1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the fiscal year ended December 31, 1999.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the transition period from ____________ to ____________.
Commission File Number: 0-22179
SPECTRX, INC.
(Exact name of registrant as specified in its charter)
Delaware 58-2029543
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
6025A Unity Drive, Norcross, GA 30071
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (770) 242-8723
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of class)
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. Yes [X] No [ ]
Indicate by check mark if disclosures of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates
of the Registrant was approximately $150 million as of February 29, 2000, based
upon the average of the high and low prices of the Registrant's Common Stock
reported for such date by the Nasdaq National Market. Shares of Common Stock
held by each executive officer and director and by each person who owns 5% or
more of the outstanding Common Stock have been excluded in that such persons
may be deemed to be affiliates. The determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of February 29, 2000, the Registrant had outstanding 8,463,638
shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE.
Parts of the following documents are incorporated by reference in Part
III of this Form 10-K Report: Proxy Statement for Registrant's 2000 Annual
Meeting of Shareholders -- Items 10, 11, 12 and 13.
2
PART I
ITEM 1. BUSINESS
OVERVIEW
SpectRx is a medical biophotonics company that develops and
manufactures painless and bloodless alternatives to traditional medical
diagnostic and monitoring procedures. Medical biophotonics is the technology of
using light beams and other forms of energy to gain unique access to the human
body to diagnose and monitor medical conditions. The Company has developed a
non-invasive alternative to conventional tests for monitoring infant jaundice,
and is developing less invasive and painless alternatives than are currently
available for conventional diabetes detection, glucose monitoring and cancer
detection tests. The Company has entered into collaborative arrangements with
Respironics, Inc. ("Respironics") through its acquired business, Healthdyne
Technologies, Inc., Abbott Laboratories ("Abbott"), Roche Diagnostics Boehringer
Mannheim Corp. ("Roche Diagnostics") and Welch Allyn, Inc. ("Welch Allyn") to
facilitate the development, commercialization and introduction of its infant
jaundice, diabetes detection, glucose monitoring and cancer detection products,
respectively.
SPECTRX'S BUSINESS STRATEGY
The Company's goal is to introduce products that reduce or eliminate
pain, are convenient to use and provide rapid results at the point of care,
thereby improving patient well being and reducing health care costs. To achieve
this objective, the Company is pursuing the following business strategy:
- Focus on Current Products. The Company intends to continue to
advance its current products to commercialization by (i)
leveraging the expertise of its collaborative partners, (ii)
seeking 510(k) clearance from the United States Food and Drug
Administration ("FDA") for these products where possible,
(iii) expanding its internal product development
capabilities, and (iv) developing its sales, marketing and
manufacturing capabilities. This includes the manufacturing
and marketing of its BiliChek(TM) system and the continued
development and introduction of the Company's diabetes
detection product.
- Develop Additional Products. Develop additional products from
the current product foundation. The Company believes that its
development activities in glucose monitoring and cancer
detection have significant promise for as many as four
additional product offerings that utilize the Company's
biophotonic technologies. The Company believes that its
diabetes detection product will lead to increased testing,
enlarging the market for glucose monitoring. The Company also
believes that the cancer detection products will be an
extension upon the technology used in the BiliChek(TM) and
diabetes detection products.
- Collaborate with Market Leaders. The Company has selectively
established collaborative arrangements with Abbott, Roche
Diagnostics, Respironics and Welch Allyn to develop and
commercialize its products. The Company intends to continue
selectively establishing strategic relationships with leading
companies, as appropriate, for the development,
commercialization and introduction of future products.
- Leverage Proprietary Technologies. The Company intends to
leverage its proprietary biophotonic technologies by
developing future products based on these technologies that
can provide cost effective, less invasive alternatives to
current diagnostic or monitoring products at the point of
care. For example, the Company believes its interstitial
fluid sampling technology may be applicable for monitoring
analytes other than glucose.
- Address Large Market Opportunities. The Company intends to
selectively develop future products for large markets in
which its products can ideally (i) apply for timely clearance
from the FDA, (ii) incorporate a disposable component and
(iii) qualify for third-party reimbursement.
-2-
3
INDUSTRY OVERVIEWS
INFANT JAUNDICE
Background
Infant jaundice is a condition that primarily affects newborns within
the first three to ten days of life. If left untreated infant jaundice may, in
extreme cases (kernicterus), lead to brain damage or death. Jaundice is
characterized by a yellowing of the skin and eyes caused by an excess of
bilirubin in the body. Bilirubin is a normal waste product resulting from the
breakdown of red blood cells and is removed from the body by the liver. Prior
to birth, the bilirubin in an infant is processed by the mother's liver and
excreted. After birth, an infant must eliminate bilirubin without the mother's
help. It may take the infant's system several days to begin eliminating the
bilirubin faster than it is produced. Infants who are born prematurely, who are
underfed, or who belong to certain ethnic groups are at increased risk of
developing jaundice. The initial screening for jaundice is the observation of
yellow skin. This is a subjective determination prone to errors due to
differing skin colors and gestational ages. If a baby is selected for further
jaundice testing, the current procedure requires that a blood sample be
obtained from the infant, usually by lancing the infant's heel, which is a
traumatic process for the infant. Since jaundice normally presents in infants
36 to 72 hours after birth, infants who are sent home after a short hospital
stay pursuant to managed care guidelines in the United States are at risk
because the condition may not have presented prior to release.
The Infant Jaundice Screening and Monitoring Market
Of the approximately four million newborns each year in the United
States, approximately 40-60% have recognizable jaundice. Annually,
approximately 1.7 million newborns receive at least one blood test for
bilirubin. Of those newborns tested, approximately 700,000 have elevated
bilirubin levels, and a portion of these newborns will receive additional
tests. The cost to the patient for a bilirubin test ranges from $22.25 to
$37.75; the laboratory processing cost usually ranges from $10.00-$12.00. Many
of those infants in the United States diagnosed with jaundice will undergo
phototherapy, a treatment that converts bilirubin into a water soluble form
that can be processed and eliminated from the infant's system. The Company
believes that the average newborn under active phototherapy treatment receives
three to four bilirubin monitoring tests.
The SpectRx Non-Invasive Infant Jaundice Product
The Company's infant jaundice product, named the "BiliChek(TM)"
Non-Invasive Bilirubin Analyzer (sold internationally as BiliCheckTM) is based
upon reflection spectroscopy and measures bilirubin regardless of the patient's
skin color or gestational age. The product is designed to provide rapid,
point-of-care bilirubin measurements and to serve as an initial screening and
ongoing monitoring device. The Company believes that the BiliChek(TM) has the
potential to replace the painful heel stick procedure currently utilized.
The design of the BiliChek(TM) consists of a hand held,
battery-operated instrument, which, when not in use, sits in a compact charger
base. This instrument incorporates a microspectrometer to collect spectroscopic
information from the skin and a proprietary, disposable calibration element,
BiliCal(TM). After calibration, the instrument is applied to the skin of the
infant for five applications, which generally takes less than one minute to
produce a measureable value. During this time the bilirubin level is measured
by collecting the light reflected from the skin and analyzing it using a
proprietary algorithm that adjusts for interfering factors that are present due
to skin color, gestational age and other factors.
In 1998, the Company received ISO 9001/EN 46001 certification and was
granted the CE mark which allowed it to begin selling the BiliChek(TM)
internationally. In April 1998, the Company announced it had begun commercially
shipping BiliChek(TM) units to certain international distributors. The
BiliChek(TM) is currently being marketed in more than 60 countries worldwide. In
August 1998, the Company announced that a 510(k) premarket notification
submission was filed with the U.S. Food and Drug Administration (FDA) on behalf
of the BiliChek(TM) by Respironics (formerly Healthdyne Technologies). In March
1999, the Company announced that it had received clearance from the FDA for
-3-
4
Respironics to market the BiliChek(TM) in the U.S. Respironics commenced
marketing of the BiliChek(TM) in the United States after obtaining FDA
clearance. In September 1998, Atom Medical Corporation was named as distributor
of the BiliChek(TM) in the Japanese market. In November 1999 the Japanese
Ministry of Health and Welfare granted marketing clearance to Atom. In January
2000 Respironics reported it had filed a 510(k) premarket notification
application with the FDA for expanded claims for use of the BiliChek(TM) during
phototherapy.
The Company's BiliChek(TM) was developed pursuant to a collaborative
arrangement with Respironics. Under the terms of the arrangement, SpectRx
developed and manufactures the product and Respironics paid and will continue
to pay certain costs associated with additional product developmental and
clinical trials. Respironics has been granted a license to market and sell the
product in the United States and Canada, while SpectRx retains the rights to
sell the product in all other geographic markets. Respironics retains a
significant degree of discretion regarding the timing of these activities and
the amount and quality of financial, personnel and other resources that they
devote to these activities. Accordingly, there can be no assurance that the
marketing schedules will be met, if at all.
DIABETES
Background
Diabetes is a major health care problem which, according to the World
Health Organization, is estimated to affect 100 million people worldwide by the
year 2000. If undiagnosed and untreated, diabetes can lead to severe medical
complications over time, including blindness, loss of kidney function, nerve
degeneration, and cardiovascular disease. Diabetes is the sixth leading cause
of death by disease in the United States and is estimated to cost the American
economy over $110 billion annually, including indirect costs such as lost
productivity.
Diabetes occurs when the body does not produce sufficient levels of,
or effectively utilize, insulin, a hormone that regulates the metabolism
(breakdown) of glucose. Glucose levels in the blood must be within a specific
concentration range to ensure proper cellular function and health. Insulin
deficiency results in an abnormally high blood glucose concentration, which
causes protein glycation throughout the body, impairs the ability of cells to
intake glucose and has other adverse effects. In Type I (insulin-dependent
juvenile-onset) diabetes, which affects from 5% to 10% of all people with
diagnosed diabetes, the cells that make insulin have been destroyed. Type I
diabetes is treated with daily insulin injections. In the more prevalent form
of diabetes, Type II (non-insulin-dependent adult-onset) diabetes, the insulin
producing cells are unable to produce enough insulin to compensate for the
patient's poor sensitivity to the hormone in glucose-using tissues such as
skeletal muscle (a condition called insulin resistance). Type II diabetes is
initially managed with proper diet, exercise and oral medication. Based on
statistics published by the National Institutes of Health the Company estimates
that approximately 50% of Type II diabetics will eventually require insulin
therapy.
The Diabetes Detection Market
The American Diabetes Association (the "ADA") estimates that
approximately 16 million people in the United States have diabetes, but only
10.3 million have been diagnosed with the disease. The long term health care
costs of a diabetic patient can be substantially reduced if the patient can be
diagnosed in the early stages of the disease. Early diagnosis allows glucose
levels to be monitored and properly controlled, thereby reducing complications
that result from long term exposure to elevated glucose levels. These
complications include diabetic retinopathy, kidney disease, nerve degeneration,
and cardiovascular disease. Currently, approximately 798,000 new cases of
diabetes are diagnosed each year in the United States, and many of those
diagnosed have complications that generally appear eight to ten years after
onset of the disease. The Company believes that the low rate of diabetes
diagnosis and the failure in many cases to diagnose the disease prior to the
onset of complications is due primarily to the lack of a convenient and
accurate diabetes detection test. In June 1997, the ADA altered its
recommendation for diabetes detection to increase the recommended level of
screening for all adults over 45 years old to every three years, which the
Company believes will increase market spending.
-4-
5
There are several diabetes detection tests in use today. The diabetes
detection procedure recommended by the ADA is the blood-based fasting plasma
glucose test. This test is difficult and inconvenient to administer because it
requires the patient to fast for eight hours prior to the drawing of blood, and
because the blood sample is usually sent to a laboratory for analysis, which
delays the receipt by the patient of the test results. Current methods for
diabetes detection that utilize random finger stick blood glucose tests are no
longer recommended by the ADA because the random nature of the tests results in
an unacceptably low level of sensitivity (i.e., the ability to correctly
determine that a particular person has diabetes) and specificity (i.e., the
ability to correctly determine that a particular person does not have
diabetes). Glucose urine test products, which are available over-the-counter,
have an even lower test sensitivity and specificity and are not recommended for
screening by the ADA. The low levels of sensitivity and specificity in both the
random finger stick blood glucose test and the glucose urine test result in
cases of both undetected diabetes, which can prevent early treatment of the
disease in such cases, and false indications of diabetes, which can cause
patients to incur the expense of, and devote the time for, needless additional
testing.
The SpectRx Non-Invasive Diabetes Detection Product (The Accu-Chek(TM)
D-Tector(TM))
The SpectRx non-invasive diabetes detection product being developed
by SpectRx and Roche is designed to detect and measure fluorescence in the lens
of the eye and evaluate that measurement using the Company's proprietary
algorithm. An abnormally high level of fluorescence in the lens of the eye may
be indicative of prolonged exposure to high levels of glucose due to diabetes.
A measurement indicating a patient is likely to have diabetes could be
confirmed by subsequent testing using conventional blood-based diagnostics. The
performance of the diabetes detection product has been shown to be comparable
to that of the blood-based screening test. Unlike the blood based tests,
however, the SpectRx diabetes detection product is painless, would provide the
patient with test results in less than a minute at the point of care, and would
not require the patient to fast for eight hours prior to administration of the
test.
The Company's non-invasive diabetes detection product is designed to
be simple and painless to use and to produce accurate point-of-care results in
a very short period of time. The Company believes that such a method of
diabetes detection is likely to become as prevalent as glaucoma testing, which
is regularly performed during eye exams. Thus, the Company believes that the
product may result in increased diagnoses of the approximately 50 million
undiagnosed diabetics worldwide, including the approximately 5.5 million in the
United States. For this reason, the Company believes that its non-invasive
diabetes detection product presents a substantial opportunity to identify new
patients who can benefit from proper treatment thereby reducing incidence of
complications and their associated cost.
The diabetes detection instrument, trademarked Accu-Chek(TM)
D-Tector(TM), is designed as a compact instrument that will meet the space
requirements of optometrists' and physicians' offices and will also be suitable
for retail establishments such as pharmacies. To use the device, the individual
looks into the instrument while placing his or her head against a rest. The
individual is instructed to look at a fixed light as the instrument locates the
eye and automatically tracks the pupil opening. The device measures
fluorescence in the lens of the eye using a low-intensity blue light. The
results of the analysis will indicate either that the patient should undergo
further diagnostic testing or that there is no indication of diabetes. In a
pilot study of more than 1,300 subjects (both diabetics and non-diabetics)
conducted by Roche Diagnostics, an early stage prototype of the Company's
diabetes detection product demonstrated an ability to detect diabetes.
The Company is in the process of final testing and manufacturing
ramp-up of the product. In December 1998, a 510(k) premarket notification
submission was filed with the U.S. Food and Drug Administration by Roche
Diagnostics on behalf of the SpectRx non-invasive diabetes detection product.
That application was withdrawn in June 1999. In June 1999 Roche reported that
the FDA required a PMA approval process for the device and began the filing
process. We expect the Accu-Chek(TM) D-Tector(TM) to be reviewed as an expedited
PMA. In addition, Roche Diagnostics retains a significant degree of discretion
regarding the timing of these activities and the amount and quality of
financial, personnel and other resources that it devotes to these activities.
Accordingly, there can be no assurance that the production or regulatory
approval will occur.
-5-
6
The Company has entered into a collaboration agreement with Roche
Diagnostics, as a result the Company has granted Roche Diagnostics an exclusive
worldwide license to sell and market the Company's non-invasive diabetes
detection product. The Company receives development milestone payments and
expects to receive a manufacturing profit on products sold to Roche
Diagnostics. Roche Diagnostics is responsible for conducting clinical testing,
obtaining regulatory approvals for, and the marketing, distribution and sales
of the Accu-Chek(TM) D-Tector(TM). In 1999 the Company received development
milestones for a total of $987,000 from Roche.
The Glucose Monitoring Market
People with diabetes have difficulty achieving optimal glucose
control. For proper glucose control, each insulin injection, or other form of
medication, should be adjusted to reflect the person's current blood glucose
concentration, carbohydrate consumption, exercise pattern, stress or other
illness. Accordingly, personal glucose monitoring products have become critical
in managing diabetes by allowing diabetics to measure their glucose levels in
order to adjust their diet, exercise and use of oral medication or insulin to
maintain proper blood glucose levels.
In June 1993, the National Institutes of Health announced the results
of the Diabetes Control and Complications Trial ("DCCT"). This long term study
of approximately 1,400 people with Type I diabetes confirmed the importance of
glucose control as a determinant of long term risk of degenerative
complications. The data from the DCCT demonstrated that the risk of
degenerative complications is significantly reduced if blood glucose
concentrations in people with Type I diabetes can be brought closer to the
concentrations measured in non-diabetic individuals. For example, the DCCT
study demonstrated that the risk of complications of diabetic retinopathy, the
leading cause of blindness in the United States, could be reduced up to 76%
through proper glucose control. The DCCT panel recommended that Type I
diabetics measure their blood glucose four times per day in order to maintain
proper control over their glucose levels. Although the DCCT study involved
people with Type I diabetes only, a similar Japanese study on Type II diabetics
supports the conclusion of the DCCT study that maintaining low average glucose
levels reduces the risks of complications associated with diabetes.
Because glucose monitoring is an important part of the every day life
of the world's diagnosed diabetics, the personal glucose monitoring market is
substantial. The Company believes that the worldwide market for glucose
monitoring products at manufacturers' price levels is approximately $3.0
billion annually and is growing at approximately 12%-18% per year. The North
American market for such products was approximately $1.0 billion in 1996. The
Company believes that the market for personal glucose monitoring products is
driven by four main factors: 1) an aging population; 2) the realization that
tight glucose control dramatically reduces the risk of complications; 3) the
availability of third-party reimbursement in developed nations; and 4) the
promotion and increased availability of glucose monitoring products. It is
estimated that diabetics currently monitor their glucose on average less than
twice a day instead of the DCCT recommendation of four times per day. The
Company believes that the pain, inconvenience and cost associated with
conventional finger stick blood glucose monitoring systems is the primary
reason that most people with diabetes fail to comply with the recommendations
of the DCCT panel. The Company believes that greater awareness of the benefit
of frequent self-monitoring and less painful, more convenient monitoring
products could significantly increase the global market. Currently, no
non-invasive glucose monitoring systems are commercially available in the U.S.
Glucose monitoring products have evolved rapidly over time. Various
factors have allowed new entrants to establish market share in the glucose
monitoring product market, including technological advances, broader product
distribution and increased patient awareness of product innovations. These
factors have also expanded the overall size of the market for glucose
monitoring products.
Current commercially available glucose monitoring systems are painful
and inconvenient. These systems require that a blood sample be obtained from a
patient, applied to a disposable test strip and then measured for glucose
concentrations using a battery-powered, handheld monitor. Under these systems,
the blood sample is usually obtained from a patient's fingertip because of the
high concentration of capillaries at this site and because the blood produced
at the fingertip can most easily be applied directly to test strips used in
such devices. These systems typically require the patient to complete the
following steps: insert the disposable test strip into the meter, lance the
finger, apply the drop of
-6-
7
blood to the test strip and wait for the meter to display the results. Because
nerve endings are concentrated in the fingertips, this sampling process can be
painful. The level of patient discomfort is compounded by the fact that the
fingertips offer a limited surface area from which to obtain a blood sample.
Thus, the patient can be required to repeatedly sample from the same site,
eventually resulting in callouses. In addition, applying the drop of blood to
the test strip is difficult for those diabetics who have lost dexterity in
their extremities due to nerve degeneration.
The SpectRx Glucose Monitoring Products
The Company is developing glucose monitoring products that utilize
the Company's proprietary interstitial fluid sampling technology that will
allow people with diabetes to easily and accurately measure their glucose
levels. Interstitial fluid is an extracellular fluid that is prevalent
throughout the body just beneath the skin. Interstitial fluid is the means by
which proteins and chemicals, including glucose, pass between capillaries and
cells. Studies based on the Company's and independent research have indicated
that interstitial fluid glucose levels correlate closely with blood glucose
levels. The Company believes that using interstitial fluid to assay glucose
levels is more efficient than using blood because it is free of interferences
such as red blood cells, which must often be separated from the plasma prior to
measurement. SpectRx's glucose monitoring products use the Company's
microporation technology to collect a sample of interstitial fluid. This
interstitial fluid sample may be measured once in a single-use application, or
a stream of interstitial fluid may be repeatedly measured for a continuous
monitoring application. Products using either sampling methodology are intended
to measure the glucose concentration of the interstitial fluid using disposable
assay technology. Because the Company's glucose monitoring products are
designed to obtain a sample of interstitial fluid from the outermost layers of
the skin and do not require a blood sample, their use does not stimulate pain
sensors and capillaries found in the deeper layers of skin and is thus free of
the pain and blood involved in conventional finger stick assaying techniques.
The Company initially focused its research effort in the area of
single use glucose monitoring in collaboration with Abbott. Since the fall of
1998 SpectRx has focused its research efforts on applications in the continuous
monitoring area. In November 1999, the Company entered into an amendment to its
agreement with Abbott to include continuous monitoring products. The primary
focus of the Abbott/SpectRx collaboration is currently upon the continuous
monitoring product.
Continuous Glucose Monitoring Product
During the course of research and development of its single-use
interstitial fluid-based glucose monitoring product, the Company discovered a
technique which allows for continuous monitoring of glucose. By applying a
constant state of low-level vacuum to an array of micropores, a stream of
interstitial fluid is produced. This stream of interstitial fluid may be passed
over a sensor which measures the glucose concentration periodically providing
the patient with multiple readings. Feasibility data generated by the company
in 1998 indicates that an array of micropores may be kept viable for up to
three days. A second feasibility study showed that the concentration of
interstitial fluid glucose continued to correlate to the concentration of blood
glucose during a three day period.
The product concept of the continuous glucose monitoring product
consists of a disposable patch electronically connected to a beeper-sized
meter. The patch would be placed over a small array of micropores created on
the body. This array could be placed in a number of locations, but the current
concept would have it placed on the torso. The patch would be designed to
eliminate spent interstitial fluid. The meter would be worn on a belt or hidden
under clothing. The system would collect a new glucose reading every 10 to 15
minutes which would be recorded by the meter and presented on the meter's
display. The stored information would be capable of being downloaded for
analysis. The meter could also indicate if the current reading is higher or
lower than any previous reading, showing a trend. The meter would also be
capable of indicating high or low glucose levels via an alarm. For convenience,
the umbilical would be detachable so that the patient may bathe or engage in
other activities, then reattach the umbilical and resume monitoring the stream
of interstitial fluid. In June 1999, at the American Diabetes Association
meeting, the Company publicly demonstrated an integrated prototype capable of
measuring glucose concentration in a stream of interstitial fluid.
-7-
8
In October 1999, the Company received a grant of $292,000 from the
Centers for Disease Control to adapt its continuous glucose monitoring
technology to monitor levels of children and the elderly.
In November 1999, the Company and Abbott entered into an amendment of
the agreement signed in 1996. The primary focus of the amendment was to include
the continuous glucose monitoring research, development and commercialization
effort with the agreement between SpectRx and Abbott. It also included potential
manufacturing by SpectRx and other potential collaborations with Abbott. In
addition, SpectRx issued redeemable, convertible preferred stock to Abbott for
$5,250,000 in conjunction with the signing of the amendment.
The research and development is focused on the integration of the
Company's microporation technology, fluid management and the glucose assay
technology into a prototype device. The Company expects prototype development to
be followed by clinical trials and a regulatory submission. Unexpected problems,
however, may arise during the development and regulatory approval processes. In
addition, Abbott retains a significant degree of discretion regarding the timing
of these activities and the amount and quality of financial, personnel and other
resources that it devotes to these activities. Accordingly, there can be no
assurance that these events will occur.
Single-use Glucose Monitoring Product
The single-use glucose monitoring product is expected to be comprised
of a small, hand held battery-powered, monitoring device and a proprietary,
disposable assay cartridge. The monitoring device will be placed on the skin,
and a laser or other suitable energy source mounted in the housing will be
directed onto the skin. When activated, an array of micropores will be
painlessly created in the outermost layer of skin, the stratum corneum. The
Company believes the creation of micropores will not damage adjacent tissue or
penetrate deeply enough to reach the capillary bed or nerve layer below the
stratum corneum. The Company anticipates that the device will have a
proprietary mechanism that will force the interstitial fluid out of the
micropores and into the disposable cartridge. When the assay cartridge is full
and the interstitial fluid has been analyzed, the results will appear on a
display.
In January 1996, the Company undertook a pilot study of 10 subjects
(six diabetics and four nondiabetics) under a protocol reviewed and approved by
the Georgia Baptist Medical Center. The study was designed to evaluate the
correlation between results obtained using early stage prototypes of the
Company's glucose monitoring product and a leading conventional personal blood
glucose monitoring system. The study compared the glucose levels in
interstitial fluid and blood of the 10 subjects who were each administered 75
grams of glucose. The study, which yielded a total of 876 glucose measurements
(438 contemporaneous measurements of interstitial fluid and blood), produced a
correlation coefficient of 0.96 between glucose levels in interstitial fluid
and blood.
In October 1996, the Company entered into a collaborative arrangement
with Abbott for the development and commercialization of the Company's glucose
monitoring products. Pursuant to the arrangement, the Company granted Abbott an
exclusive worldwide license for the Company's single use glucose monitoring
product and other related glucose monitoring devices in all countries except
Singapore and the Netherlands, where the license is non-exclusive. Pursuant to
the terms of the collaborative arrangement, Abbott agreed to pay all costs
associated with a joint research and development program, to make certain
milestone payments to the Company and to pay the Company a royalty based on net
sales. Abbott will also be responsible for conducting clinical trials,
obtaining regulatory approval for and manufacturing, marketing, distributing,
and selling the products covered by the arrangement. In addition, Abbott made a
$3 million equity investment in the Company in 1996 whereby it purchased
500,000 shares of Series C Preferred Stock which converted into 357,143 shares
of Common Stock upon the Company's initial public offering.
The Company conducted research on the single use glucose monitoring
product through the third quarter of 1998. At that point in time that research
work was transferred to Abbott. Abbott is currently responsible for the research
program for single use glucose monitoring. The focus of that research will be to
produce methodologies that will permit collection of interstitial fluid at a
minimum volume level, and within a specified time, on a universal basis within
the target diabetic population. Abbott retains a significant degree of
discretion regarding the timing of these activities and the amount and quality
of financial, personnel and other resources that it devotes to these activities.
Accordingly, there can be no assurance that these events will occur.
-8-
9
NON-INVASIVE CANCER DETECTION
Background
According to the American Cancer Society, cancer is a group of many
related diseases. All forms of cancer involve out-of-control growth and spread
of abnormal cells. Normal body cells grow, divide, and die in an orderly
fashion. Cancer cells, however, continue to grow and divide, and can spread to
other parts of the body. In America, half of all men and one-third of all women
will develop cancer during their lifetimes. According to the Society, the
sooner a cancer is found, and the sooner treatment begins, the better a
patient's chances are of a cure.
Cervical Cancer
Cervical cancer is a cancer which begins in the lining of the cervix
(the lower part of the uterus) which may spread to other parts of the body if
left untreated. Cervical cancers form over time. There is generally a gradual
change from a normal cervix to cervix with precancer cells to cervical cancer.
For some women, precancerous changes may go away without any treatment. While
the majority of precancerous changes do not advance to cancer, if these
precancers are treated, true cancers can be prevented. The Pap smear, where a
sample of cervical tissue is placed on a slide and observed in a laboratory, is
the most common form of cervical cancer screening.
Cervical Cancer Market
The American Cancer Society estimates that during 1999, about 12,800
cases of invasive cervical cancer will be diagnosed in the United States.
Cervical cancer is the ninth most deadly cancer in the U.S. with 4,800 deaths
predicted in 1999. According to published data, cervical cancer results in
approximately 190,000 deaths annually worldwide with 371,000 new cases reported
each year.
The major market opportunities are in screening and diagnosis. Since
the introduction of better screening and diagnosis methods, the number of
cervical cancer deaths in the U.S. has declined dramatically. The main reason
for this change is the increased use of the Pap smear screening test. However
the Pap smear screening test has a wide variation in sensitivity (11% to 99%)
and specificity (14% to 97%), according to a meta-analysis of Pap test accuracy
published in the American Journal of Epidemiology, Vol. 141, No. 7, 1995.
Approximately 55 million Pap tests are given annually in the U.S. and Europe.
The average price of a Pap test in the U.S. is $26. New technologies improving
the sensitivity and specificity of pap smear screening have recently been
introduced and are finding acceptance in the market place.
The standard for cervical cancer diagnosis, after screening, is a
visual examination of the cervix using a Colposcope followed by a biopsy. This
method looks for visual morphological changes attributable to cancer. There are
approximately two million Colposcope examinations annually in the U.S. and
Europe. The average cost of a Colposcope examination in the U.S. is $185.
Non-invasive Cervical Cancer Product
The Company, in collaboration with Welch Allyn, is developing a
non-invasive cervical cancer detection product. The product is based on
SpectRx's proprietary biophotonic technology and the intended design is
expected to identify cancers and precancers painlessly, non-invasively and at
the point of care by shining light onto the cervix, then analyzing the light
reflected from the cervix. The information presented by the reflected light
will be used to produce a map or image of diseased tissue. Consequently, this
test, unlike the Pap smear test or biopsy, preserves the perspective and
positional information of disease on the cervix, allowing for more accurate
diagnosis. The SpectRx/Welch-Allyn product, in addition to detecting the
morphological changes, is also expected to detect the biochemical changes that
precede the development of visual lesions. In this way the cancer is detected
early in its development thereby increasing the chances of effective treatment.
The product is expected to incorporate a calibration disposable.
During 1999, the Company conducted human clinical feasibility studies
of laboratory prototypes. In December 1999, the Company concluded the
feasibility studies and received a $700,000 milestone from Welch Allyn.
As a result the program moved into the development/engineering phase.
-9-
10
The feasibility clinical studies were conducted at three U.S. centers
and resulted in 252 enrolled patient tests. The prototype devices effectively
differentiated cancerous and precancerous lesions from normal tissue and other
lesions with sensitivity from the three studies ranging from 89% to 100% (0% to
11% false negative rate) and specificity ranging from 80% to 89% (11% to 20%
false positive rate). In contrast, for patients where Pap test data could be
obtained, the Pap test classified 30% of cancerous and precancerous lesions as
normal or infection for a sensitivity of 70% (30% false negative rate), with a
corresponding specificity of 72% (28% false positive rate). The majority of the
cancerous and precancerous lesions missed by the Pap test were accurately
classified by the SpectRx test as precancerous.
The Company expects prototype development to be followed by pivotal
clinical trials and a regulatory submission. Unexpected problems, however, may
arise during the development and regulatory approval processes. In addition,
Welch Allyn retains a significant degree of discretion regarding the timing of
these activities and the amount and quality of financial, personnel and other
resources that it devotes to these activities. Accordingly, there can be no
assurance that these events will occur.
COLLABORATIVE ARRANGEMENTS
The Company's business strategy for the development, clinical
testing, regulatory approval, manufacturing, and commercialization of its
products depends upon the Company's ability to selectively enter into and
maintain collaborative arrangements with leading medical device companies. The
Company has been successful in its history in developing such strategic
relationships. The Company currently has collaborative arrangements with
Abbott, Roche Diagnostics, Respironics and Welch Allyn. The Company is, to
varying degrees, dependent upon its collaborative partners for the development,
clinical testing, regulatory approval, manufacturing, and commercialization of
its products.
Respironics
In June 1996, SpectRx entered into a Purchasing and Licensing
Agreement with Healthdyne Technologies, Inc., which was later acquired by
Respironics (the "Respironics Agreement"). This agreement was amended October
21, 1998. Pursuant to the Respironics Agreement, Respironics is responsible for
clinical trials, the regulatory approval process and sale of the BiliChek(TM)
in the United States and Canada. The Company retains manufacturing rights and
is responsible for the regulatory approval process and sale of the infant
jaundice product outside of the United States and Canada. Under the Respironics
Agreement, the Company receives from Respironics licensing fees and a
manufacturing profit on products sold to Respironics and shares any profit from
the sales of disposables by Respironics. Respironics receives an exclusive
license for the United States and Canada (i) to use and sell instruments for
non-invasive bilirubin measurement ("Instruments"), (ii) to use and sell
disposable probes, tips or other devices which, when used with Instruments,
measure bilirubin levels ("Disposables") and items accessory to and not
necessary for the operation of Instruments or Disposables ("Accessories"), and
(iii) to make Instruments, Disposables and/or Accessories (collectively,
"Licensed Products"). Unless SpectRx is unable to supply Licensed Products,
Respironics must purchase its requirements for Licensed Products from SpectRx.
Respironics has agreed to pay SpectRx's cost for manufacturing each Licensed
Product. Respironics and SpectRx then share equally the margin earned on the
sale of Licensed Products. In order to maintain license exclusivity,
Respironics has agreed to purchase from SpectRx certain minimum amounts of
Licensed Products or pay a royalty to SpectRx for an equivalent number of
Licensed Products. In the event that SpectRx is unable to supply Licensed
Products, Respironics receives a license to manufacture the Licensed Products
and pays a royalty to SpectRx on sales of Licensed Products.
SpectRx has granted to Respironics the exclusive option to acquire an
exclusive license for the United States and Canada, on terms substantially
similar to those contained in the Respironics Agreement, with respect to any
new intellectual property that comes into existence after the effective date of
the Respironics Agreement, which covers devices that would compete, directly or
indirectly, with the Licensed Products and for which SpectRx has the right and
authority to grant licenses. In such event, Respironics has agreed to reimburse
SpectRx for one-half of SpectRx's cost to develop and commercialize such
product, in lieu of paying any license fees. If Respironics fails to exercise
such option,
-10-
11
SpectRx may license such intellectual property to any third party on terms no
more favorable than those offered to Respironics.
The Respironics Agreement remains in effect for the longer of fifteen
years or until the expiration date of the last licensed patent to expire. Upon
expiration of the Respironics Agreement, Respironics has the option to renew
the Respironics Agreement for additional fifteen year terms indefinitely.
Respironics also has the right to terminate the Respironics Agreement without
cause upon not less than 30 days' written notice to the Company.
Roche Diagnostics
In December 1994, SpectRx entered into a Development and License
Agreement with Boehringer Mannheim Corp. (which has since merged with Roche
Diagnostics) with respect to a non-invasive instrument that measures changes in
the lens of the human eye for the purpose of detecting diabetes. The agreement
was superceded by a new Development and License Agreement (the "Development
Agreement") between SpectRx and Roche in June 1999. Pursuant to the Development
Agreement, SpectRx has granted to Roche Diagnostics an exclusive, worldwide
license to sell and market the Company's diabetes detection product. SpectRx
receives development milestone payments from Roche Diagnostics pursuant to the
Development Agreement. The Development Agreement remains exclusive for so long
as Roche Diagnostics meets certain minimum volume purchase requirements set
forth in the Supply Agreement with Roche Diagnostics (discussed below). The
Development Agreement may be terminated at any time by Roche Diagnostics upon
written notice to SpectRx.
In January 1996, Roche Diagnostics and SpectRx entered into a Supply
Agreement for the supply by SpectRx to Roche Diagnostics of the Company's
diabetes detection product. This agreement was also superceded by a new Supply
Agreement (the "Supply Agreement") in June 1999. Roche Diagnostics 's purchase
price for the Company's diabetes detection product is calculated pursuant to a
formula based on a gross margin. Roche Diagnostics is required to meet minimum
annual purchase requirements for the diabetes detection product each year or
Roche Diagnostics forfeits its exclusivity under the marketing license granted
in the Development Agreement. The term of the Supply Agreement is coincident
with the term of the Development Agreement. Roche Diagnostics may terminate the
Supply Agreement for material breach (including a failure to supply adequate
requirements) of the agreement by the Company, which breach remains unremedied
for 30 days after notice to the Company and in which case Roche Diagnostics is
deemed to have acquired a manufacturing license under the Development
Agreement. If Roche Diagnostics acquires this manufacturing license, it must
pay royalties to SpectRx on Roche Diagnostics sales of the diabetes detection
product. SpectRx would retain the right to reacquire the manufacturing license.
During the term of the Supply Agreement, SpectRx cannot enter into any
agreement to develop or manufacture a non-invasive diabetes detection
instrument using the same or similar technology as used in the Company's
diabetes detection product other than with Roche Diagnostics affiliates. Roche
Diagnostics is not restricted from pursuing the development of a diabetes
detection instrument with another party.
Abbott Laboratories
In October 1996, SpectRx entered into a Research & Development and
License Agreement with Abbott for the development and commercialization of the
Company's glucose monitoring technology in the field of extracting interstitial
fluid samples for glucose monitoring (the "Field"). In November 1999, SpectRx
and Abbott entered into an amendment of the Research Development and License
Agreement which included specific terms related to the continuous monitoring
program (the "Abbott Agreement".) Pursuant to the Agreement, SpectRx has
granted to Abbott a worldwide license under its patents, patent applications
and know how (the "Technology") useful in the Field, including improvements, to
manufacture and sell products in the Field. The license is exclusive in all
countries except Singapore and the Netherlands where the license is
non-exclusive. Abbott also has certain rights of first negotiation with the
Company regarding any rights the Company may have to license the Technology for
the development and commercialization of other products relating to the
measurement of analytes in interstitial fluid and the delivery of therapeutic
agents based on such measurements. Under the Abbott Agreement, SpectRx receives
from Abbott development funding, payments on achievement of milestones and a
royalty on Abbott product sales.
-11-
12
In conjunction with the first agreement, Abbott made a $3 million
equity investment in SpectRx in 1996 whereby it purchased 500,000 shares of
Series C Preferred Stock which converted into 357,143 shares of Common Stock
upon the Company's initial public offering. Abbott subsequently purchased
SpectRx Common Stock on the open market and currently owns 6.2% of the
outstanding Stock of the Company. In conjunction with the signing of the
amendment, Abbott made a $5.25 million equity investment whereby it purchased
100,000 shares of Redeemable, Convertible Preferred Stock which is convertible
into the Company Common Stock. The conversion price is to be set at the market
price at the date of conversion, or at $9.388 per share, whichever is higher.
If the stock were to convert at $9.388 per share, Abbott would own 13.2% of the
outstanding stock of the Company, based upon shares outstanding on December 31,
1999.
Under the Abbott Agreement, the parties agreed to jointly conduct a
research program designed to demonstrate that the Company's single use glucose
monitoring product can extract an adequate sample of interstitial fluid in a
targeted time period. The focus of that development activity through August
1998 was toward a single use product concept. During the joint development
program, which began in the fourth quarter of 1996, Abbott paid mutually agreed
development costs. Abbott currently is responsible for all research on means of
extracting adequate samples of interstitial fluid related to single use glucose
monitoring applications. The current focus of research and development activity
is on the continuous monitoring application. After satisfactory demonstration
of sample extraction and measurement of glucose in interstitial fluid using the
continuous process, and if Abbott wishes to commercialize the product, it is
responsible for further product development and obtaining all required
regulatory approvals. After obtaining these regulatory approvals, Abbott is
required to diligently pursue the sales of the products but is not prohibited
from marketing competing products. If Abbott elects not to commercialize the
product the agreement may be terminated by either party. Abbott has a fixed
period from the date of notice to the Company of its intention to commercialize
the product in which to complete commercialization and begin shipment of
products. If such commercialization has not been completed within the permitted
time, SpectRx may terminate the agreement.
Under the Abbott Agreement, all technology invented solely by SpectRx
during the joint development program is owned solely by SpectRx. All technology
invented solely by Abbott and all clinical data, regulatory filings and
government marketing approvals developed solely by Abbott are the property of
Abbott. On certain early termination events, SpectRx has a right to obtain a
license to certain of the relevant Abbott technology. Technology jointly
invented during the joint development program will be jointly owned pursuant to
a royalty sharing arrangement.
The Abbott Agreement remains in effect until the expiration of the
last licensed patent to expire. Abbott has the right to terminate the Abbott
Agreement without cause upon not less than 60 days' prior notice to the Company
at any time prior to the first shipment of products and upon not less than 120
days' prior notice to the Company thereafter. Abbott may terminate the Abbott
Agreement upon not less than 30 days' prior notice to the Company for certain
product development failures.
Welch Allyn
In December 1998, SpectRx entered into a Development and
Commercialization Agreement with Welch Allyn, Inc. with respect to noninvasive
cervical and skin cancer diagnostic products. Under the terms of the agreement,
the two companies jointly share in the development costs for such products and
also will jointly share in the revenue produced by such products, if those
products are developed to commercialization. SpectRx can also receive certain
milestone payments pursuant to the agreement. The agreement further anticipates
that both Welch Allyn and SpectRx would manufacture portions of any
commercialized products and would collaborate in sales and marketing. Both
SpectRx and Welch Allyn are prohibited from pursuing development of devices,
utilizing the technology covered by the agreement, with another party while the
collaboration remains in effect. The agreement specifically focuses on the
development of a cervical cancer detection product. Should SpectRx determine
through research efforts that an application of the technology for the
detection of skin cancer is feasible, the agreement provides for, and retains
certain rights for Welch Allyn to expand the relationship with SpectRx to
develop and commercialize a skin cancer (melanoma) detection product. In
December 1999, SpectRx completed the requirements for Phase II (feasibility),
which triggered a milestone payment of $700,000.
-12-
13
LICENSING ARRANGEMENTS
Georgia Tech Research Corporation
The Company has a license agreement with Georgia Tech Research
Corporation ("GTRC") pursuant to which GTRC has granted the Company an
exclusive, worldwide license (including the right to grant sublicenses) to
make, use and sell products that incorporate GTRC's know how related to a
method of using non-invasive instrumentation to quantitatively measure
molecular changes in living human lenses for the purposes of diagnosing
diabetes and precataractous conditions (the "GTRC Agreement"). Under the
license, the Company must pay a royalty to GTRC on net sales of any such
products manufactured and sold by the Company. The term of the GTRC Agreement
is until the expiration date of the last expiring patent covering any of the
technology licensed or, if no patent issues, for 15 years from the date of
execution of the GTRC Agreement.
Altea Technologies, Inc
In March 1996, SpectRx entered into a License and Joint Development
Agreement (the "Altea/Nimco Agreement") among the Company, Altea ("Altea") and
Non-Invasive Monitoring Company, Inc. ("Nimco") pursuant to which certain
rights in respect of jointly developed technology are allocated between the
Company and Altea. Both Altea and Nimco are jointly controlled by Jonathan
Eppstein, a former Vice President of the Company, and his sister. The
Altea/Nimco Agreement also covers one granted patent and know how related to
the glucose monitoring product, the joint application of the Company and Altea
for a U.S. patent and an international patent related to the glucose monitoring
product, and provides for continued joint development efforts between SpectRx
and Altea as mutually agreed. The Altea/Nimco Agreement further provides for
the joint ownership by SpectRx and Altea of certain patents and technology
relating to the transdermal/intradermal movement of substances utilizing
various methods. Under the Altea/Nimco Agreement, SpectRx receives worldwide,
exclusive rights to any technology for monitoring applications covered by the
Nimco patents and related joint technology and Altea receives exclusive,
worldwide rights to any technology for delivery applications covered by the
joint technology. Future inventions in certain areas made by each of SpectRx
and Altea based on newly developed technology related to the licensed
technology could be included within the Altea/Nimco Agreement.
SpectRx is obligated to pay royalties to Nimco for products using its
technology and to Altea for products using its technology, in each case based
on net sales of products and net revenues from sublicensees. Royalties on
products using both Nimco and Altea technology will be allocated as mutually
agreed. Minimum annual royalties are payable by SpectRx to Altea. See Note 8 of
Notes to Consolidated Financial Statements. If actual accrued royalties are
less than the minimum royalty amount, SpectRx may pay Altea the difference or
the license will become non-exclusive. Thereafter, SpectRx must offer a right
of first refusal to acquire exclusive rights to the monitoring technology to
Altea.
The term of the Altea/Nimco Agreement is for the life of the patents
covered by the agreement. The agreement may be terminated by any party in the
event of a default by any other party that is not cured within 90 days of
notice to the defaulting party. The agreement may be terminated globally by
Altea if SpectRx fails to commercialize any product, use or application
utilizing the monitoring technology in any major country by the date of the
first commercial shipment date under the Abbott Agreement and may be terminated
by Altea with respect to certain regions if SpectRx fails to commercialize any
product, use or application in those regions by this date. SpectRx may
terminate the agreement upon not less than three months prior notice to Altea
and Nimco if given before it has commercialized the technology and upon not
less than six months prior notice to each party if given after
commercialization has commenced. Except in the case of termination of the
agreement by SpectRx for breach, upon termination all technology and joint
technology shall become the exclusive property of Altea, except the Nimco
patents. If the agreement is terminated by SpectRx for breach, all rights to
the monitoring technology in the countries in which SpectRx has retained its
exclusive rights shall become the exclusive property of SpectRx, each party
shall retain non-exclusive rights to the monitoring technology in other
countries, and Altea shall retain all rights to the delivery technology. If
SpectRx loses its rights to the monitoring technology for failure to
commercialize (but not due to breach), Altea and Nimco, after their
reacquisition of rights from
-13-
14
SpectRx, will pay an amount of money by way of a royalty to SpectRx according
to a formula to reflect each party's relative investment.
The University of Texas M.D. Anderson Cancer Center
In March 1996, SpectRx, entered into a Patent License Agreement with
the Board of Regents (the "Board") of the University of Texas System and M.D.
Anderson pursuant to which the Board granted SpectRx an exclusive license under
certain of its patents to manufacture, have manufactured, use and sell products
within the United States for use within the licensed field of optical
measurement of bilirubin in human tissue (the "MDA Patent License Agreement").
SpectRx has the right to assign this license to affiliates and the right to
sublicense the foregoing rights. In connection with the MDA Patent License
Agreement, SpectRx has agreed to pay all expenses incurred in prosecuting and
maintaining the patents licensed and a royalty on net sales of products that
incorporate the licensed patents, subject to annual minimum royalty payments.
See Note 8 of Notes to Consolidated Financial Statements. The term of the MDA
Patent License Agreement is until the expiration date of the last expiring
patent licensed. The Board has the right at any time after one year from the
effective date of the MDA Patent License Agreement to terminate the license if
SpectRx, within 90 days after written notice from the Board, fails to provide
written evidence satisfactory to the Board that SpectRx has commercialized or
is actively and effectively attempting to commercialize an invention licensed
under the MDA Patent License Agreement.
Joseph Lakowicz, Ph.D.
The Company has a license agreement with Joseph Lakowicz, Ph.D.
whereby Dr. Lakowicz has granted the Company an exclusive, worldwide license
(including the right to grant sublicenses) to make, use, and sell medical
products that incorporate Dr. Lakowicz's intellectual property related to
lifetime fluorescence technology (the "Lakowicz Agreement"). The intellectual
property consists of a portfolio of granted patents, patent applications and
foreign filings in the area of lifetime fluorescence technology. The Company
has agreed to pay a royalty to Dr. Lakowicz on net sales of such products
manufactured and sold. Additionally, the Company is committed to fund certain
research programs under the direction of Dr. Lakowicz. See Note 8 of Notes to
Consolidated Financial Statements, which includes these funding commitments.
The Company has sublicensed some parts of this intellectual property related to
invasive blood tests to its subsidiary, FluorRx, Inc. The term of the Lakowicz
Agreement is until the expiration date of the last expiring patent covering any
of the technology licensed.
RESEARCH, DEVELOPMENT AND ENGINEERING
To date, the Company has been engaged primarily in the research,
development and testing of the Company's glucose monitoring, diabetes
detection, infant jaundice and cancer detection products, including research
for and development of its core biophotonic technologies. Since inception to
December 31, 1999, the Company incurred approximately $17.6 million in research
and development expenses, net of approximately $4.6 million which was
reimbursed through collaborative arrangements. Three distinct groups within the
Company conduct research, development and engineering. One group consists of 24
engineers and support personnel who design optics, electronics, mechanical
components and software for the infant jaundice, diabetes detection, continuous
glucose monitoring and non-invasive cervical cancer detection products. A
second group consists of 21 scientists and engineers who devote their time to
the development of microporation technology for the monitoring of glucose and
other analytes. The third group consists of 12 scientists and engineers focused
on the development of cancer detection products.
The Company believes that the interstitial fluid sampling technology
under development at SpectRx and Abbott for use in connection with the
Company's glucose monitoring products may also be used to develop alternatives
for certain blood tests where the analyte being tested is also present in
comparable volumes in interstitial fluid. Abbott has a right of first
negotiation with the Company regarding the use of interstitial fluid sampling
technology for these applications.
-14-
15
In 1996, SpectRx executed a licensing agreement with Dr. Lakowicz of
the University of Maryland pursuant to which the Company licenses a portfolio
of intellectual property related to lifetime fluorescence technology, a
technology used to determine the spectroscopic fingerprint of a substance. The
Company believes lifetime fluorescence technology may have applications
including in vitro blood chemistry, molecular diagnostics, flow cytometry,
combinatorial chemistry for pharmaceutical discovery research and noninvasive
optical diagnostics. All activity related to this technology is being conducted
by our subsidiary, FluorRx.
To date, the Company has only tested prototypes of its glucose
monitoring and cancer products. Because the Company's research and clinical
development programs are at an early stage, substantial additional research and
development and clinical trials will be necessary before commercial prototypes
of the Company's glucose monitoring and cancer detection products are produced.
The company is developing the pre-production prototypes and beginning its
ramp-up for production of the diabetes detection device. While significant
progress has been made in development and engineering, considerable additional
effort and expense will be required before a commercial device is shipped.
MANUFACTURING
One element of the Company's business strategy is to manufacture
certain of its products and to outsource the production of other, high volume
products and associated disposables. To date, the Company's manufacturing
activities have consisted of building certain prototype devices, developing
production infrastructure and building production versions of its BiliChek(TM)
and BiliCal(TM) products. If the Company successfully develops its diabetes
detection product and, together with Roche Diagnostics obtains FDA clearance
and other regulatory approvals to market this product, the Company will
undertake to manufacture both of these products in commercial quantities. The
Company has little experience manufacturing such products in the volumes that
would be necessary for the Company to achieve significant commercial sales.
Currently 12 individuals are employed by the Company to accomplish the
production planning, quality system management, facility development, and
production scaling that will be needed to bring production to commercial
levels. The Company announced in 1998 that it had received ISO 9001/EN46001 and
CE mark Certification. These approvals enabled the Company to commence
production of its BiliChek(TM) and BiliCal(TM) products and to begin shipment
of these products into markets for which it has received regulatory clearance.
SALES, MARKETING AND DISTRIBUTION
The Company has elected to focus most of the sales and distribution
of its current and developing products through its collaborative partners. The
Company believes that by aligning with larger, more established partners, in
specific market segments, it can utilize its partners' already developed
strengths and more effectively and quickly penetrate the market place. The
Company's primary efforts to date have been to build the skill and information
base to identify and quantify market segments to which the Company's
technologies can be economically developed and marketed and to launch the
BiliChek(TM) product system.
The Company has developed the BiliChek(TM) and BiliCal(TM) internal
marketing and distribution program to an introductory stage. SpectRx has
developed packaging, advertising, display materials, and training, and has, in
addition, signed distribution agreements or is in negotiation with companies it
believes to be highly experienced in the neonatal markets that SpectRx is
targeting in Europe, Asia and South America. The Company has also added or
engaged marketing personnel to develop and execute the programs necessary to
launch the BiliChek(TM) system and to manage sales of these products. The
Company launched its products in markets outside the U.S. and Canada in April
1998 and began introductory programs during the remainder of 1998.
Nevertheless, significant volumes of these products have not yet been shipped
and the efficacy of the marketing programs or the distributors has not yet been
tested with SpectRx's products.
-15-
16
Respironics has the exclusive right to market and sell the Company's
infant jaundice product in the United States and Canada. Abbott has the
exclusive right to market and sell the Company's glucose monitoring products in
all countries except Singapore and the Netherlands, where the license is
non-exclusive. Roche Diagnostics has the exclusive worldwide right to market
and sell the Company's diabetes detection product. It is anticipated that Welch
Allyn and SpectRx will jointly manage the sales and marketing of any cancer
products that are developed.
PATENTS
The Company has pursued a strategy of developing and acquiring patents
and patent rights and licensing technology. SpectRx's success depends in large
part upon its ability to establish and maintain the proprietary nature of its
technology through the patent process and to license from others patents and
patent applications necessary to develop its products. The Company has licensed
from Nimco one granted patent and know-how related to its glucose monitoring
product, jointly applied with Altea for a U.S. patent and an international
patent related to this device and has licensed this granted patent and these
patent applications to Abbott pursuant to the parties' collaborative
arrangements. SpectRx has license agreements with GTRC that give the Company the
right to use two patents related to its diabetes detection product, and the
Company has licensed this proprietary technology to Roche Diagnostics pursuant
to the Company's collaborative arrangement. The Company has license agreements
with M.D. Anderson that give SpectRx access to one patent related to the
Company's infant jaundice product, and the Company has applied for two patents
related to this product. SpectRx has licensed the one patent and two patent
applications to Respironics pursuant to its collaborative arrangement with that
company. In addition, SpectRx has licensed from Dr. Joseph Lakowicz of the
University of Maryland several granted patents and patent applications related
to fluorescence spectroscopy that it intends to use in its research and
development efforts.
There can be no assurance that one or more of the patents held
directly by the Company or licensed by the Company from third parties,
including the disposable components to be used in connection with its glucose
monitoring and infant jaundice products, or processes used in the manufacture
of the Company's products, will not be successfully challenged, invalidated or
circumvented or that the Company will otherwise be able to rely on such patents
for any reason. In addition, there can be no assurance that competitors, many
of whom have substantial resources and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents that
prevent, limit or interfere with the Company's ability to make, use and sell
its products either in the United States or in foreign markets. If any of the
Company's patents are successfully challenged, invalidated or circumvented or
the Company's right or ability to manufacture its products were to be
proscribed or limited, the Company's ability to continue to manufacture and
market its products could be adversely affected, which would likely have a
material adverse effect upon the Company's business, financial condition and
results of operations.
COMPETITION
The medical device industry in general, and the markets for glucose
monitoring, cervical cancer detection and diabetes detection devices and
processes in particular, are intensely competitive. If successful in its
product development, the Company will compete with other providers of personal
glucose monitors, diabetes detection tests, infant jaundice and cancer
products.
A number of competitors, including Johnson & Johnson, Inc. (which
owns Lifescan, Inc.), Roche Diagnostics, Bayer AG (which owns Miles
Laboratories, Inc.) and Abbott (which owns MediSense, Inc.) are currently
marketing traditional single use glucose monitors. These monitors are widely
accepted in the health care industry and have a long history of accurate and
effective use. Furthermore, a number of companies have announced that they are
developing products that permit non-invasive and less invasive glucose
monitoring. Accordingly, competition in this area is expected to increase.
-16-
17
There is also competition in the diabetes detection and infant
jaundice markets. The existing blood test providers, companies that produce
blood tests and other technologies that could replace blood testing will
compete for a share of these markets.
Competition in cancer detection is also intense. Current screening
systems, primarily the Pap smear and colposcopy, are well established and
pervasive. The Company will be required, in conjunction with Welch Allyn, to
develop devices that are more accurate, easier to use or less costly to
administer, such that these devices have a competitive advantage to be
commercially successful. In addition to existing external competitors,
SpectRx's partner, Welch Allyn, is currently a competitor in the colposcopy
market.
GOVERNMENT REGULATION
All of the Company's products are regulated as medical devices.
Medical device products are subject to rigorous FDA and other governmental
agency regulations in the United States and may be subject to regulations of
relevant foreign agencies. The FDA regulates the clinical testing, manufacture,
labeling, packaging, marketing, distribution and record keeping for such
products in order to ensure that medical products distributed in the United
States are safe and effective for their intended uses. Noncompliance with
applicable requirements can result in import detentions, fines, civil
penalties, injunctions, suspensions or losses of regulatory approvals or
clearances, recall or seizure of products, operating restrictions, refusal of
the government to approve product export applications or allow the Company to
enter into supply contracts, and criminal prosecution. Failure to obtain
regulatory approvals, the restriction, suspension or revocation of regulatory
approvals or clearances, if obtained, or any other failure to comply with
regulatory requirements would have a material adverse effect on the Company's
business, financial condition and results of operations.
The Clinical Chemistry Branch of the FDA's Division of Clinical
Laboratory Devices (the "Branch") has traditionally been the reviewing branch
for blood-based personal glucose monitoring products. The Clinical Chemistry
and Clinical Toxicology Devices Panel (the "Panel") is an external advisory
panel that provides advice to the Branch regarding devices that are reviewed by
the Branch. The panel meets from time to time and provides comments on testing
guidelines. There can be no assurance that the Panel's comments will not result
in a FDA policy or change in FDA policy that is materially adverse to the
Company's regulatory position.
In the United States, medical devices are classified into one of
three classes (Class I, II or III), on the basis of the controls deemed
necessary by the FDA to reasonably assure their safety and effectiveness. Under
FDA regulations, Class I devices are subject to general controls (for example,
labeling, premarket notification and adherence to GMP), and Class II devices
are subject to general and special controls (for example, performance
standards, postmarket surveillance, patient registries, and FDA guidelines).
Generally, Class III devices are those which must receive premarket approval
from the FDA to ensure their safety and effectiveness (for example,
life-sustaining, life-supporting and implantable devices, or new devices which
have not been found substantially equivalent to legally marketed Class I or II
devices).
A medical device manufacturer may seek clearance to market a medical
device by filing a 510(k) premarket notification with the FDA if a medical
device manufacturer establishes that a newly developed device is "substantially
equivalent" to either a device that was legally marketed prior to May 28, 1976,
the date upon which the Medical Device Amendments of 1976 were enacted, or to a
device that is currently legally marketed and has received 510(k) premarket
clearance from the FDA. The 510(k) premarket notification must be supported by
appropriate information, including, where appropriate, data from clinical
trials, establishing the claim of substantial equivalence to the satisfaction
of the FDA. Commercial distribution of a device for which a 510(k) premarket
notification is required can begin only after the FDA issues an order finding
the device to be "substantially equivalent" to a predicate device. The FDA has
recently been requiring a more rigorous demonstration of substantial
equivalence than in the past. It generally takes from four to 12 months from
the date of submission to obtain clearance of a 510(k) submission, but it may
take substantially longer. The FDA may determine that a proposed device is not
substantially equivalent to a legally marketed device, or that additional
information is needed before a substantial equivalence determination can be
made.
-17-
18
A "not substantially equivalent" determination, or a request for
additional information, could delay the market introduction of new products
that fall into this category and could have a material adverse effect on the
Company's business, financial condition and results of operations. For any of
the Company's products that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect the safety or
efficacy of the device or that constitute a major change to the intended use of
the device will require new 510(k) submissions or approval of a PMA
application. Any modified device for which a new 510(k) premarket notification
is required cannot be distributed until 510(k) clearance is obtained for the
modified device. There can be no assurance that the Company will obtain 510(k)
clearance in a timely manner, if at all, for any devices or modifications to
devices for which it may submit a 510(k) notification.
A PMA application must be submitted if a proposed device is not
substantially equivalent to a legally marketed Class I or Class II device, or
for a Class III device for which FDA has called for PMAs. The PMA application
must contain valid scientific evidence to support the safety and effectiveness
of the device which includes the results of clinical trials, all relevant bench
tests, and laboratory and animal studies. The PMA application must also contain
a complete description of the device and its components, and a detailed
description of the methods, facilities and controls used for manufacture,
including, where appropriate, the method of sterilization and its assurance. In
addition, the submission must include proposed labeling, advertising literature
and training methods (if required). If human clinical trials of a device are
required in connection with a PMA application, and the device presents a
"significant risk," the sponsor of the trial (usually the manufacturer or the
distributor of the device) is required to file an investigational device
exemption ("IDE") application prior to commencing human clinical trials. The
IDE application must be supported by data, typically including the results of
animal and laboratory testing, and a description of how the device will be
manufactured. If the IDE application is reviewed and approved by the FDA and
one or more appropriate institutional review boards ("IRBs"), human clinical
trials may begin at a specific number of investigational sites with a specific
number of patients, as approved by the FDA. If the device presents a
"nonsignificant risk" to the patient, a sponsor may begin clinical trials after
obtaining approval for the study by one or more appropriate IRBs, but FDA
approval for the commencement of the study is not required. Sponsors of
clinical trials are permitted to sell those devices distributed in the course
of the study provided such compensation does not exceed recovery of costs of
manufacture, research, development and handling. An IDE supplement must be
submitted to and approved by FDA before a sponsor or an investigator may make a
significant change to the investigational plan that may affect the plan's
scientific soundness or the rights, safety or welfare of human subjects.
Upon receipt of a PMA application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit
a substantive review. If the FDA determines that the PMA application is
sufficiently complete to permit a substantive review, the FDA will accept the
application for filing. An incomplete application will be returned to the
sponsor and must be resubmitted and accepted for filing before the application
will be substantively reviewed. Once the submission is accepted for filing, the
FDA begins an in-depth review of the PMA application. An FDA review of a PMA
application generally takes one to two years from the date the PMA application
is accepted for filing, but may take significantly longer. The review time is
often significantly extended by the FDA asking for more information or
clarification of information already provided in the submission. During the PMA
application review period, the submission may be sent to an FDA-selected
scientific advisory panel composed of physicians and scientists with expertise
in the particular field. The FDA scientific advisory panel issues a
recommendation to the FDA that may include conditions for approval. The FDA is
not bound by the recommendations of the advisory panel. Toward the end of the
PMA application review process, the FDA will conduct an inspection of the
manufacturer's facilities to ensure that the facilities are in compliance with
applicable GMP requirements.
If the FDA evaluations of both the PMA application and the
manufacturing facilities are favorable, the FDA will issue an approvable
letter, which usually contains a number of conditions which must be met in
order to secure final approval of the PMA application. When those conditions
have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA
application approval letter authorizing commercial marketing of the device for
certain indications and intended uses. The PMA application review process can
be expensive, uncertain and lengthy. A number of devices for which a PMA has
been sought have never been approved for marketing. The FDA may also determine
that additional clinical trials are necessary, in which case the PMA may be
significantly delayed while such trials are conducted and
-18-
19
data is submitted in an amendment to the PMA application. Modifications to the
design, labeling or manufacturing process of a device that is the subject of an
approved PMA application, its labeling, or manufacturing process may require
approval by the FDA of PMA supplements or new PMA applications. Supplements to
a PMA often require the submission of the same type of information required for
an initial PMA, except that the supplement is generally limited to that
information needed to support the proposed change from the product covered by
the original PMA. The FDA generally does not call for an advisory panel review
for PMA supplements. There can be no assurance that, if required, the Company
will be able to meet the FDA's PMA requirements or that any necessary approvals
will be received. Failure to comply with regulatory requirements would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Regulatory approvals and clearances, if granted, may include
significant labeling limitations and limitations on the indicated uses for
which the product may be marketed. In addition, to obtain such approvals and
clearances, the FDA and certain foreign regulatory authorities impose numerous
other requirements with which medical device manufacturers must comply. FDA
enforcement policy strictly prohibits the marketing of approved medical devices
for unapproved uses. Any products manufactured or distributed by the Company
pursuant to FDA clearances or approvals are subject to pervasive and continuing
regulation by the FDA. The FDA also requires the Company to provide it with
information on death and serious injuries alleged to have been associated with
the use of the Company's products, as well as any malfunctions that would
likely cause or contribute to death or serious injury. Failure to comply with
applicable regulatory requirements can result in, among other things, warning
letters, fines, injunctions, civil penalties, recall or seizure of products,
total or partial suspension of production, refusal by the government to grant
premarket clearance or premarket approval for devices, withdrawals of approvals
and criminal prosecutions.
The Company is required to register with the FDA as a device
manufacturer and list its products with the Agency. The Company also is subject
to biannual inspections, for compliance with GMP, by the FDA and state agencies
acting under contract with the FDA. The GMP regulations require that the
Company manufacture its products and maintain its documents in a prescribed
manner with respect to manufacturing, testing, quality assurance and quality
control activities. The FDA also has promulgated final regulatory changes to
the GMP regulations that require, among other things, design controls and
maintenance of service records, and which will increase the cost of complying
with GMP requirements.
Labeling and promotional activities are subject to scrutiny by the
FDA and in certain instances, by the Federal Trade Commission. The FDA actively
enforces regulations prohibiting marketing of products for unapproved users.
The Company and its products are also subject to a variety of state and local
laws and regulations in those states and localities where its products are or
will be marketed. Any applicable state or local regulations may hinder the
Company's ability to market its products in those states or localities.
Manufacturers are also subject to numerous federal, state and local laws
relating to such matters as safe working conditions, manufacturing practices,
environmental protection, fire hazard control and disposal of hazardous or
potentially hazardous substances. There can be no assurance that the Company
will not be required to incur significant costs to comply with such laws and
regulations now or in the future or that such laws or regulations will not have
a material adverse effect upon the Company's ability to do business.
International sales of the Company's products are subject to the
regulatory requirements of each target country. The regulatory review process
varies from country to country. The ISO 9000 series of standards for quality
operations have been developed to ensure that companies know the standards of
quality to which they must adhere to receive certification. The European Union
has promulgated rules which require that medical products received by mid-1998
the right to affix the CE mark, an international symbol of adherence to quality
assurance standards and compliance with applicable European medical device
directives. The ISO 9001 certification was one of the CE mark certification
requirements required by mid-1998. The Company currently has ISO 9001/EN46001
certification. Failure, however, to maintain the right to affix the CE mark
would prohibit the Company from selling its products in member countries of the
European Union.
-19-
20
The Company will rely upon its corporate partners to obtain certain
United States and foreign regulatory approvals and if such approvals are
obtained the Company will rely upon its corporate partners to remain in
compliance with ongoing United States and foreign regulatory restrictions. The
inability or failure of such third parties to comply with the varying
regulations or the imposition of new regulations would materially adversely
affect the Company's business, financial condition and results of operations.
EMPLOYEES AND CONSULTANTS
As of December 31, 1999, the Company had 62 employees and consulting
or other contract arrangements with 41 additional persons to provide services
to the Company on a full- or part-time basis. Of the 103 people so employed or
engaged by the Company, 59 are engaged in research and development activities,
10 are engaged in sales and marketing activities, 7 are engaged in regulatory
affairs and quality assurance, 13 are engaged in manufacturing and development,
and 14 are engaged in administration and accounting. No employees are covered
by collective bargaining agreements, and the Company believes it maintains good
relations with its employees.
The Company's ability to operate successfully and manage its
potential future growth depends in significant part upon the continued service
of certain key scientific, technical, managerial and finance personnel, and its
ability to attract and retain additional highly qualified scientific,
technical, managerial and finance personnel. None of these key employees has an
employment contract with the Company nor are any of these employees covered by
key person or similar insurance. In addition, if the Company, together with its
collaborative partners, is able to successfully develop and commercialize the
Company's products, the Company will need to hire additional scientific,
technical, marketing, managerial and finance personnel. The Company faces
intense competition for qualified personnel in these areas, many of whom are
often subject to competing employment offers, and there can be no assurance
that the Company will be able to attract and retain such personnel. The loss of
key personnel or inability to hire and retain additional qualified personnel in
the future could have a material adverse effect on the Company's business,
financial condition and results of operations.
RISK FACTORS
The following risk factors should be considered carefully in addition
to the other information presented in this report. This report contains forward
looking statements that involve risks and uncertainties. The Company's actual
results may differ significantly from the results discussed in the forward
looking statements. Factors that might cause such differences include, but are
not limited to, the following risk factors.
Early Stage of Development; No Assurance of Successful Product Development
To date, the Company has released for sale one product line. For the
remainder of its expected products, the company has only tested prototypes and
pre-release production versions of its products. Because the Company's research
and clinical development programs are at an early stage, substantial additional
research and development and clinical trials will be necessary before
commercial prototypes of the Company's other products are produced. The Company
could encounter unforeseen problems in the development of those products such
as delays in conducting clinical trials, delays in the supply of key components
or delays in overcoming technical hurdles. There can be no assurance that the
Company will be able to successfully address the problems that may arise during
the development and commercialization process. In addition, there can be no
assurance that all of the Company's products will be successfully developed,
proven safe and efficacious in clinical trials, meet applicable regulatory
standards, be capable of being produced in commercial quantities at acceptable
costs, be eligible for third-party reimbursement from governmental or private
insurers, be successfully marketed or achieve market acceptance. If any of the
Company's development programs are not successfully completed, required
regulatory approvals or clearances are not obtained, or products for which
approvals or clearances are obtained are not commercially successful, the
Company's business, financial condition and results of operations would be
materially adversely affected.
-20-
21
The Company's business is subject to the risks inherent in the
development of new products using new technologies and approaches. There can be
no assurance that unforeseen problems will not develop with these technologies
or applications, that the Company will be able to successfully address
technological challenges it encounters in its research and development programs
or that commercially feasible products will ultimately be developed by the
Company.
Dependence on Collaborative Arrangements
The Company's business strategy for the development, clinical
testing, regulatory approval, manufacturing and commercialization of its
products depends upon the Company's ability to selectively enter into and
maintain collaborative arrangements with leading medical device companies. The
Company has entered into collaborative arrangements with, (i) Respironics under
which Respironics has significant responsibility for undertaking or funding the
development, clinical testing, regulatory approval process and sale of the
Company's infant jaundice product in the United States and Canada, (ii) Roche
Diagnostics under which Roche Diagnostics has significant responsibility for
undertaking or funding the development, clinical testing, regulatory approval
process and sale of the Company's diabetes detection product, (iii) Abbott
under which Abbott is primarily responsible for undertaking or funding the
development, clinical testing, regulatory approval process, manufacture and
sale of the Company's glucose monitoring products and (iv) Welch Allyn which is
a cooperative development program in the early stages of product development
for a cervical cancer detection product. The agreements evidencing these
collaborative arrangements grant a substantial amount of discretion to each of
Abbott, Roche Diagnostics, Respironics and Welch Allyn. For example, each of
these collaborative partners may terminate their respective collaborative
arrangements with the Company effective upon the expiration of certain notice
periods. In addition, the obligation of each of the Company's collaborative
partners to fund or undertake the development, clinical testing, regulatory
approval process, marketing, distribution and/or sale of the products covered
by their respective collaborative arrangements with the Company is, to a large
extent, dependent upon the satisfaction of certain goals or "milestones" by
certain specified dates, some of which are outside the Company's control. To
the extent that the obligations of the Company's collaborative partners to fund
or undertake all or certain of the foregoing activities are not contingent upon
the satisfaction of certain goals or milestones, the collaborative partners
nevertheless retain a significant degree of discretion regarding the timing of
these activities and the amount and quality of financial, personnel and other
resources that they devote to these activities. Furthermore, there can be no
assurance that disputes will not arise between the Company and one or more of
its collaborative partners regarding their respective rights and obligations
under the collaborative arrangements. Finally, there can be no assurance that
one or more of the Company's collaborative partners will not be able, due to
financial, regulatory or other reasons, to satisfy its obligations under its
collaborative arrangement with the Company or will not intentionally or
unintentionally breach its obligations under the arrangement.
There can be no assurance that one or more of the Company's
collaborative partners will not, for competitive reasons, support, directly or
indirectly, a company or product that competes with the Company's product that
is the subject of its collaborative arrangement with the Company. Furthermore,
any dispute between the Company and one of its collaborative partners might
require the Company to initiate or defend expensive litigation or arbitration
proceedings.
Any termination of any collaborative arrangement by one of the
Company's collaborative partners, any inability of a collaborative partner to
fund or otherwise satisfy its obligations under its collaborative arrangements
with the Company and any significant dispute with, or breach of a contractual
commitment by, a collaborative partner, would likely require the Company to
seek and reach agreement with another collaborative partner or to assume, to
the extent possible and at its own expense, all the responsibilities being
undertaken by this collaborative partner. There can be no assurance that the
Company would be able to reach agreement with a replacement collaborative
partner. If the Company were not able to find a replacement collaborative
partner, there can be no assurance that the Company would be able to perform or
fund the activities for which such collaborative partner is currently
responsible. Even if the Company were able to perform and fund these
activities, the Company's capital requirements would increase substantially. In
addition, the further development and the clinical testing, regulatory approval
process, marketing, distribution and sale of the product covered by such
collaborative arrangement would be significantly delayed.
-21-
22
Any of the foregoing circumstances could have a material adverse
effect upon the Company's business, financial condition and results of
operations.
Limited Operating History; History of Losses and Expectations of Future Losses
The Company has a limited operating history upon which its prospects
can be evaluated. Such prospects must be considered in light of the substantial
risks, expenses and difficulties encountered by entrants into the medical
device industry, which is characterized by an increasing number of
participants, intense competition and a high failure rate. The Company has
experienced operating losses since its inception, and, as of December 31, 1999,
the Company had an accumulated deficit of approximately $25.3 million. To date,
the Company has engaged primarily in research and development efforts. The
Company has only generated limited revenues from product sales and does not
have significant experience in manufacturing, marketing or selling its
products. There can be no assurance that the Company's development efforts will
result in commercially viable products, that the Company will be successful in
introducing its products, or that required regulatory clearances or approvals
will be obtained in a timely manner, or at all. There can be no assurance that
the Company's products will ever gain market acceptance or that the Company
will ever generate significant revenues or achieve profitability. The
development and commercialization of its products will require substantial
development, regulatory, sales and marketing, manufacturing and other
expenditures. The Company expects its operating losses to continue through 2001
as it continues to expend substantial resources to complete development of its
products, obtain regulatory clearances or approvals, build its marketing,
sales, manufacturing and finance organizations and conduct further research and
development.
Government Regulations; No Assurance of Regulatory Approvals
The design, manufacturing, labeling, distribution and marketing of
the Company's products will be subject to extensive and rigorous government
regulation in the United States and certain other countries where the process
of obtaining and maintaining required regulatory clearance or approvals is
lengthy, expensive and uncertain. In order for the Company to market its
products in the United States, the Company must obtain clearance or approval
from the FDA. The Company intends to seek clearance to market each of its
products, where possible through a 510(k) premarket notification supported by
clinical data. A 510(k) premarket notification has been filed with and approved
by the FDA, for clearance to market the Company's infant jaundice product. A
510(k) has been filed for expanded use during phototherapy treatment for the
BiliChek(TM). A 510(k) premarket notification was filed in 1998 with the FDA
for clearance to market the diabetes detection product. The 510(k) was later
withdrawn, and discussions have been held by Roche Diagnostics with the FDA in
preparation for clinical activity and the submission of a PMA for this product
to be filed in 2000. The Company has not filed any other 510(k) premarket
notification or PMA for clearance with the FDA. A 510k or PMA for the glucose
monitoring product is expected after the completion of development. There can
be no assurance that any such notifications will be filed in accordance with
this schedule, that the FDA will act favorably or quickly on such 510(k)
submissions, or that significant difficulties and costs will not be encountered
during efforts to obtain FDA clearance or approval. Specifically, the FDA may
request additional data or require additional clinical studies be conducted to
obtain 510(k) clearance for one or more of the Company's products. In addition,
there can be no assurance that the FDA will not require the submission of a
premarket approval ("PMA") application to obtain FDA approval to market one or
more of the Company's products. Preliminary expectations regarding the
Company's cancer program and glucose program are that those filings would be a
PMA. The PMA process is more rigorous and lengthier than the 510(k) clearance
process and can take several years from initial filing and require the
submission of extensive supporting data and clinical information. In addition,
there can be no assurance that the FDA will not impose strict labeling or other
requirements as a condition of its 510(k) clearance or PMA, any of which could
limit the Company's ability to market its products. Further, if the Company
wishes to modify a product after FDA clearance of a 510(k) premarket
notification or approval of a PMA application, including changes in indications
or other modifications that could affect safety and efficacy, additional
clearances or approvals will be required from the FDA. Any request by the FDA
for additional data or any requirement by the FDA that the Company conduct
additional clinical studies or submit to the more rigorous and lengthier PMA
process could result in a significant delay in bringing the Company's products
to market and substantial additional research and other expenditures by the
Company. Similarly, any labeling or other conditions or restrictions imposed by
the FDA on the marketing of the Company's products could hinder the Company's
ability to effectively market its products. Any of the foregoing actions by the
FDA could delay or prevent altogether the
-22-
23
Company's ability to market and distribute its products and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In order for the Company to market its products under development in
Europe and certain other foreign jurisdictions, the Company and its
distributors and agents must obtain required regulatory registrations or
approvals and otherwise comply with extensive regulations regarding safety,
efficacy and quality in those jurisdictions. Specifically, certain foreign
regulatory bodies have adopted various regulations governing product standards,
packaging requirements, labeling requirements, import restrictions, tariff
regulations, duties and tax requirements. These regulations vary from country
to country. In order to commence sales in Europe, the Company has obtained ISO
9001 certification and CE mark certification, which is an international symbol
of quality and compliance with applicable European medical device directives.
While the Company has received ISO 9001 and CE mark certification, it must
maintain its certifications in future periods. Failure to receive or maintain
ISO 9001 or CE mark certification or other foreign regulatory approvals could
have a material adverse effect on the Company's business, financial condition
and results of operations. There can be no assurance that the Company will
obtain any other required regulatory registrations or approvals in such
countries or that it will not be required to incur significant costs in
obtaining or maintaining such regulatory registrations or approvals. Delays in
obtaining any registrations or approvals required to market the Company's
products, failure to receive these registrations or approvals, or future loss
of previously obtained registrations or approvals could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The Company and its collaborative partners will be required to adhere
to applicable FDA regulations regarding Good Manufacturing Practice ("GMP") and
similar regulations in other countries, which include testing, control, and
documentation requirements. Ongoing compliance with GMP and other applicable
regulatory requirements will be strictly enforced in the United States through
periodic inspections by state and federal agencies, including the FDA, and in
foreign jurisdictions by comparable agencies. Failure to comply with applicable
regulatory requirements could result in, among other things, warning letters,
fines, injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, refusal of the government to grant premarket
clearance or premarket approval for devices, withdrawal of approvals previously
obtained and criminal prosecution. The restriction, suspension or revocation of
regulatory approvals or any other failure to comply with regulatory
requirements would have a material adverse effect on the Company's business,
financial condition and results of operations.
The Clinical Chemistry Branch of the FDA's Division of Clinical
Laboratory Devices (the "Branch") has traditionally been the reviewing branch
for blood-based personal glucose monitoring products. The Clinical Chemistry
and Clinical Toxicology Devices Panel (the "Panel") is an external advisory
panel that provides advice to the Branch regarding devices that are reviewed by
the Branch. The panel meets from time to time and provides comments to the
Branch regarding guidelines. There can be no assurance that the Panel's
comments will not result in a FDA policy or change in FDA policy that is
materially adverse to the Company's regulatory position.
The Company will rely upon Abbott, Roche Diagnostics and Respironics
to obtain United States and foreign regulatory approvals and clearances for its
glucose monitoring, diabetes detection and infant jaundice products,
respectively, and if such approvals or clearances are obtained the Company will
rely upon these collaborative partners to maintain them in full force and
effect and to otherwise remain in compliance with all applicable United States
and foreign regulatory restrictions. The inability or failure of such third
parties to comply with the varying regulations or the imposition of new
regulations would materially adversely affect the Company's business, financial
condition and results of operations.
Dependence on Licensed Patent Applications and Proprietary Technology
SpectRx's success depends in large part upon its ability to establish
and maintain the proprietary nature of its technology through the patent
process and to license from others patents and patent applications necessary to
develop its products. The Company has licensed from Non-Invasive Monitoring
Company, Inc. ("Nimco") one granted patent and know-how related to its glucose
monitoring product, jointly applied with Altea Technologies, Inc. ("Altea") for
a U.S. patent and an international patent related to this device and has
licensed this granted patent and these patent applications
-23-
24
to Abbott pursuant to the parties' collaborative arrangements. SpectRx has
license agreements with Georgia Tech Research Corporation ("GTRC") that give
the Company the right to use two patents related to its diabetes detection
product, and the Company has licensed this proprietary technology to Roche
Diagnostics pursuant to the Company's collaborative arrangement with Boehringer
Mannheim. The Company has license agreements with the University of Texas M.D.
Anderson Cancer Center ("M.D. Anderson") that give SpectRx access to one patent
related to the Company's infant jaundice product, and the Company has applied
for two patents related to this product. SpectRx has licensed the one patent
and two patent applications to Respironics pursuant to its collaborative
arrangement with that company. In addition, SpectRx has licensed from Joseph
Lakowicz, Ph.D. of the University of Maryland several granted patents and
patent applications related to fluorescence spectroscopy that it intends to use
in its research and development efforts.
There can be no assurance that one or more of the patents held
directly by the Company or licensed by the Company from third parties,
including the disposable components to be used in connection with its glucose
monitoring and infant jaundice products, or processes used in the manufacture
of the Company's products, will not be successfully challenged, invalidated or
circumvented or that the Company will otherwise be able to rely on such patents
for any reason. In addition, there can be no assurance that competitors, many
of whom have substantial resources and have made substantial investments in
competing technologies, will not seek to apply for and obtain patents that
prevent, limit or interfere with the Company's ability to make, use and sell
its products either in the United States or in foreign markets. If any of the
Company's patents are successfully challenged, invalidated or circumvented or
the Company's right or ability to manufacture its products were to be
proscribed or limited, the Company's ability to continue to manufacture and
market its products could be adversely affected, which would likely have a
material adverse effect upon the Company's business, financial condition and
results of operations.
The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights. Certain
companies in the medical device industry have instituted intellectual property
litigation, including patent infringement actions, for legitimate and, in
certain cases, competitive reasons. In addition, the United States Patent and
Trademark Office ("USPTO") may institute litigation or interference
proceedings. There can be no assurance that the Company will not become subject
to patent infringement claims or litigation or interference proceedings
instituted by the USPTO to determine the priority of inventions. The defense
and prosecution of intellectual property suits, USPTO interference proceedings
and related legal and administrative proceedings are both costly and time
consuming. Litigation may be necessary to enforce patents issued to the
Company, to protect trade secrets or know-how owned by the Company or to
determine the enforceability, scope and validity of the proprietary rights of
others. Any litigation or interference proceedings brought against, initiated
by or otherwise involving the Company may require the Company to incur
substantial legal and other fees and expenses and may require some of the
Company's employees to devote all or a substantial portion of their time to the
prosecution or defense of such litigation or proceedings. An adverse
determination in litigation or interference proceedings to which the Company
may become a party, including any litigation that may arise against the
Company, could subject the Company to significant liabilities to third parties,
require the Company to seek licenses from third parties or prevent the Company
from selling its products in certain markets, or at all. Although patent and
intellectual property disputes regarding medical devices are often settled
through licensing or similar arrangements, there can be no assurance that the
Company would be able to reach a satisfactory settlement of such a dispute that
would allow it to license necessary patents or other intellectual property.
Even if such a settlement were reached, the settlement process may be expensive
and time consuming and the terms of the settlement may require the Company to
pay substantial royalties. An adverse determination in a judicial or
administrative proceeding or the failure to obtain a necessary license could
prevent the Company from manufacturing and selling its products, which would
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition to patents, the Company relies on trade secrets and
proprietary know-how, which it seeks to protect, in part, through
confidentiality and proprietary information agreements. There can be no
assurance that such confidentiality or proprietary information agreements will
not be breached, that the Company would have adequate remedies for any breach,
or that the Company's trade secrets will not otherwise become known to or be
independently developed by competitors.
-24-
25
Royalty Rates and Manufacturing Profits
The majority of the Company's revenues and profits are expected to be
derived from royalties and manufacturing profits that the Company will receive
from Abbott, Roche Diagnostics and Respironics resulting from sales of its
glucose monitoring, diabetes detection and infant jaundice products,
respectively. The royalties and manufacturing profits that the Company is
expected to receive from each of its collaborative partners depend on sales of
such products. There can be no assurance that the Company, together with its
collaborative partners, will be able to sell sufficient volumes of the
Company's products to generate substantial royalties and manufacturing profits
for the Company. In addition, the Company's profit margins on some of its
products are not likely to increase over time because the royalty rates and
manufacturing profit rates on those products are predetermined.
In addition, it is common practice in the glucose monitoring device
industry for manufacturers to sell their glucose monitoring devices at
substantial discounts to their list prices or to offer customers rebates on
sales of their products. Manufacturers offer such discounts or rebates to
expand the use of their products and thus increase the market for the
disposable assay strips they sell for use with their products. Because Abbott
may, pursuant to its collaborative arrangement with the Company, determine the
prices at which it sells the Company's glucose monitoring devices, it may
choose to adopt this marketing strategy. If Abbott adopts this marketing
strategy and discounts the prices at which it sells the Company's glucose
monitoring devices, the royalties earned by the Company in respect of such
sales will be less. There can be no assurance that, if this strategy is
adopted, royalties earned by the Company on sales of the disposable cartridges
to be used in connection with its glucose monitoring device will be equal to or
greater than the royalties the Company would have earned had its glucose
monitoring devices not been sold at a discount. This possible reduction in
royalties on sales of the Company's glucose monitoring devices could have a
material adverse effect upon the Company's business, financial condition and
results of operations.
The collaboration with Welch Allyn is a joint development and
commercialization effort. It is anticipated that both SpectRx and Welch Allyn
would manufacture portions of the cancer detection device and both would share
in the revenues of products sold to customers. There can be no assurance,
however, that the Company, together with Welch Allyn, will sell sufficient
volumes of these products to generate substantial revenues.
Uncertainty of Market Acceptance
The Company's products are based upon new methods of glucose
monitoring, diabetes detection, infant jaundice monitoring and cervical cancer
detection. There can be no assurance that any of these products will gain market
acceptance. Physicians and individuals will not recommend or use the Company's
products unless they determine, based on experience, clinical data, relative
cost, and other factors, that these products are an attractive alternative to
current blood-based or other tests that have a long history of safe and
effective use. To date, the Company's products have been utilized by only a
limited number of subjects, and no independent studies regarding the Company's
products have been published. The lack of any such independent studies may have
an adverse effect on the Company's ability to successfully market its products.
In addition, purchase decisions for products like the Company's diabetes
detection and infant jaundice products are greatly influenced by health care
administrators who are subject to increasing pressures to reduce costs. Failure
of the Company's products to achieve significant market acceptance would have a
material adverse effect on the Company's business, financial condition and
results of operations.
Intense Competition
The medical device industry in general, and the markets in which the
company expects to offer products in particular, are intensely competitive. If
successful in its product development, the Company will compete with other
providers of personal glucose monitors, diabetes detection tests, infant
jaundice and cancer detection products.
A number of competitors, including Johnson & Johnson, Inc. (which
owns Lifescan, Inc.), Roche Diagnostics, Bayer AG (which owns Miles
Laboratories, Inc.) and Abbott (which owns MediSense, Inc.), are currently
marketing traditional glucose monitors. These monitors are widely accepted in
the health care industry and have a long history of
-25-
26
accurate and effective use. Furthermore, a number of companies have announced
that they are developing products that permit non-invasive and less invasive
glucose monitoring. Accordingly, competition in this area is expected to
increase.
Many of the Company's competitors have substantially greater
financial, research, technical, manufacturing, marketing and distribution
resources than the Company and have greater name recognition and lengthier
operating histories in the health care industry. There can be no assurance that
the Company will be able to effectively compete against these and other
competitors. In addition, there can be no assurance that the Company's glucose
monitoring, diabetes detection, infant jaundice or cancer detection products
will replace any currently used devices or systems, which have long histories
of safe and effective use. Furthermore, there can be no assurance that the
Company's competitors will not succeed in developing, either before or after
the development and commercialization of the Company's products, devices and
technologies that permit more efficient, less expensive non-invasive and less
invasive glucose monitoring, diabetes detection, infant jaundice monitoring and
cancer detection. It is also possible that one or more pharmaceutical or other
health care companies will develop therapeutic drugs, treatments or other
products that will substantially reduce the prevalence of diabetes or infant
jaundice or otherwise render the Company's products obsolete. Such competition
could have a material adverse effect on the Company's business, financial
condition and results of operation.
In addition, there can be no assurance that one or more of the
Company's collaborative partners will not, for competitive reasons, reduce its
support of its collaborative arrangement with the Company or support, directly
or indirectly, a company or product that competes with the Company's product
that is the subject of the collaborative arrangement.
Little Manufacturing Experience; Dependence on Sole Sources of Supply
To date, the Company's manufacturing activities have only included
its BiliChek(TM) and BiliCal(TM) products on a limited scale. If the Company
successfully develops its diabetes detection product and, together with Roche
Diagnostics obtains FDA clearance and other regulatory approvals to market that
product, the Company will undertake to manufacture this product in significant
volumes. The Company has no experience manufacturing such products in the
volumes that would be necessary for the Company to achieve significant
commercial sales. There can be no assurance that the Company will be able to
establish and maintain reliable, full scale manufacturing of these products at
commercially reasonable costs. Although the Company has leased space that it
plans to use to manufacture its products, it may encounter various problems in
establishing and maintaining its manufacturing operations, resulting in
inefficiencies and delays. Specifically, companies often encounter difficulties
in scaling up production, including problems involving production yield,
quality control and assurance, and shortages of qualified personnel. In
addition, the Company's manufacturing facilities will be subject to GMP
regulations, including possible preapproval inspection, international quality
standards and other regulatory requirements. Difficulties encountered by the
Company in manufacturing scale-up or failure by the Company to implement and
maintain its manufacturing facilities in accordance with GMP regulations,
international quality standards or other regulatory requirements could result
in a delay or termination of production, which could have a material adverse
effect on the Company's business, financial condition and results of
operations.
The microspectrometer and disposable calibration element, components
of the Company's infant jaundice product, and the blue light module and
calibration element, components of the Company's diabetes detection product,
are each available from only one supplier and these products would require a
major redesign in order to incorporate a substitute component. Certain other
components of the infant jaundice and diabetes detection products are currently
obtained from only one supplier, but have readily available substitute
components that can be incorporated in the applicable product with minimal
design modifications. For the Company's products which require a PMA, the
inclusion of substitute components could require the Company to qualify the new
supplier with the appropriate government regulatory authorities. Alternatively,
for the Company's products which qualify for a 510(k) premarket notification,
the substitute components need only meet the Company's product specifications.
Any significant problem experienced by one of the Company's sole source
suppliers may result in a delay or interruption in the supply of components to
the Company until such supplier cures the problem or an alternative source of
the component is located and qualified. Any delay or interruption would likely
lead to a delay or interruption in the Company's manufacturing operations,
which could have a material adverse effect upon the Company's business,
financial condition and results of operations.
-26-
27
Limited Marketing and Sales Experience
The Company is responsible for marketing its infant jaundice product
in countries other than the United Sates and Canada. The Company has relatively
limited experience in marketing or selling medical device products and only has
a six person marketing and sales staff. In order to successfully continue to
market and sell its infant jaundice product outside the United States and
Canada, the Company must either develop a marketing and sales force or expand
its arrangements with third parties to market and sell this product. While the
Company has signed distributor agreements for its BiliCheck(TM) and BiliCal(TM)
products, there can be no assurance that the Company will be able to
successfully fully develop a marketing and sales force or that it will be able
to enter into and maintain marketing and sales agreements with third parties on
acceptable terms. If the Company develops its own marketing and sales
capabilities, it will compete with other companies that have experienced and
well-funded marketing and sales operations. If the Company enters into a
marketing arrangement with a third party for the marketing and sale of its
infant jaundice product outside the United States and Canada, any revenues to
be received by the Company from this product will be dependent on this third
party, and the Company will likely be required to pay a sales commission or
similar amount to this party. Furthermore, the Company is currently dependent
on the efforts of Abbott and Roche Diagnostics for any revenues to be received
from its glucose monitoring and diabetes detection products, respectively.
There can be no assurance that the efforts of these third parties for the
marketing and sale of the Company's products will be successful.
Product Liability Risk; Limited Insurance Coverage
The development, manufacture and sale of medical products entail
significant risks of product liability claims. The Company currently has no
product liability insurance coverage beyond that provided by its general
liability insurance. Accordingly, there can be no assurance that the Company is
adequately protected from any liabilities, including any adverse judgments or
settlements, it might incur in connection with the development, clinical
testing, manufacture and sale of its products. In addition, product liability
insurance is expensive and may not be available to the Company on acceptable
terms, if at all. A successful product liability claim or series of claims
brought against the Company that results in an adverse judgment against or
settlement by the Company in excess of any insurance coverage could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Need for Additional Capital; Uncertainty of Access to Capital
Substantial capital will be required to develop the Company's
products, including completing product testing and clinical trials, obtaining
all required United States and foreign regulatory approvals and clearances,
commencing and scaling up manufacturing and marketing its products. Pursuant to
the Company's collaborative arrangements with Abbott, Roche Diagnostics,
Respironics and Welch Allyn, these collaborative partners will either directly
undertake these activities or will fund a substantial portion of these
expenditures. The obligations of the Company's collaborative partners to fund
the Company's capital expenditures is largely discretionary and depends on a
number of factors, including the Company's ability to meet certain milestones
in the development and testing of its products. There can be no assurance that
the Company will meet such milestones or that the Company's collaborative
partners will continue to fund the Company's capital expenditures. Any failure
of the Company's collaborative partners to fund its capital expenditures would
have a material adverse effect on the Company's business, financial condition
and results of operations.
In addition to funds that the Company expects to be provided by its
collaborative partners, the Company may be required to raise additional funds
through public or private financing, additional collaborative relationships or
other arrangements. The Company believes that its existing capital resources
will be sufficient to satisfy its funding requirements for at least the next 12
months, but may not be sufficient to fund the Company's operations to the point
of commercial introduction of either of its glucose monitoring product concepts.
There can be no assurance that any required additional funding, if needed, will
be available on terms attractive to the Company, or at all, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. Any additional equity financing may be dilutive to
stockholders, and debt financing, if available, may involve restrictive
covenants.
-27-
28
Uncertainty of Third-Party Reimbursement
In the United States, patients, hospitals and physicians who purchase
medical devices such as the Company's products, generally rely on third-party
payors, principally federal Medicare, state Medicaid and private health
insurance plans, to reimburse them for all or a portion of the cost of the
medical device. Reimbursement for devices that have received FDA approval has
generally been available in the United States. In addition, certain health care
providers are gradually adopting a managed care system in which such providers
contract to provide comprehensive health care services for a fixed cost per
person. The Company is unable to predict what changes will be made in the
reimbursement methods utilized by third-party health care payors. Although the
Company anticipates that patients, hospitals and physicians will justify the
use of the Company's products by the attendant cost savings and clinical
benefits that the Company believes will be derived from the use of its
products, there can be no assurance that this will be the case. Furthermore,
the Company could be adversely affected by changes in reimbursement policies of
governmental or private health care payors. Any inability of patients,
hospitals, physicians and other users of the Company's products to obtain
sufficient reimbursement from health care payors for the Company's products or
adverse changes in relevant governmental policies or the policies of private
third-party payors regarding reimbursement for such products could have a
material adverse effect on the Company's business, financial condition and
results of operations.
If the Company obtains the necessary foreign regulatory approvals,
market acceptance of the Company's products in international markets will be
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country and include both government
sponsored health care and private insurance. Although the Company intends to
seek international reimbursement approvals, there can be no assurance that such
approvals will be obtained in a timely manner, if at all. Any failure to
receive international reimbursement approvals could have an adverse effect on
market acceptance of the Company's products in the international markets in
which such approvals are sought.
In the United States and elsewhere, sales of medical products are
dependent, in part, on the ability of consumers of these products to obtain
reimbursement for all or a portion of their cost from third-party payors, such
as government and private insurance plans. Third-party payors are increasingly
challenging the prices charged for medical products and services. If the
Company succeeds in bringing one or more products to market, there can be no
assurance that these products will be considered cost effective and that
reimbursement to the consumer will be available or sufficient to allow the
Company to sell its products on a competitive basis.
Need to Attract and Retain Key Employees
The Company's ability to operate successfully and manage its
potential future growth depends in significant part upon the continued service
of certain key scientific, technical, managerial and finance personnel, and its
ability to attract and retain additional highly qualified scientific,
technical, managerial and finance personnel. The officers listed in the
Executive Officers and Directors table included in the Company's 2000 Proxy
Statement comprise the Company's key personnel. None of these key employees has
an employment contract with the Company nor are any of these employees covered
by key person or similar insurance. In addition, if the Company, together with
its collaborative partners, is able to successfully develop and commercialize
the Company's products, the Company will need to hire additional scientific,
technical, marketing, managerial and finance personnel. The Company faces
intense competition for qualified personnel in these areas, many of whom are
often subject to competing employment offers, and there can be no assurance
that the Company will be able to attract and retain such personnel. The loss of
key personnel or inability to hire and retain additional qualified personnel in
the future could have a material adverse effect on the Company's business,
financial condition and results of operations.
-28-
29
Control by Directors, Executive Officers and Affiliated Entities
The Company's directors, executive officers and entities affiliated
with them, in the aggregate, beneficially owned as of December 31, 1999
approximately 32% of the Company's outstanding Common Stock. These
stockholders, acting together, would be able to control substantially all
matters requiring approval by the stockholders of the Company, including the
election of directors and the approval of mergers and other business
combination transactions.
Potential Volatility of Stock Price
The stock markets have experienced extreme price and volume
fluctuations that have substantially affected small capitalization medical
technology companies, resulting in changes in the market prices of the stocks
of many such companies that may not have been directly related to their
operating performance. Such broad market fluctuations may adversely affect the
market price of the Company's Common Stock. In addition, the market price of
the Common Stock may be highly volatile. Factors such as variations in the
Company's financial results, changes in the Company's collaborative
arrangements, comments by security analysts, announcements of technological
innovations or new products by the Company or its competitors, changing
government regulations and developments with respect to FDA submissions,
patents and proprietary rights, or litigation may have a material adverse
effect on the market price of the Common Stock.
Anti-Takeover Effect of Certain Charter and Bylaw Provisions on Price of Common
Stock
Certain provisions of the Company's Certificate of Incorporation and
Bylaws may have the effect of making it more difficult for a third party to
acquire, or of discouraging a third party from attempting to acquire, control
of the Company. Such provisions could limit the price that certain investors
might be willing to pay in the future for shares of the Company's Common Stock.
Certain of these provisions allow the Company to issue Preferred Stock without
any vote or further action by the stockholders, eliminate the right of
stockholders to act by written consent without a meeting and specify procedures
for director nominations by stockholders and submission of other proposals for
consideration at stockholder meetings. Certain provisions of Delaware law
applicable to the Company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholders for a period of three years unless certain conditions are met,
could also delay or make more difficult a merger, tender offer or proxy contest
involving the Company. The possible issuance of Preferred Stock, the procedures
required for director nominations and stockholder proposals and Delaware law
could have the effect of delaying, deferring or preventing a change in control
of the Company, including without limitation, discouraging a proxy contest or
making more difficult the acquisition of a substantial block of the Company's
Common Stock. These provisions could also limit the price that investors might
be willing to pay in the future for shares of the Company's Common Stock.
Lack of Dividends
The Company has not paid any dividends and does not anticipate paying
any dividends in the foreseeable future.
-29-
30
ITEM 2. PROPERTIES
The Company leases approximately 38,000 square feet in Norcross,
Georgia, which comprise the Company's administrative, research and development,
marketing and production facilities and the Company's planned manufacturing
facility. The Company's lease for the portion of this facility housing the
finance department and certain planned manufacturing operations extends through
2001, the portions housing certain research and development operations expire
in June 2002 and March 2003 and the portion housing administration, sales and
marketing, engineering and certain other planned manufacturing operations
expires in March 2001.
ITEM 3. LEGAL PROCEEDINGS
In March 2000, SpectRx filed a Demand for Arbitration of certain
disputes arising under its License Agreement with Altea/NIMCO and a former
officer-employee of SpectRx, Jonathan Eppstein, who is also a principal in
Altea/NIMCO. SpectRx seeks an interpretation of certain portions of the License
Agreement relating to SpectRx's obligation to assign future intellectual
property rights and seeks relief and damages for these and other issues. Altea
has subsequently sent a letter to SpectRx purporting to give notice of material
breach of the License Agreement for failure to assign certain intellectual
property rights to Altea or NIMCO and to participate in a joint development
program. The company believes that Altea's claims are without merit, but intends
to abide by the decision of the Arbitration panel as to the proper scope of
SpectRx's duties to assign future intellectual property rights under the
License Agreement and to participate in a joint development program.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The Company's Common Stock is traded on the Nasdaq National Market
(ticker symbol SPRX). The number of record holders of the Company's Common
Stock at February 28, 2000 was 103.
The Company completed an initial public offering of 2,361,699 shares
of Common Stock in July 1997. Prior to the initial public offering, the
Company's Common Stock was not publicly traded.
The high and low last sales prices for the calendar year 1999 as
reported by the Nasdaq National Market are as follows:
1999
-----------------------
HIGH LOW
------ ------
First Quarter $ 8.00 $4.875
Second Quarter $8.125 $ 6.00
Third Quarter $11.25 $ 7.25
Fourth Quarter $12.50 $ 8.25
The Company has not paid any dividends since its inception and does
not intend to pay any dividends in the foreseeable future.
On July 1, 1997, the Company commenced and completed its initial
public offering (the "IPO") of 2,361,699 shares (including 201,699 shares sold
by selling stockholders and including the exercise of the underwriters'
over-allotment option consisting of 160,000 shares) of its Common Stock, $0.001
par value per share, at a public offering price of $7.00 per share pursuant to
a registration statement on Form S-1 (file no. 333-80453) filed with the
Securities and Exchange Commission. All of the shares registered were sold.
Hambrecht & Quist LLC and Volpe Brown Whelan & Company, LLC were the managing
underwriters of the IPO. Aggregate gross proceeds to the Company from the IPO
(prior to deduction of underwriting discounts and commissions and expenses of
the offering) were $15,120,000.
-30-
31
The Company paid underwriting discounts and commissions of $1,058,400
and other expenses of approximately $896,000 in connection with the IPO. The
total expenses paid by the Company in the IPO were $1,954,400, and the net
proceeds to the Company in the IPO were $13,165,600.
In conjunction with the amendment of the Abbott Agreement in November
1999, the Company received a total of $5.25 million in November 1999 and
January 2000. The funds received are to be applied to research on the
continuous monitoring technology.
In February of 2000, the Company sold 400,000 shares of Common Stock
in a private placement transaction to a small group of individual investors for
total gross proceeds of $5.0 million.
-31-
32
ITEM 6. SELECTED FINANCIAL DATA
SPECTRX
(IN THOUSANDS EXCEPT FOR PER SHARE FIGURES)
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1999 1998 1997 1996 1995 1994
STATEMENTS OF OPERATIONS DATA:
REVENUES $ 3,337 $ 1,406 $ 901 $ 452 $ 1,179 $ 122
COST AND EXPENSES:
COST OF PRODUCT SALES 1,708 1,626 0 0 0 0
RESEARCH & DEVELOPMENT 5,170 4,234 3,714 1,815 1,189 869
MARKETING 900 1,058 835 221 146 126
GENERAL & ADMINISTRATIVE 2,222 1,908 2,272 1,526 637 350
------- ------- -------- ------- ------- -------
LOSS FROM OPERATIONS (6,663) (7,420) (5,920) (3,110) (793) (1,223)
NET INTEREST AND OTHER INCOME (EXPENSE) 125 783 194 (68) 113 (124)
------- ------- -------- ------- ------- -------
NET LOSS $(6,538) $(6,637) $ (5,726) $(3,178) $ (680) $(1,347)
======= ======= ======== ======= ======= =======
PREFERRED STOCK DIVIDENDS (14)
-------
LOSS AVAILABLE TO COMMON SHARE STOCKHOLDERS $(6,552)
=======
NET LOSS PER SHARE
BASIC $ (.82) $ (.84) $ (1.26) $ (2.13) $ (0.48) $ (0.96)
DILUTED $ (.82) $ (.84) $ (1.26) $ (2.13) $ (0.48) $ (0.96)
SHARES USED TO COMPUTE NET LOSS PER SHARE
BASIC 8,033 7,926 4,528 1,494 1,410 1,410
DILUTED 8,033 7,926 4,528 1,494 1,410 1,410
CONSOLIDATED BALANCE SHEET DATA
TOTAL ASSETS 7,693 7,654 14,999 5,946 751 1,327
TOTAL LONG TERM OBLIGATIONS, INCLUDING 5,645 0 752 250 0 475
CONVERTIBLE, REDEEMABLE PREFERRED STOCK
-32-
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Statements in this report which express "belief", "anticipation" or
"expectation" as well as other statements which are not historical fact are
forward looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
forward looking statements are subject to certain risks and uncertainties that
could cause actual results to differ materially from historical results or
anticipated results, including those set forth under "Risk Factors" in this
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and elsewhere in or incorporated by reference into this report.
Examples of such uncertainties and risks include, but are not limited to,
whether the Company's products in development will prove safe and effective;
whether and when the Company or its strategic partners will obtain approval
from the United States Food and Drug Administration ("FDA") and corresponding
foreign agencies; the Company's need to achieve manufacturing scale-up in a
timely manner, and its need to provide for the efficient manufacturing of
sufficient quantities of its products; the lack of immediate alternate sources
of supply for some critical components of its products; the Company's patent
and intellectual property position; the company's need to fully develop the
marketing, distribution, customer service and technical support and other
functions critical to the success of the Company's potential product lines; the
effectiveness and ultimate market acceptance of the Company's products; and the
dependence of the Company on its strategic partners for funding, development
assistance, clinical trials, distribution and marketing of products developed
by the Company. The following discussion should be read in conjunction with the
Company's Financial Statements and Notes thereto included elsewhere in this
report.
OVERVIEW
SpectRx was incorporated on October 27, 1992, and since that date has
raised capital through the sale of preferred stock, issuance of debt securities,
the public and private sale of common stock and funding from collaborative
arrangements. Following its initial funding in early 1993, the Company
immediately began research and development activities with the objective of
commercializing less invasive diagnostic, screening and monitoring products. As
part of its business strategy, the Company has selectively established
arrangements with leading medical device companies for the development,
commercialization and introduction of its products. The company has entered into
collaborative arrangements with Abbott, Roche Diagnostics, Respironics, (a
successor to Healthdyne Technologies, Inc.) and Welch Allyn for its glucose
monitoring, diabetes detection, infant jaundice and cancer detection products,
respectively. In December 1996, the Company sublicensed certain technology to
and acquired a 64.8% interest in FluorRx, Inc., a Delaware corporation formed
for the purpose of developing and commercializing technology related to
fluorescence spectroscopy. At December 31, 1999, as a result of a subsequent
financing, SpectRx's interest in FluorRx was 45%.
The Company has a limited operating history upon which its prospects
can be evaluated. Such prospects must be considered in light of the substantial
risks, expenses and difficulties encountered by entrants into the medical
device industry, which is characterized by an increasing number of
participants, intense competition and a high failure rate. The Company has
experienced operating losses since its inception, and, as of December 31, 1999,
the Company had accumulated deficit of approximately $25.3 million. To date,
the Company has engaged primarily in research and development efforts. The
Company first generated revenues from product sales in 1998 and does not have
significant experience in manufacturing, marketing or selling its products.
There can be no assurance that the Company's development efforts will result in
commercially viable products, that the Company will be successful in
introducing its products, or that required regulatory clearances or approvals
will be obtained in a timely manner, or at all. There can be no assurance that
the Company's products will ever gain market acceptance or that the Company
will ever generate significant revenues or achieve profitability. The
development and commercialization of its products will require substantial
development, regulatory, sales and marketing, manufacturing and other
expenditures. The Company expects its operating losses to continue through 2001
as it continues to expend substantial resources to complete development of its
products, obtain regulatory clearances or approvals, build its marketing,
sales, manufacturing and finance organizations and conduct further research and
development.
The majority of the Company's revenues and profits are expected to be
derived from royalties and manufacturing profits that the Company will receive
from Abbott, Roche Diagnostics and Respironics resulting from
-33-
34
sales of its glucose monitoring, diabetes detection and infant jaundice
products, respectively. The royalties and manufacturing profits that the
Company is expected to receive from each of its collaborative partners depend
on sales of such products. There can be no assurance that the Company, together
with its collaborative partners, will be able to sell sufficient volumes of the
Company's products to generate substantial royalties and manufacturing profits
for the Company.
The Company has entered into collaborative arrangements with Abbott,
Roche Diagnostics, Respironics, and Welch Allyn. The agreements evidencing
these collaborative arrangements grant a substantial amount of discretion to
each collaborative partner. If one or more of the Company's collaborative
partners were to terminate its arrangement with the Company, the Company would
either need to reach agreement with a replacement collaborative partner or
undertake at its own expense the activities handled by its collaborative
partner prior to such termination, which would require the Company to develop
expertise it does not currently possess, would significantly increase the
Company's capital requirements and would limit the programs the Company could
pursue. The Company would likely encounter significant delays in introducing
its products and the development, manufacture and sales of its products would
be adversely affected by the absence of such collaborative arrangements. The
termination of any of the Company's collaborative arrangements would have a
material adverse effect on the Company's business, financial condition and
results of operations.
RESULTS OF OPERATIONS
Comparison of 1999 and 1998
General. Net losses were approximately $6.6 million, or ($.82) per
share, for the year ended December 31, 1999 compared to approximately $6.6
million, or ($.84) per share, in 1998 due to increases in cost of production,
research and development expenses and administrative expenses. The Company
expects net losses to continue. If the Company is unable to attain certain
milestones under a collaboration agreement, its collaborative partner may not
make milestone payments under, or may terminate altogether, such agreement. If
this were to happen, future net losses would escalate rapidly because of
spending increases necessary to complete research, development and clinical
trials of the Company's products, commence sales and marketing efforts and
establish a manufacturing capability.
Revenues and Cost of Sales. Revenues increased to approximately $3.3
million for the year ended December 31, 1999 from approximately $1.4 million in
1998. The increase was both in revenue from product sales and milestones from
collaboration partners. Product sales of the Company's BiliCheck(TM) product
grew 75% to approximately $1.4 million in 1999. Revenue from collaborative
agreements, which is generally predicated on achievement of milestones,
increased to approximately $1.9 million for the twelve months ended December
31, 1999 from approximately $600,000 in 1998. Cost of Sales were approximately
$1.7 million for the twelve months ended December 31, 1999, compared to $1.6
million in 1998. All Cost of Sales are related to product sales and those costs
exceeded sales revenues because the Company is in the early stages of product
introduction and has excess capacity.
Research and Development Expenses. Research and development expenses
increased to approximately $5.2 million for the year ended December 31, 1999
from approximately $4.2 million in 1998. The increase in research and
development expenses was primarily due to increases in prototype materials
($290,000) temporary help ($130,000) and royalty expense ($125,000) primarily
related to the initiatives in continuous glucose monitoring and cancer
detection, in clinical costs ($70,000) for the company's infant jaundice and
diabetes detection products, in legal expenses ($183,000) for patent filings and
patent maintenance and a reduction in reimbursed expenses. The Company expects
research and development expenses to increase in the future as it expands
clinical trials for its products.
Sales and marketing expenses. Sales and marketing expenses decreased to
approximately $900,000 for the year ended December 31, 1999 from $1.1 million in
1998. The decrease was due primarily to decreases in marketing materials
($112,000), and in travel costs ($56,000) related to the infant jaundice product
introduction and marketing activity. Sales and marketing expenses are expected
to increase in the future, however, as the Company begins to market this product
in additional territories.
-34-
35
General and administrative expenses. General and administrative
expenses increased to approximately $2.2 million for the year ended December 31,
1999 from approximately $1.9 million in 1998. The increase in general and
administrative expense was due to the increases in compensation ($112,000), and
outside professional fees ($148,000). General and administrative expenses are
expected to increase in the future as a result of overhead costs associated with
expanded research and development activities and, to a lesser extent, expenses
associated with being a public company.
Net interest income and other expense. Net interest and other income
decreased to $125,000 for the year ended December 31, 1999 from $783,000 in
1998. This decrease results primarily from recognizing $329,000 of income in
1998 relating to the deconsolidation of FluorRx and lower interest income due
to lower cash balances.
Comparison Of 1998 and 1997
General. Net losses increased to approximately $6.6 million, or
($.84) per share (on more shares), for the year ended December 31, 1998 from
approximately $5.7 million, or ($1.26) per share, in 1997 due to increases in
cost of production, research and development expenses and marketing expenses.
Revenues and Cost of Sales. Revenues increased to approximately $1.4
million for the year ended December 31, 1998 from approximately $900,000 in
1997. All of the increase was due to product sales of the Company's
BiliChek(TM) product (approximately $823,000) which was introduced in April
1998. Revenue from collaborative agreements, which is generally predicated on
achievement of milestones, declined to approximately $583,000 for the twelve
months ended December 31, 1998 from approximately $900,000 in 1997. Cost of
Sales were approximately $1.6 million for the twelve months ended December 31,
1998. There was no Cost of Sales in 1997. All Cost of Sales are related to
product sales and those costs exceeded sales revenues because the Company is in
the early stages of product introduction and has excess capacity.
Research and development expenses. Research and development expenses
increased to approximately $4.2 million for the year ended December 31, 1998
from approximately $3.7 million in 1997. The increase in research and
development expenses was primarily due to increases in compensation ($392,000)
primarily related to new initiatives in continuous glucose monitoring and
cancer detection, in clinical costs ($108,000) for the company's infant
jaundice and diabetes detection products, in legal expenses ($76,000) for
patent filings and patent maintenance, offset by a reduction in FluorRx expense
($550,000) as a result of reporting FluorRx results under the equity method.
Sales and marketing expenses. Sales and marketing expenses increased
to approximately $1.1 million for the year ended December 31, 1998 from
$835,000 in 1997. The increase was due primarily to increases in advertising
and marketing materials ($110,000), in travel ($70,000) and compensation costs
($50,000) for additional personnel all related to the infant jaundice product
introduction and marketing activity.
General and administrative expenses. General and administrative
expenses decreased to approximately $1.9 million for the year ended December
31, 1998 from approximately $2.3 million in 1997. The decrease in general and
administrative expense was due to the exclusion of FluorRx administrative
expense in 1998. SpectRx did not consolidate FluorRx during 1998 as its
ownership declined below 50%. (See Note 3 in the accompanying notes). In
addition, production planning and development expenses of approximately
$750,000 were incurred as general and administrative expense in 1997; and
because production began in 1998 all such costs are included in cost of product
sales. These decreases were offset primarily by increases in compensation
($200,000), recruiting expenses ($105,000), and outside professional fees
($85,000).
Net interest expense and other expense. Net interest and other income
increased to $783,000 for the year ended December 31, 1998 from $194,000 in
1997. This increase results primarily from a one-time gain of $329,000 (net of
previously recognized losses in connection with the deconsolidation of FluorRx)
(See Note 3 in the accompanying notes), and from an increase in interest
received on cash balances received from the initial public offering, available
for a full year in 1998, offset by other expense items.
-35-
36
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its operations since inception primarily
through private sales of its debt and equity securities and public sale of its
common stock. From October 27, 1992 (inception) through December 31, 1999, the
Company received approximately $31.2 million in net proceeds from sales of its
debt and equity securities. At December 31, 1999, the Company had cash of
approximately $2.1 million and working capital of approximately $4.8 million.
In November 1999, the Company received $2.75 million from its sale of
redeemable convertible preferred stock to Abbott in conjunction with an
amendment to its Agreement with Abbott for research and development of the
Company's glucose monitoring technology. The Company completed an initial
public offering of its common stock on July 7, 1997 which resulted in net
proceeds received by the Company, of approximately $13.2 million. The Company
currently invests its excess cash balances primarily in short-term,
investment-grade, interest-bearing obligations until such funds are utilized in
operations. Substantial capital will be required to develop the Company's
products, including completing product testing and clinical trials, obtaining
all required United States and foreign regulatory approvals and clearances,
commencing and scaling up manufacturing and marketing its products. Any failure
of the Company's collaborative partners to fund its development expenditures
would have a material adverse effect on the Company's business, financial
condition and results of operations.
Subsequent to December 31, 1999, the Company received additional
financing. In January 2000 it received $2.5 million for completion of its sale
of Redeemable Convertible Preferred Stock to Abbott, and in February 2000, it
received $5.0 million in gross proceeds from the sale of 400,000 shares of its
Common Stock in a private placement transaction.
In addition to funds that the Company expects to be provided by its
collaborative partners, the Company may be required to raise additional funds
through public or private financing, additional collaborative relationships or
other arrangements. The company believes that its existing capital resources
will be sufficient to satisfy its funding requirements for at least the next 12
months, but may not be sufficient to fund the Company's operations to the point
of commercial introduction of its glucose monitoring product.
OTHER MATTERS
Year 2000 Issue Update: We did not experience any significant
malfunctions or errors in our operating or business systems when the date
changed from 1999 to 2000. Based on operations since January 1, 2000, we do not
expect any significant impact to our ongoing business as a result of the year
2000 issue. However, it is possible that the full impact of the date change has
not been fully recognized. We believe that any such problems are likely to be
minor and correctable. In addition, we could still be negatively affected if our
customers or suppliers are adversely affected by year 2000 or similar issues.
Currently we are not aware of any significant year 2000 or similar problems that
have arisen for our customers and suppliers. Expenditures related to year 2000
compliance efforts were less than $40,000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE REGARDING MARKET RISK
[Not applicable]
-36-
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
SPECTRX, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS 1998 1999
------ -------- -------
CURRENT ASSETS:
Cash and cash equivalents $ 4,962 2,143
Accounts receivable, net of allowance for doubtful accounts of $24 and $69 in 1998 AND 1999, 683 952
respectively
Inventories 404 541
Subscription receivable 0 2,500
-------- -------
Other current assets 119 204
-------- -------
Total current assets 6,168 6,340
-------- -------
PROPERTY AND EQUIPMENT, NET 973 839
-------- -------
OTHER ASSETS:
Other assets, net 42 15
Due from related parties 471 499
-------- -------
Total other assets 513 514
-------- -------
$ 7,654 7,693
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1999
------------------------------------ -------- -------
CURRENT LIABILITIES:
Accounts payable $ 436 534
Accrued liabilities 399 1,044
-------- -------
Total current liabilities 835 1,578
-------- -------
COLLABORATIVE PARTNER ADVANCE 0 381
REDEEMABLE CONVERTIBLE PREFERRED STOCK 0 5,264
-------- -------
COMMITMENTS AND CONTINGENCIES (NOTE 6)
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value; 5,000 shares authorized , 0 and 525 shares 0 0
issued as redeemable convertible preferred stock in 1998 and 1999 respectively
Common stock, $.001 par value; 50,000 shares authorized, 8,014 and 8,056 shares 8 8
issued and outstanding in 1998 and 1999, respectively
Additional paid-in capital 25,761 25,888
Deferred compensation (134) (58)
Notes receivable from officers (31) (31)
Accumulated deficit (18,785) (25,337)
-------- -------
Total stockholders' equity 6,819 470
-------- -------
$ 7,654 7,693
======== =======
The accompanying notes are an integral part of these balance sheets.
-37-
38
SPECTRX, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
1997 1998 1999
------- -------- --------
REVENUES
PRODUCT SALES 0 823 1,440
COLLABORATIVE AGREEMENTS 901 583 1,897
------- -------- --------
TOTAL REVENUE $ 901 $ 1,406 $ 3,337
EXPENSES:
Cost of Product sales 0 1,626 1,708
Research and development 3,714 4,234 5,170
Sales and marketing 835 1,058 900
General and administrative 2,272 1,908 2,222
------- -------- --------
6,821 8,826 10,000
------- -------- --------
Operating loss (5,920) (7,420) (6,663)
INTEREST EXPENSE (INCOME), NET (430) (462) (133)
OTHER (INCOME) EXPENSE 236 (321) 8
------- -------- --------
NET LOSS $(5,726) $ (6,637) $ (6,538)
======= ======== ========
PREFERRED STOCK DIVIDENDS 0 0 (14)
LOSS AVAILABLE TO COMMON SHAREHOLDERS $(5,726) $ (6,637) $ (6,552)
======= ======== ========
BASIC AND DILUTED NET LOSS PER SHARE $ (1.26) $ (0.84) $ (0.82)
======= ======== ========
BASIC AND DILUTED WEIGHTED AVERAGE 4,528 7,926 8,033
======= ======== ========
SHARES OUTSTANDING
The accompanying notes are an integral part of these statements.
-38-
39
SPECTRX, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
DECEMBER 31, , 1997, 1998 AND 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
SERIES A SERIES B SERIES C COMMON STOCK ADDITIONAL
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK --------------- PAID-IN
---------------- ---------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT CAPITAL
-------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 3,104 3 1,272 1 500 1 1,532 2 11,503
Issuance of common stock at $7 0 0 0 0 0 0 2,160 1 13,152
per share, net of issuance
costs of $909,000
Conversion of convertible (3,104) (3) (1,272) (1) (500) (1) 3,483 4 1
preferred stocks
Exercise of warrants at a 0 0 0 0 0 0 560 1 693
weighted average price per
share of $1.24
Exercise of stock options at a 0 0 0 0 0 0 10 0 3
weighted average price per
share of $.26
Employee stock purchase plan at 0 0 0 0 0 0 3 0 20
a weighted average price per
share of $5.95
Amortization of deferred 0 0 0 0 0 0 0 0 0
compensation
Net loss 0 0 0 0 0 0 0 0 0
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 0 $ 0 0 $ 0 0 $ 0 7,748 $ 8 $25,372
====================================================================================
Exercise of stock options 0 0 0 0 0 0 169 0 37
Employee stock purchase plan 0 0 0 0 0 0 14 0 63
Amortization of deferred 0 0 0 0 0 0 0 0 0
compensation
Conversion of subordinated 0 0 0 0 0 0 83 0 289
promissory notes to equity
securities
Repayment of note receivable 0 0 0 0 0 0 0 0 0
from officer
Net loss 0 0 0 0 0 0 0 0 0
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 0 $ 0 0 $ 0 0 $ 0 8,014 $ 8 $25,761
====================================================================================
Exercise of stock options 0 0 0 0 0 0 31 0 84
Employee stock purchase plan 0 0 0 0 0 0 11 0 43
Amortization of deferred 0 0 0 0 0 0 0 0 0
compensation
Dividend on preferred stock 0 0 0 0 0 0 0 0 0
Net loss 0 0 0 0 0 0 0 0 0
------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1999 0 $ 0 0 $ 0 0 $ 0 8,056 $ 8 $25,888
====================================================================================
DEFERRED NOTES ACCUMULATED STOCKHOLDERS
RECEIVABLE DEFICIT EQUITY
FROM
COMPENSATION OFFICERS
--------------------------------------------------------
BALANCE, DECEMBER 31, 1996 (286) (48) (6,422) 4,754
Issuance of common stock at $7 0 0 0 13,153
per share, net of issuance
costs of $909,000
Conversion of convertible 0 0 0 0
preferred stocks
Exercise of warrants at a 0 0 0 694
weighted average price per
share of $1.24
Exercise of stock options at a 0 0 0 3
weighted average price per
share of $.26
Employee stock purchase plan at 0 0 0 20
a weighted average price per
share of $5.95
Amortization of deferred 76 0 0 76
compensation
Net loss 0 0 (5,726) (5,726)
----------------------------------------------------
BALANCE, DECEMBER 31, 1997 $ (210) $(48) $(12,148) $12,974
Exercise of stock options 0 0 0 37
Employee stock purchase plan 0 0 0 63
Amortization of deferred 76 0 0 76
compensation
Conversion of subordinated 0 0 0 289
promissory notes to equity
securities
Repayment of note receivable 0 17 0 17
from officer
Net loss 0 0 (6,637) (6,637)
----------------------------------------------------
BALANCE, DECEMBER 31, 1998 $ (134) $(31) $(18,785) $ 6,819
====================================================
Exercise of stock options 0 0 0 84
Employee stock purchase plan 0 0 0 43
Amortization of deferred 76 0 0 76
compensation
Dividend on preferred stock 0 0 (14) (14)
Net loss 0 0 (6,538) (6,538)
----------------------------------------------------
BALANCE, DECEMBER 31, 1999 $ (58) $(31) $(25,337) $ 470
====================================================
The accompanying notes are an integral part of these statements.
-39-
40
SPECTRX, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31
1997 1998 1999
-------- -------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (5,726) $ 6,637 $(6,538)
-------- -------- -------
Adjustments to reconcile net loss to net cash in operating activities:
Depreciation and amortization 281 375 374
Gain on deconsolidation of FluorRx 0 (329) 0
Retirement of Fixed Assets 0 0 38
Amortization of deferred compensation 76 76 76
Changes in operating assets and liabilities:
Accounts receivable (553) (129) (269)
Inventory (218) (186) (137)
Other assets (36) (16) (85)
Due from related parties (30) (29) (28)
Accounts payable (42) (79) 98
Accrued liabilities 354 (4) 645
-------- -------- -------
Total adjustments (168) (321) 712
-------- -------- -------
Net cash used in operating activities (5,894) (6,958) (5,826)
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (769) (321) (251)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net 13,870 100 127
Issuance of redeemable convertible preferred stock 0 0 2,750
Advance from a collaborative partner 521 0 381
Repayment of note receivable from officer 0 17 0
-------- -------- -------
Net cash provided by financing activities 14,391 117 3,258
-------- -------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS 7,728 (7,162) (2,819)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,721 12,124 4,962
-------- -------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR $ 12,449 $ 4,962 $ 2,143
======== ======== =======
CASH PAID FOR:
Interest $ 10 $ 8 $ 2
======== ======== =======
Income taxes $ 0 $ 0 $ 0
======== ======== =======
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Conversion of subordinated promissory notes to equity securities $ 0 $ 289 $ 0
======== ======== =======
The accompanying notes are an integral part of these statements.
-40-
41
SPECTRX, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1998 AND 1999
1. ORGANIZATION AND BACKGROUND
SpectRx, Inc. (the "Company") is engaged in the research and
development of products that offer painless and less invasive
alternatives to blood tests currently used for glucose monitoring,
diabetes screening, and infant jaundice. The Company is also in the
process of developing a cervical cancer detection system. The Company's
goal is to introduce products that reduce or eliminate pain, are
convenient to use, and provide rapid results at the point of care,
thereby improving patient well-being and reducing health care costs.
The Company's infant jaundice product and products in development for
glucose monitoring, diabetes screening, and cervical cancer are based
on proprietary electro-optical and microporation technology that can
eliminate the pain and inconvenience of a blood sample. The Company has
entered into collaborative arrangements with Abbott Laboratories
("Abbott"), Roche Diagnostics BMC ("Roche"), Respironics, Inc.
("Respironics"), and Welch Allyn, Inc. ("Welch Allyn") to facilitate
the development, commercialization, and introduction of its glucose
monitoring, diabetes screening, infant jaundice, and cervical cancer
detection system products, respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRESENTATION
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 at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments purchased
with a maturity of three months or less to be cash or cash equivalents.
INVENTORIES
Inventories are stated at lower of cost or market using the
first-in, first-out method. Inventories are summarized as follows at
December 31, 1998 and 1999 (in thousands):
1998 1999
------ ------
Raw materials $ 261 $ 323
Work in process 5 78
Finished goods 138 140
------ ------
$ 404 $ 541
====== ======
-41-
42
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is
computed using the straight-line method over estimated useful lives of
five to seven years. Expenditures for repairs and maintenance are
expensed as incurred. Property and equipment are summarized as follows
at December 31, 1998 and 1999 (in thousands):
1998 1999
------ ------
Equipment $1,496 $1,676
Furniture and fixtures 314 287
------ ------
1,810 1,963
Less accumulated depreciation 837 1,124
------ ------
Property and equipment, net $ 973 $ 839
====== ======
LONG-LIVED ASSETS
The Company periodically reviews the values assigned to
long-lived assets, such as property and equipment and purchased
technology, to determine whether any impairments are other than
temporary. Management believes that the long-lived assets in the
accompanying balance sheets are appropriately valued.
PATENT COSTS
Costs incurred in filing, prosecuting, and maintaining patents
are expensed as incurred. Such costs aggregated approximately $286,000,
$496,000, and $608,000 in 1997, 1998, and 1999, respectively.
REVENUE RECOGNITION
Revenue from product sales is recorded upon shipment of the
product to the customer.
Revenue from collaborative research and development agreements
is recorded when milestones have been met. Periodic license fee
payments under collaborative agreements related to future performance
are deferred and recognized as income when earned.
RESEARCH AND DEVELOPMENT
Research and development expenses consist of expenditures for
research conducted by the Company and payments made under contracts
with consultants or other outside parties. All research and development
costs are expensed as incurred.
NET LOSS PER SHARE
The calculation and presentation of net loss per share are
presented in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 128, "Earnings Per Share." Basic earnings per
share are based on the weighted average number of shares outstanding.
Diluted earnings per share are based on the weighted average number of
shares outstanding and the dilutive effect of common stock equivalent
shares ("CSEs") issuable on the conversion of convertible preferred
stock (using the if-converted method) and stock options and warrants
(using the treasury stock method). For all periods presented, CSEs have
been excluded from weighted average shares outstanding, as their impact
was antidilutive.
-42-
43
FAIR VALUE OF FINANCIAL INSTRUMENTS
The book values of cash, trade accounts receivable, trade
accounts payable, and other financial instruments approximate their
fair values principally because of the short-term maturities of these
instruments. The fair value of the Company's collaborative partner
advance is estimated based on the current rates offered to the Company
for debt of similar terms and maturities. Under this method, the fair
value of the Company's collaborative partner advance was not
significantly different than the stated value at December 31, 1999.
COMPREHENSIVE INCOME
The Company has adopted the provisions of SFAS No. 130,
"Reporting Comprehensive Income," which establishes new rules for the
reporting and display of comprehensive income and its components;
however, the Company has no other comprehensive income items as defined
in SFAS No. 130.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board
("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which establishes accounting and reporting
standards requiring that every derivative instrument (including certain
derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair
value, and changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are
met. In June 1999, the FASB issued SAFS No. 137 which deterred the
effective date of SFAS No. 133 for fiscal quarters of all fiscal years
beginning after June 15, 2000, although earlier adoption is permitted.
The Company plans to adopt SFAS No. 133 in the first quarter of fiscal
2001. Management does not believe the adoption of this statement will
have a material effect on the financial statements of the Company.
3. INVESTMENT IN FLUORRX, INC.
In December 1996, the Company sublicensed certain technology
to and acquired a 65% interest in FluorRx, Inc. ("FluorRx"), a
corporation organized for the purpose of developing and commercializing
technology related to fluorescence spectroscopy. The Company's interest
in FluorRx is represented by two seats on the board of directors and
1.2 million shares of convertible preferred stock purchased for
$250,000. In December 1997, March 1998, August 1998, and April 1999,
FluorRx sold additional convertible preferred stock for net cash
proceeds of $521,000, $429,000, $511,000, and $300,000, respectively.
The issuance of additional preferred stock reduced the Company's
ownership (on a converted basis) to 45%.
For the year ended December 31, 1997, FluorRx incurred an
operating loss of $632,000 which was fully consolidated as the Company
represented FluorRx's sole source of financial support and
substantially all the capital at risk related to investments and
advances from the Company. Beginning with the December 1997 funding and
through the August 1998 funding, the Company consolidated the FluorRx
losses, but with appropriate allocations to the minority shareholders.
FluorRx losses recorded by the Company during the fiscal 1998 amounted
to $306,000. Effective with the August 1998 funding, the Company began
accounting for its investment in FluorRx under the equity method of
accounting. In connection with the change in accounting from
consolidation to the equity method, the Company adjusted its investment
in FluorRx to $0, which resulted in a one-time gain of $635,000. All
FluorRx activity (losses and the one-time gain) is reflected in other
(income) expense in the accompanying statements of operations. The
Company has also suspended recording losses from its investment in
FluorRx. Suspended equity losses amounted to $577,000 and $342,000 for
the years ended December 31, 1998 and 1999, respectively. At December
31, 1999, the cumulative suspended equity loss amounted to $1,133,000.
-43-
44
In 1997, 1998, and 1999, the Company paid certain patent
maintenance and minimum royalty costs amounting to $157,000, $57,000,
and $80,000, respectively, related to technology owned by the Company
and sublicensed to FluorRx. These costs have been expensed as paid.
4. STOCKHOLDERS' EQUITY
INITIAL PUBLIC OFFERING
In July 1997, the Company successfully completed its initial
public offering of common stock. The Company sold 2,160,000 shares of
common stock, including an underwriter's overallotment of 160,000
shares, at an initial public offering price of $7. The total proceeds
of the initial public offering, net of underwriting discounts and
offering expenses, were approximately $13.2 million. In connection with
the offering, all outstanding shares of Series A, B, and C preferred
stock converted into 3,482,762 shares of common stock. Additionally,
warrants to purchase 559,986 shares of common stock were exercised for
proceeds of $694,000.
PREFERRED STOCK
In January 1997, the Company authorized 5,000,000 shares of
preferred stock with a $.001 par value. The board of directors has the
authority to issue these shares and to fix dividends, voting and
conversion rights, redemption provisions, liquidation preferences, and
other rights and restrictions.
In November 1999, the board of directors designated 525,000
shares of the preferred stock as redeemable convertible preferred
stock. Dividends are payable annually in cash or securities at a rate
of 6% per annum. The preferred shares, together with any accrued but
unpaid dividends, are convertible into common shares at the greater of
$9.39 per share or the average of the closing sales price for 15 days
prior and 15 days subsequent to the conversion and automatically
convert on December 31, 2004 at the then conversion rate. The shares
are mandatorily redeemable at $10 per share, plus accrued but unpaid
dividends, at the later of December 31, 2002 or 60 days subsequent to
the date upon which the Company gives notice to Abbott of Abbott's
right to redeem the shares (which notice may not be given prior to June
1, 2002). Additionally, the Company may redeem the shares upon
receiving a conversion notice. The shares have a liquidation preference
of $10 per share, plus all accrued but unpaid dividends.
In November 1999, Abbott subscribed to 525,000 shares of
Redeemable Convertible Preferred Stock for consideration of $5,250,000
of which $2,750,000 was received in November 1999 and $2,500,000 was
received in January 2000.
CONVERSION OF SUBORDINATED PROMISSORY NOTES
In June 1996, the Company issued an 8% convertible
subordinated promissory note for $250,000. In June 1998, the holder of
the note converted outstanding principal and interest into 82,637
shares of common stock at a conversion rate of $3.50.
STOCK OPTIONS
In May 1995, the Company adopted the 1995 Stock Option Plan
(the "Plan") (as amended), under which 1,428,572 shares of common stock
are authorized and reserved for use in the Plan. The Plan allows the
issuance of incentive stock options, nonqualified stock options, and
stock purchase rights. The exercise price of options is determined by
the Company's board of directors, but incentive stock options must be
granted at an exercise price equal to the fair market value of the
Company's common stock as of the grant date. Options generally become
exercisable over four years and expire ten years from the date of
grant. At December 31, 1999, options to purchase 110,494 shares of
common stock were available for future grant under the Plan.
-44-
45
Stock option activity for each of the three years ended
December 31, 1999 is as follows:
WEIGHTED
AVERAGE
NUMBER OF PRICE PER
OPTIONS SHARE
--------- ---------
Outstanding, December 31, 1996 663,362 $ 0.64
Granted 418,000 7.50
Exercised (10,065) 0.26
Canceled (5,656) 0.46
---------
Outstanding, December 31, 1997 1,065,641 3.34
Granted 121,000 6.43
Exercised (169,472) 0.22
Canceled (44,256) 3.69
---------
Outstanding, December 31, 1998 972,913 4.25
Granted 194,500 7.52
Exercised (31,130) 2.65
Canceled (29,274) 6.51
---------
Outstanding, December 31, 1999 1,107,009 4.82
=========
Exercisable, December 31, 1999 645,243 3.39
========= ========
The following table sets forth the range of exercise prices, number of
shares, weighted average exercise price, and remaining contractual
lives by groups of similar price:
OPTIONS OUTSTANDING
------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED --------------------------
WEIGHTED AVERAGE WEIGHTED
RANGE OF NUMBER AVERAGE CONTRACTUAL NUMBER AVERAGE
EXERCISE PRICES OF SHARES PRICE LIFE OF SHARES PRICE
--------------- --------- -------- ----------- --------- --------
$0.21-$0.70 364,621 $ 0.55 6.2 years 338,617 $ 0.53
$2.45-$4.13 94,288 2.90 8.9 years 60,700 2.65
$5.13-$8.50 648,100 7.51 8.5 years 245,926 7.50
--------- -------
Total 1,107,009 4.82 7.7 years 645,243 3.39
========= =======
In June 1996, November 1996, and December 1996, the Company
granted options to purchase 269,652, 8,573, and 60,715, respectively,
shares of common stock at exercise prices of $.70, $2.45, and $2.45 per
share, respectively. In connection with the issuance of these options,
the Company recognized $304,000 as deferred compensation for the excess
of the deemed value for accounting purposes of the common stock
issuable upon exercise of such options over the aggregate exercise
price of such options. This deferred compensation is amortized ratably
over the vesting period of the options.
-45-
46
The Company has elected to account for its stock-based
compensation plan under Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," however, the Company has
computed for pro forma disclosure purposes the value of all options
granted in each of the three years ended December 31, 1999 using the
Black-Scholes option pricing model as prescribed by SFAS No. 123,
"Accounting for Stock-Based Compensation," and using the following
weighted average assumptions used for grants in 1997, 1998, and 1999:
1997 1998 1999
------- ------- --------
Risk-free interest rate 5.86% 5.17% 5.09%
Expected dividend yield 0% 0% 0%
Expected lives 4 years 4 years 4 years
Expected volatility 58% 58% 58%
The total values of the options granted during the years ended December
31, 1997, 1998, and 1999 were computed as approximately $1,587,000,
$437,000, and $749,000, respectively, which would be amortized over the
vesting period of the options. If the Company had accounted for these
plans in accordance with SFAS No. 123, the Company's reported net loss
and net loss per share for each of the three years ended December 31,
1999 would have increased by the following pro forma amounts (in
thousands, except per share amounts):
1997 1998 1999
--------- --------- ---------
Net loss available to common shareholders:
As reported $ (5,726) $ (6,637) $ (6,552)
SFAS No. 123 Pro forma (5,890) (7,226) (7,315)
Basic and diluted net loss per share:
As reported $ (1.26) $ (.84) $ (.82)
SFAS No. 123 Pro forma (1.30) (.91) (.91)
WARRANTS
In connection with the November 1995 and April 1996 note sales
(Note 4), the Company issued warrants to purchase 317,613 shares of
common stock at an exercise price per share of 20% of the price per
share paid in the next equity financing of $5,000,000 or more,
inclusive of the notes and warrants subject to conversion. In August
1996, the exercise price was set at $1.12 per share.
Upon the close of the initial public offering, all outstanding
warrants to purchase 559,986 shares of common stock were exercised
providing proceeds of approximately $694,000.
EMPLOYEE STOCK PURCHASE PLAN
In connection with the offering, the Company adopted an
employee stock purchase plan under which the Company may issue up to
214,286 shares of common stock. Eligible employees may use up to 10% of
their compensation to purchase, through payroll deductions, the
Company's common stock at the end of each plan period for 85% of the
lower of the beginning or ending stock price in the plan period. At
December 31, 1999, there were 185,948 shares available for future
issuance under the Plan.
-46-
47
5. INCOME TAXES
The Company has incurred net operating losses ("NOLs") since
inception. As of December 31, 1999, the Company had net operating loss
carryforwards of approximately $24,357,000 available to offset its
future income tax liability. The NOL carryforwards begin to expire in
2007. The Company has recorded a valuation allowance for all NOL
carryforwards. Utilization of existing NOL carryforwards may be limited
in future years if significant ownership changes have occurred.
Components of deferred tax assets are as follows at December
31, 1998 and 1999 (in thousands):
1998 1999
------- -------
NOL carryforwards $ 6,852 $ 9,256
Valuation allowance (6,852) (9,256)
------- -------
Deferred tax assets $ 0 $ 0
======= =======
6. COMMITMENTS AND CONTINGENCIES
Future minimum rental payments at December 31, 1999 under
noncancellable operating leases for office space and equipment are as
follows (in thousands):
2000 $270
2001 249
2002 102
Rental expense was $215,000, $261,000, and $225,000 in 1997,
1998, and 1999, respectively.
In the past, the Company has been subject to certain asserted
and unasserted claims against certain intellectual property rights
owned and licensed by the Company. A successful claim against
intellectual property rights owned or licensed by the Company could
subject the Company to significant liabilities third parties, require
the Company to seek licenses from third parties, or prevent the Company
from selling its products in certain markets or at all. In the opinion
of management, there are no known claims against the Company's owned or
licensed intellectual property rights that will have a material adverse
impact on the Company's financial position or results of operations.
7. RELATED-PARTY TRANSACTIONS
In connection with a June 1994 sale of restricted stock, the
Company loaned two officers of the Company $48,000, of which $31,000 is
outstanding at December 31, 1999. These loans are secured by common
stock of the Company held by the officers, bear interest at 6% per
annum, and become payable on December 31, 2001. Outstanding balances
are classified as a reduction of stockholders' equity in the
accompanying balance sheets.
In October 1996, the Company loaned two officers a total of
$400,000. The loans are secured by common stock of Laser Atlanta
Optics, Inc. ("LAO"). The Company and LAO are related through a common
group of shareholders. The loans bear interest at 6.72% per annum and
are due and payable in cash in October 2001. Outstanding balances are
reflected as due from related parties in the accompanying balance
sheets.
-47-
48
In 1997, a portion of the proceeds from the Company's sale of
convertible subordinated promissory notes and Series A and B preferred
stock were received from officers, directors, or other parties related
to the Company as a result of previous equity transactions. The sales
were conducted concurrently with and on the same terms as those entered
into with unrelated parties.
8. LICENSE AND TECHNOLOGY AGREEMENTS
As part of the Company's efforts to conduct research and
development activities and to commercialize potential products, the
Company, from time to time, enters into agreements with certain
organizations and individuals that further those efforts but also
obligate the Company to make future minimum payments or to remit
royalties ranging from 1% to 3% of revenue from the sale of commercial
products developed from the research.
The Company generally has the option not to make required
minimum royalty payments, in which case the Company loses the exclusive
license to develop applicable technology. Minimum required payments to
maintain exclusive rights to licensed technology are as follows at
December 31, 1999 (in thousands):
2000 $ 858
2001 1,160
2002 1,410
2003 1,410
2004 1,410
During 1997, 1998, and 1999, the Company incurred royalty expenses of
$110,000, $188,000, and $423,000, respectively.
Additionally, the Company is obligated to obtain and maintain
certain patents, as defined by the agreements.
9. COLLABORATIVE AGREEMENTS
The Company has entered into collaborative research and
development agreements (the "Agreements") with collaborative partners
for the joint development, regulatory approval, manufacturing,
marketing, distribution, and sales of products. The Agreements
generally provide for nonrefundable payments upon contract signing and
additional payments upon reaching certain milestones with respect to
technology.
ABBOTT
The Abbott Agreement, as amended, requires Abbott to make
milestone payments based on progress achieved, to remit royalties to
the Company based on net product sales, and to reimburse certain direct
expenses incurred by the Company in connection with the development of
glucose monitoring products. Reimbursed expenses of $1,798,000,
$1,260,000, and $39,000 for the years ended December 31, 1997, 1998,
and 1999, respectively, have been netted with research and development
expenses in the accompanying statements of operations.
The Company recorded revenues of $500,000 during 1997 related
to the achievement of a milestone. Additionally, in 1997, Abbott
purchased $3,000,000 of Series C preferred stock and in November 1999,
subscribed to $5,250,000 of redeemable convertible preferred stock
(Note 4).
-48-
49
WELCH ALLYN
The Welch Allyn agreement requires Welch Allyn to share
equally the operating expenses and cost of capital assets, to make
milestone payments based on progress achieved, and to pay the Company a
technology access fee. Reimbursed expenses of $0, $250,000, and
$524,000 for the years ended December 31, 1997, 1998, and 1999,
respectively, have been netted with research and development expenses
in the accompanying statements of operations. Welch Allyn will have the
exclusive rights to manufacture and supply the cervical cancer
detection system product with the exception of a certain module. The
parties have agreed to enter into a joint venture for purposes of
carrying out the commercialization of the cervical product. The Company
recorded revenues of $0, $250,000, and $700,000 during 1997, 1998, and
1999, respectively, related to the achievement of certain milestones.
At December 31, 1999, a receivable from Welch Allyn
represented 74 % of accounts receivable. The balance due was paid in
January 2000.
ROCHE
The Roche agreement requires Roche to make milestone payments
based on progress achieved and to purchase diabetes screening products
manufactured by the Company at a predetermined profit margin, subject
to renegotiation between the parties in certain instances. During 1997,
1998, and 1999, the Company recorded $0, $0, and $987,000,
respectively, in revenues related to the achievement of certain
milestones.
In July 1999, the Company received $381,000 in advance
payments for inventory components with long lead times from Roche. The
balance is non interest bearing and is due January 2001.
RESPIRONICS
The Respironics agreement requires Respironics to make
milestone payments based on progress achieved and to purchase infant
jaundice products manufactured by the Company at a predetermined profit
margin, subject to renegotiation between the parties in certain
instances. The Company recorded revenues of $250,000, $275,000, and
$200,000 in 1997, 1998, and 1999, respectively, related to the
achievement of certain milestones. Additionally, Respironics purchased
products amounting to $0, $191,000, and $364,000 during 1997, 1998, and
1999, respectively, from the Company.
10. BUSINESS SEGMENT INFORMATION
The Company operates in one business segment, the research and
development of products that offer less invasive and painless
alternatives to blood tests currently used for glucose monitoring,
diabetes screening, cervical cancer detection, and infant jaundice. The
Company had no product sales prior to fiscal year 1998. During fiscal
years 1998 and 1999, total product revenues of $823,000 and $1,440,000,
respectively, related to the Company's infant jaundice product. The
Company has licensed the right to distribute the infant jaundice
product within the United States and Canada to Respironics. The Company
distributes the product outside the United States and Canada through a
diverse group of foreign distributors. All sales are payable in United
States dollars. Product revenues attributable to countries based on the
location of the customer are as follows (in thousands):
-49-
50
1997 1998 1999
------ ------ ------
Europe $ 0 $ 480 $ 566
United States and Canada 0 191 364
Mexico 0 4 209
Middle East 0 64 154
Far East 0 39 81
Other 0 45 66
------ ------ ------
Total $ 0 $ 823 $1,440
====== ====== ======
Because all product revenues are derived from the sale of U.S.-produced
product, the Company has no significant long-lived assets located
outside the United States.
11. SUBSEQUENT EVENT
On February 23, 2000, the Company completed a private
placement of 400,000 shares of common stock. The shares were sold for
$12.50 per share resulting in gross proceeds of $5,000,000.
-50-
51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
-51-
52
PART III
Certain information required by Part III is omitted from this Report on
Form 10-K in that the Registrant will file a definitive proxy statement within
120 days after the end of the fiscal year covered by this Report pursuant to
Regulation 14A relating to the Registrant's 2000 Annual Meeting of Stockholders
(the "Proxy Statement") to be held on May 25, 2000, and certain information
included therein is incorporated herein by reference.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information regarding directors and nominees for directors of the
Company is incorporated by reference to the Company's Proxy Statement.
The executive officers of the Company, who are elected by and serve at
the discretion of the Board of Directors, and their ages at February 28, 2000,
are as follows:
NAME AGE POSITION
Mark A. Samuels 42 Chairman, Chief Executive Officer and Director
Keith D. Ignotz 52 President, Chief Operating Officer and Director
Thomas H. Muller, Jr. 58 Executive Vice President, Chief Financial Officer and Secretary
Mark L. Faupel 44 Vice President, Research & Development
Richard L. Fowler 43 Vice President, Engineering
Robert G. Rothfritz 50 Vice President, Operations
Except as set forth below, all of the executive officers have been
associated with the Company in their present or other capacities for more than
the past five years. Officers are elected annually by the Board of Directors and
serve at the discretion of the Board. There are no family relationships among
executive officers of the Company.
Mark A. Samuels has served as a member of the Company's Board of
Directors and Chief Executive Officer since co-founding the Company in
1992. Prior to that time, Mr. Samuels was a founder of Laser Atlanta Optics,
Inc., an optical sensor company, where he held the position of President and
Chief Executive Officer until 1992, and was a director until October 1996. While
at Laser Atlanta Optics, Mr. Samuels focused on the development of commercial
and medical applications of electro-optics. Mr. Samuels earned a B.S. in Physics
and an M.S. (Electrical Engineering) from Georgia Institute of Technology.
Keith D. Ignotz has served as a member of the Company's Board of
Directors and Chief Operating Officer since co-founding the Company in 1992.
Formerly, Mr. Ignotz was President of Humphrey Instruments SmithKline Beckman
(Japan), President of Humphrey Instruments GmbH (Germany), and Senior Vice
President of Allergan Humphrey Inc., a $100 million per year ophthalmic
diagnostic company. Mr. Ignotz is a member of the board of directors of Vismed,
Inc. (Dicon), an ophthalmic diagnostic products company, and Pennsylvania
College of Optometry. Mr. Ignotz earned a B.A. in Sociology from San Jose State
University and an M.B.A. from Pepperdine University.
Thomas H. Muller, Jr. has served as the Company's Chief Financial
Officer since joining the Company in December 1996. Prior to that time, Mr.
Muller was President of Muller & Associates, an operational and financial
management services company and Chief Financial Officer of Nurse On Call, Inc.
From 1984 to 1992, Mr. Muller was Chief Financial Officer of HBO & Company, a
provider of information systems and services to the health care industry. Mr.
Muller is a member of the board of directors of NetB@nk, Inc., an internet
banking company. Mr. Muller earned a B.I.E. in Industrial Engineering from
Georgia Institute of Technology and an M.B.A. from Harvard Business School.
-52-
53
Mark L. Faupel, Ph.D. has served as the Company's Vice President of Research and
Development since August 1998. Dr. Faupel joined the Company on February 2, 1998
in the capacity of Vice President, New Product Development. Prior to that time,
Dr. Faupel was an independent consultant to the Company and other firms in
cancer research. From 1987-1997, Dr. Faupel held various positions with Biofield
Corporation, a medical device company in the area of breast cancer detection, a
firm which he co-founded and served as Vice President, Director of Science and
Vice President, Research and Development.
Richard L. Fowler has served as the Company's Vice President of
Engineering since joining the Company in February 1996. Prior to that time, Mr.
Fowler worked for Laser Atlanta Optics, Inc., where he held the positions of
President and Chief Executive Officer from August 1994 to February 1996. As Vice
President of Engineering for Laser Atlanta Optics from 1992 to 1994, Mr. Fowler
managed the development of three laser sensor products. Mr. Fowler earned a B.S.
in Electrical Engineering from University of Texas.
Robert G. Rothfritz, has served as the Company's Vice President of
Operations since joining the Company in July 1996. From 1994 to 1996, Mr.
Rothfritz was Director of Manufacturing for Atlantic Envelope Company, a
National Service Industries, Inc. division, and from 1993 to 1994, he was a
Senior Manager, Manufacturing Systems Leader for Ethicon EndoSurgery, a Johnson
& Johnson division. From 1988 to 1992, Mr. Rothfritz was Vice President,
Operations for the Oral Care Division of Bausch & Lomb, Inc. Mr. Rothfritz
earned a B.S. in Mechanical Engineering from Georgia Institute of Technology.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to
the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to
the Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to
the Company's Proxy Statement.
-53-
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(A) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS
2. FINANCIAL STATEMENT SCHEDULE.
Schedules are not included in this Annual Report on Form 10-K,
as they are not required or the information required to be set
forth therein is included in the Consolidated Financial
Statements on Notes thereto.
3. EXHIBITS
Refer to (c) below.
(B) REPORTS ON FORM 8-K
The Company was not required to and did not file any Current
Reports on Form 8-K during the quarter ended December 31,
1998.
(C) EXHIBITS
The exhibits listed on the accompanying Index to Exhibits are
filed as part hereof, or incorporated by reference into, this
Report.
-54-
55
EXHIBIT INDEX
EXHIBIT DESCRIPTION
NO. -------------------------------------------------------------------------------------------------
- ------------
3.1 (2) Certificate of Incorporation of the Company, as amended, as
currently in effect.
3.2 (1) Bylaws of the Company.
4.1 (1) Specimen Common Stock Certificate.
10.1 (1) 1997 Employee Stock Purchase Plan and form of agreement
thereunder.
10.2 (1) 1995 Stock Plan, as amended, and form of Stock Option Agreement
thereunder.
10.3 (1) Stock Purchase Agreement, dated June 30, 1994, between Mark A.
Samuels and the Company.
10.4 (1) Stock Purchase Agreement, dated June 30, 1994, between Keith D.
Ignotz and the Company.
10.5 (1) Assignment and Bill of Sale, dated February 29, 1996, between
Laser Atlanta Optics, Inc. and the Company.
10.6 (1) Security Agreement, dated October 31, 1996, between Mark A. Samuels
and the Company.
10.7 (1) Security Agreement, dated October 31, 1996, between Keith D. Ignotz
and the Company.
10.11A (1)* License Agreement, dated May 7, 1991, between Georgia Tech Research
Corporation and Laser Atlanta Optics, Inc.
10.11B (1) Agreement for Purchase and Sale of Technology, Sale, dated
January 16, 1993, between Laser Atlanta Optics, Inc. and the
Company.
10.11C (1) First Amendment to License Agreement, dated October 19,
1993, between Georgia Tech Research Corporation and the
Company.
10.12 (1) Clinical Research Study Agreement, dated July 22, 1993, between
Emory University and the Company.
10.13A (1)* Development and License Agreement, dated December 2, 1994,
between Boehringer Mannheim Corporation and the Company.
10.13B (1)* Supply Agreement, dated January 5, 1996, between Boehringer
Mannheim and the Company.
10.14 (1) Sponsored Research Agreement, No. SR95-006, dated May 3, 1995,
between University of Texas, M.D. Anderson Cancer Center and the
Company.
10.15 (1) Sole Commercial Patent License Agreement, dated May 4, 1995,
between Martin Marietta Energy Systems, Inc. and the Company.
10.16A (1) License Agreement, dated November 22, 1995, between Joseph R.
Lakowicz, Ph.D. and the Company.
10.16B (1) Amendment of License Agreement, dated November 28, 1995, between
Joseph R. Lakowicz, Ph.D. and the Company.
10.16C (1) Second Amendment to License Agreement, dated March 26, 1997,
between Joseph R. Lakowicz, Ph.D. and the Company.
10.16D (4) Third Amendment to License Agreement, dated November 20, 1998,
between Joseph R. Lakowicz, Ph.D. and the Company.
10.16E (4)** Fourth Amendment to License Agreement, dated November 20, 1998,
between Joseph R. Lakowicz, Ph.D. and the Company.
10.17 (1) License and Joint Development Agreement, dated March 1, 1996,
between NonInvasive-Monitoring Company, Inc., Altea Technologies,
Inc. and the Company.
10.18 (1)* Patent License Agreement, dated March 12, 1996, between the
Board of Regents of the University of Texas System, M.D. Anderson
and the Company.
10.19A (1)* Purchasing and Licensing Agreement, dated June 19, 1996, between
Respironics and the Company.
10.19B** Amendment to Purchasing and Licensing Agreement, dated October
21, 1998 between Respironics and the Company.
10.20 (1) Research Services Agreement, dated September 3, 1996,
between Sisters of Providence in Oregon doing business as the
Oregon Medical Laser Center, Providence St. Vincent Medical
Center and the Company.
10.21A (1)* Research and Development and License Agreement, dated
October 10, 1996, between Abbott Laboratories and the Company.
10.21B(3)* Letter Agreement, dated December 22, 1997, between Abbott
Laboratories and the Company.
56
EXHIBIT DESCRIPTION
NO. -------------------------------------------------------------------------------------------------
- ------------
10.21C** Third Amendment to Research and Development and License
Agreement, dated November 30, 1999 between Abbott Laboratories
and the Company
10.22A (1) Lease, dated September 21, 1993, between National Life Insurance
Company d/b/a Plaza 85 Business Park and the Company, together with
amendments 1, 2 and 3 thereto and Tenant Estoppel Certificate,
dated September 20, 1994.
10.24 (4)** Development and Commercialization Agreement, dated December 31, 1998,
between Welch Allyn, Inc. and the Company.
10.25A**(5) Development and License Agreement, dated July 13, 1999, between
Roche Diagnostics Corporation and the Company.
10.25B**(5) Supply Agreement, dated July 13, 1999, between Roche Diagnostics
Corporation and the Company.
11.1 Calculation of earnings per share.
21.1 Subsidiaries of the Registrant.
23.1 Consent of independent accountants.
24.1 Power of Attorney (included at signature page.)
27.1 Financial Data Schedule.
- -------------------
* Confidential treatment granted for portions of these agreements.
** Confidential treatment requested for portions of this agreement.
(1) Incorporated by reference to the exhibit filed with the Registrant's
Registration Statement on Form S-1 (No. 333-22429) filed February 27,
1997, and amended on April 24, 1997, June 11, 1997, and June 30, 1997,
which Registration Statement became effective June 30, 1997.
(2) Incorporated by reference to the exhibit filed with the Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1997 filed
August 12, 1997.
(3) Incorporated by reference to the exhibit filed with the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997, filed
March 26, 1998.
(4) Incorporated by reference to the exhibit filed with the Registrant's
Annual Report on Form 10K for the year ended December 31, 1998, filed
March 30, 1999.
(5) Incorporated by reference to the exhibit filed with the Registrant's
Annual Report on Form 10-Q for the quarter ended June 30, 1999 filed
August 13, 1999.
57
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Norcross, State of Georgia, on the 30th day of March 2000.
SPECTRX, INC.
By: /s/ MARK A. SAMUELS
---------------------------------------
Mark A. Samuels
Chairman and Chief Executive Officer
KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose
signature appears below constitutes and appoints Mark A. Samuels and Thomas H.
Muller, Jr., jointly and severally, his or her attorneys-in-fact, and each with
the power of substitution, for him or her in any and all capacities, to sign any
amendments to this Annual Report on Form 10-K, and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his or her substitute or substitutes, may do
or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
----------------------------------------------- -----------------------
/s/ MARK A. SAMUELS Chairman, Chief Executive Officer and Director March 30, 2000
- ---------------------------------------
(Principal Executive Officer)
Mark A. Samuels
/s/ THOMAS H. MULLER, JR. Executive Vice President and Chief Financial March 30, 2000
- ---------------------------------------
Officer (Principal Financial and Accounting
Thomas H. Muller, Jr. Officer)
/s/ KEITH D. IGNOTZ President, Chief Operating Officer and Director March 30, 2000
- ---------------------------------------
Keith D. Ignotz
/s/ CHARLES G. HADLEY Director March 30, 2000
- ---------------------------------------
Charles G. Hadley
/s/ EARL R. LEWIS Director March 30, 2000
- ---------------------------------------
Earl R. Lewis
/s/ WILLIAM E. ZACHARY Director March 30, 2000
- ---------------------------------------
William E. Zachary