % | ||||||||
Other income | 1,491,472 | 621,783 | 869,689 | 139.9 | % | |||||||||||
Net income | $ | 958,488 | $ | 177,366 | $ | 781,122 | 440.4 | % |
Revenues
There was no revenue during the three months ended September 30, 2014 compared to revenue of $60,000 for the three months ended September 30, 2013, when two WaveSTAT4 systems were shipped. We anticipate that revenue will increase as a result of our distribution agreement with PENTAX and continuing direct sales efforts in certain locations once sufficient information has been accumulated from our MORDIS trials in Europe.
19 |
Cost of Revenue
There was no cost of revenue for the quarter ended September 30, 2014 compared to $36,756 for the quarter ended September 30, 2013, when two WaveSTAT4 systems were shipped. We anticipate that cost of revenue will increase in proportion to revenue as a result of our distribution agreement with PENTAX and continuing direct sales efforts in certain locations once sufficient information has been accumulated from our MORDIS trials in Europe.
Research and Development Expenses
Research and development expenses increased by $79,630, 134.6%, to $138,806 for the quarter ended September 30, 2014 from $59,176 for the quarter ended September 30, 2013. This increase was due to an increase in payroll over the previous year’s quarter of approximately $67,000 when activity was reduced awaiting funding coupled with an increase in clinical studies of approximately $7,000. We anticipate that clinical costs will increase as we proceed with our introduction of the WaveSTAT4 in Europe.
General and Administrative Expenses
General and administrative expenses decreased by $95,200, 25.4%, to $280,000 for the quarter ended September 30, 2014 from $375,200 for the quarter ended September 30, 2013. The primary reasons for the decrease was a decrease during the current quarter compared to the same quarter of the previous year as follows: stock option expense of $63,000 and compensation expense of $27,000. We anticipate that general and administrative expenses will increase as we increase our activity in Europe.
Sales and Marketing Expenses
Sales and marketing expenses increased by $80,893, 243.0%, to $114,178 for the quarter ended September 30, 2014 from $33,285 for the quarter ended September 30, 2013. The primary reason for the increase was an increase in payroll costs of $64,000 and an increase in stock option expense of $22,000. We anticipate that sales and marketing expenses will increase as we increase our activity in Europe.
Other Income (Expense)
Other income (expense) for the quarter ended September 30, 2014 was income of $1,491,472 compared to income of $621,783 for the quarter ended September 30, 2013. This change was due primarily to a gain on the extinguishment of convertible debentures for approximately $227,000 coupled with the change in valuation of our derivative liabilities. We anticipate continued large fluctuations in other income (expense) as a result of quarterly re-evaluating these obligations.
20 |
Comparison of the Nine months Ended September 30, 2014 and 2013
Nine Months Ended September 30, | Favorable | |||||||||||||||
2014 | 2013 | (Unfavorable) | % | |||||||||||||
Revenue | $ | - | $ | 180,000 | $ | (180,000 | ) | NM | ||||||||
Cost of revenue | (6,000 | ) | 110,269 | 116,269 | NM | |||||||||||
Gross profit | 6,000 | 69,731 | (63,731 | ) | NM | |||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 673,173 | 440,086 | (233,087 | ) | 53.0 | % | ||||||||||
General and administrative | 1,092,689 | 1,527,780 | 435,091 | 28.5 | % | |||||||||||
Sales and marketing | 344,529 | 200,355 | (144,174 | ) | 72.0 | % | ||||||||||
2,110,391 | 2,168,221 | 57,830 | 2.7 | % | ||||||||||||
Loss from operations | (2,104,391 | ) | (2,098,490 | ) | (5,901 | ) | -0.3 | % | ||||||||
Other income (expense) | (1,357,621 | ) | (1,011,170 | ) | (346,451 | ) | 34.3 | % | ||||||||
Net loss | $ | (3,462,012 | ) | $ | (3,109,660 | ) | $ | (352,352 | ) | 11.3 | % |
Revenues
There was no revenue during the nine months ended September 30, 2014 compared to revenue of $180,000 for the nine months ended September 30, 2013, when six WaveSTAT4 systems were shipped. We anticipate that revenue will increase as a result of our distribution agreement with PENTAX and continuing direct sales efforts in certain locations once sufficient information has been accumulated from our MORDIS trials in Europe.
Cost of Revenue
There was a reduction in the cost of revenue of $6,000 for the nine months ended September 30, 2014, as a result of a reduction in warranty expense as two previously shipped WaveSTAT4 systems came off of warranty compared to cost of revenue of $110,269 for the nine months ended September 30, 2013, when six WaveSTAT4 systems were shipped. We anticipate that cost of revenue will increase in proportion to revenue as a result of our distribution agreement with PENTAX and continuing direct sales efforts in certain locations once sufficient information has been accumulated from our MORDIS trials in Europe.
Research and Development Expenses
Research and development expenses increased by $233,087, 53.0%, to $673,173 for the nine months ended September 30, 2014 from $440,086 for the nine months ended September 30, 2013. This increase was primarily due to continuing clinical studies being conducted in the European Union of approximately $126,000 coupled with an increase in payroll expense of $96,000. We anticipate that clinical costs will increase as we proceed with our introduction of the WaveSTAT4 in Europe.
21 |
General and Administrative Expenses
General and administrative expenses decreased by $435,091. 28.5%, to $1,092,689 for the nine months ended September 30, 2014 from $1,527,780 for the nine months ended September 30, 2013. The primary reasons for the decrease was a decrease during the current nine months compared to the same nine months of the previous year as follows: consulting expenses related to financings- $185,000, professional fees expense - $87,000, compensation expense- $130,000 and investor relations expense - $23,000. We anticipate that general and administrative expenses will increase as we increase our activity in Europe.
Sales and Marketing Expenses
Sales and marketing expenses increased by $144,174, 72.0%, to $344,529 for the nine months ended September 30, 2014 from $200,355 for the nine months ended September 30, 2013. The primary reason for the increase was an increase in costs related to establishing a presence in the UK of approximately $48,000, payroll expense of $26,000, a $50,000 increase in stock option expense and a $20,000 increase in travel related costs. We anticipate that sales and marketing expenses will increase as we increase our activity in Europe.
Other Income (Expense)
Other income (expense) for the nine months ended September 30, 2014 was expense of $1,357,621 compared to expense of $1,011,170 for the nine months ended September 30, 2013. This change was due primarily to a gain on the extinguishment of convertible debentures for approximately $244,000 coupled with the change in valuation of our derivative liabilities. We anticipate continued large fluctuations in other income (expense) as a result of quarterly re-evaluating these obligations.
22 |
Liquidity and Capital Resources
As of | Increase | |||||||||||
September 30, 2014 | December 31, 2013 | (Decrease) | ||||||||||
Working Capital | ||||||||||||
Current assets | $ | 671,989 | $ | 801,109 | $ | (129,120 | ) | |||||
Current liabilities | 6,510,847 | 4,881,597 | 1,629,250 | |||||||||
Working capital deficit | $ | (5,838,858 | ) | $ | (4,080,488 | ) | $ | 1,758,370 | ||||
Long-term debt | $ | - | $ | - | $ | - | ||||||
Stockholders' deficit | $ | (4,444,162 | ) | $ | (2,551,231 | ) | $ | 1,892,931 |
Nine Months Ended September 30, | Increase | |||||||||||
2014 | 2013 | (Decrease) | ||||||||||
Statements of Cash Flows Select Information | ||||||||||||
Net cash provided (used) by: | ||||||||||||
Operating activities | $ | (1,873,681 | ) | $ | (1,079,243 | ) | $ | 794,438 | ||||
Investing activities | $ | (6,275 | ) | $ | (1,600 | ) | $ | 4,675 | ||||
Financing activities | $ | 1,687,000 | $ | 1,229,136 | $ | 457,864 |
As of | Increase | |||||||||||
September 30, 2014 | December 31, 2013 | (Decrease) | ||||||||||
Balance Sheet Select Information | ||||||||||||
Cash | $ | 43,641 | $ | 236,597 | $ | (192,956 | ) | |||||
Accounts receivable | $ | - | $ | 60,000 | $ | (60,000 | ) | |||||
Inventory | $ | 316,680 | $ | 247,433 | $ | 69,247 | ||||||
Accounts payable and accrued expenses | $ | 1,481,436 | $ | 1,440,063 | $ | 41,373 |
Historically, the Company’s sources of cash have come from the issuance and sales of equity securities and convertible debentures. The Company’s historical cash outflows have been primarily used for operating activities including research, development, administrative and sales activities. Fluctuations in the Company’s working capital due to timing differences of its cash receipts and cash disbursements also impact its cash flow. The Company expects to incur significant additional operating losses through at least the end of 2014, as it completes proof-of-concept trials, conducts outcome-based clinical studies and increases sales and marketing efforts to commercialize the WavSTAT4 Systems in Europe. If the Company does not receive sufficient funding, there is substantial doubt that the Company will be able to continue as a going concern. The Company may incur unknown expenses or may not be able to meet its revenue forecast, and one or more of these circumstances would require the Company to seek additional capital. The Company may not be able to obtain equity capital or debt funding on terms that are acceptable. Even if the Company receives additional funding, such proceeds may not be sufficient to allow the Company to sustain operations until it becomes profitable and begins to generate positive cash flows from operations.
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As of September 30, 2014, the Company had a working capital deficit of $5,838,858 and cash of $43,641, compared to a working capital deficit of $4,080,488 and cash of $236,597 as of December 31, 2013. In December 2011, the Company entered into an Engagement Agreement with Laidlaw & Company (UK) Ltd., which Engagement Agreement was amended in July 2012. Under the Engagement Agreement, Laidlaw agreed to assist the Company in raising up to $20.0 million in capital over a two year period from the date of the Engagement Agreement. Subsequent to September 30, 2013, the Company has engaged other agents to assist the Company with raising capital and has commenced raising capital on its own. During the nine months ended September 30, 2014, The Company raised $1,856,376, net of transaction costs of $158,000, under these agreements. However, if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined in the Engagement Agreements occur as expected, or if the Company is otherwise able to raise a similar level of funds, such proceeds will be sufficient to allow the Company to sustain operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be able to meet its revenue expectations requiring it to seek additional capital. In such event, the Company may not be able to find capital or raise capital or debt on terms that are acceptable.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not required
Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Report (the “Evaluation Date”). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of the Evaluation Date.
Changes in Internal Financial Controls
There was no change in the Company’s internal control over financial reporting that occurred during the Company’s most recently completed quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II | OTHER INFORMATION |
Item 1. | Legal Proceedings |
None
Item 1A. | Risk Factors |
There have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
During the quarter ended September 30, 2014 we issued the following equity securities:
Number of | ||||||||||||||||
Date of | Common Shares | Source of | ||||||||||||||
Common Stock | Issuance | Issued | Payment | Amount | ||||||||||||
7/31/2014 | 5,057,834 | Convertible Debetnures | $ | 289,814 |
Common Stock Purchase Warrants | Date of | |||||||||||||||
Issued With Convertible Debentures | Issuance | Number of Shares | Exercise Price | Expiration Date | ||||||||||||
8/16/2014 | 25,000 | $ | 0.0900 | 8/16/2019 | ||||||||||||
9/3/2014 | 555,556 | $ | 0.0900 | 9/3/2019 | ||||||||||||
9/5/2014 | 555,556 | $ | 0.0900 | 9/5/2019 | ||||||||||||
9/12/2014 | 3,086,418 | $ | 0.0900 | 9/12/2019 |
With respect to the above equity securities issuances, the Company relied on exemptions provided by Sections 4(a)(2) and 3(a)9 of the Securities Act of 1933, as amended (the “Securities Act”). No advertising or general solicitation was employed in offering the securities. The securities were issued to a limited number of persons all of whom were accredited investors as that term is defined in Rule 501 of Regulation D under the Securities Act. All were capable of analyzing the merits and risks of their investment, acknowledged in writing that they were acquiring the securities for investment and not with a view toward distribution or resale, and understood the speculative nature of their investment. All securities issued contained a restrictive legend prohibiting transfer of the shares except in accordance with federal securities laws.
Item 3. | Defaults Upon Senior Securities |
As of November 12, 2014 there are 5% Original Issue Discount Unsecured Convertible Debentures with a face value of $1,624,211 held by 32 individual Holders in default. As a result, the outstanding principal amount of these Debentures, plus accrued but unpaid interest, liquidated damages and other amounts owing shall become immediately due and payable in cash at the election of the Holders. As of November 12, 2014, none of the Holders of these Debentures have elected to provide notice of default.
Item 4. | Mine Safety Disclosures |
None
Other Information |
None
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Item 6. | Exhibits |
31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. |
32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
101* | Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended September 30, 2014, formatted in XBRL; (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statement of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements. |
* Furnished herewith
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SpectraScience, Inc. (Registrant) | ||
Date: November 12, 2014 | /s/ Michael P. Oliver | |
Michael P. Oliver | ||
President and Chief Executive Officer | ||
(Principal executive officer) | ||
Date: November 12, 2014 | /s/ Lowell W. Giffhorn | |
Lowell W. Giffhorn | ||
Chief Financial Officer | ||
(Principal financial officer and principal accounting officer) |
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