UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
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 NUMBER)
6025A UNITY DRIVE
NORCROSS, GEORGIA 30071
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(770) 242-8723
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such requirements for
the past 90 days.
YES [X] NO [ ]
The number of issued and outstanding shares of the Registrant's Common Stock,
$0.001 par value, as of April 30, 2002, was 11,195,251.
THIS FILING INCLUDES UNAUDITED FINANCIAL STATEMENTS THAT HAVE NOT BEEN REVIEWED
IN ACCORDANCE WITH RULE 10-01(d) OF REGULATION S-X PROMULGATED BY THE
SECURITIES AND EXCHANGE COMMISSION, BECAUSE WE WERE UNABLE TO OBTAIN SUCH A
REVIEW FROM OUR CURRENT AUDITOR, ARTHUR ANDERSEN. SEE "INFORMATION WITH RESPECT
TO FINANCIAL STATEMENTS" IN THIS FILING FOR MORE INFORMATION.
SPECTRX, INC.
INDEX
PART I. FINANCIAL INFORMATION ....................................... 3
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
CONSOLIDATED BALANCE SHEETS -
DECEMBER 31, 2001 AND MARCH 31, 2002 ......... 4
CONSOLIDATED STATEMENTS OF OPERATIONS -
THREE MONTHS ENDED MARCH 31, 2001 AND 2002 ... 5
CONSOLIDATED STATEMENTS OF CASH FLOWS -
THREE MONTHS ENDED MARCH 31, 2001 AND 2002 ... 6
NOTES TO FINANCIAL STATEMENTS .......................... 7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS ............................. 11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 27
PART II. OTHER INFORMATION ........................................... 28
ITEM 1. LEGAL PROCEEDINGS ................................... 28
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K .................... 28
SIGNATURES ........................................................... 29
PART 1. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INFORMATION WITH RESPECT TO FINANCIAL STATEMENTS
Arthur Andersen LLP audited our accounts for fiscal 2001. As previously
reported, in light of recent business and legal developments affecting the firm,
we have not formally selected an independent accountant for fiscal 2002. The
audit committee continues to monitor developments at Arthur Andersen and will
make a recommendation to the board of directors as to the firm that will be
engaged to audit our accounts for fiscal 2002 after further evaluation.
Arthur Andersen advised us orally that it would not be able to perform
its review of our interim financial statements contained in this quarterly
report on Form 10-Q, as it would not be able to provide reasonable assurance
that there was appropriate continuity of Arthur Andersen personnel to perform
the review. In accordance with Release No. 34-45589 under the Securities
Exchange Act of 1934, our interim financial statements contained in this
quarterly report on Form 10-Q have not been reviewed by an independent public
accountant pursuant to Rule 10-01 of Regulation S-X. The interim financial
statements will be reviewed by our accountants for fiscal 2002 after they are
selected. If in the opinion of the accountants any changes to the interim
financial statements are required, we will file an amended report on Form 10-Q
in accordance with the release.
SPECTRX, INC.
UNAUDITED CONSOLIDATED BALANCE SHEETS
DECEMBER 31, MARCH 31,
2001 2002
(UNAUDITED)
----------- -----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 9,458 $ 5,769
Accounts receivable 1,229 869
Inventory 437 482
Other current assets 408 1,117
-------- --------
Total Current Assets 11,532 8,237
-------- --------
NON-CURRENT ASSETS
Property & Equipment, Net 513 461
Intangibles 5,723 5,670
Due from related parties 557 564
-------- --------
Total Non-Current Assets 6,793 6,695
-------- --------
TOTAL ASSETS $ 18,325 $ 14,932
======== ========
LIABILITIES & STOCKHOLDER'S EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,018 $ 602
Accrued liabilities 1,194 552
-------- --------
Total Current Liabilities 2,212 1,154
-------- --------
DEFERRED TAX LIABILITY 1,591 1,591
-------- --------
COLLABORATIVE PARTNER ADVANCE 381 381
-------- --------
REDEEMABLE CONVERTIBLE PREFERRED STOCK 4,769 4,833
-------- --------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Preferred stock 1,125 1,140
Common stock 11 11
Additional paid-in-capital 47,604 47,633
Treasury stock (38) (38)
Deferred compensation (19) (13)
Accumulated deficit (39,280) (41,729)
Notes receivable from officers (31) (31)
-------- --------
Total Stockholders' Equity 9,372 6,973
-------- --------
TOTAL LIABILITIES & EQUITY $ 18,325 $ 14,932
======== ========
The accompanying notes are an integral part of the financial statements.
SPECTRX, INC.
UNAUDITED CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS
ENDED MARCH 31
2001 2002
---- ----
REVENUE
Product sales $ 521 $ 552
Collaborative agreements 100 100
------- --------
TOTAL 621 652
------- --------
EXPENSES
Cost of sales 501 424
Research & development 1,572 1,453
Sales & marketing 177 305
General & administrative 717 876
------- --------
Total 2,967 3,058
------- --------
Operating loss (2,346) (2,406)
OTHER INCOME 0 0
INTEREST INCOME 36 36
------- --------
NET LOSS (2,310) (2,370)
PREFERRED STOCK DIVIDENDS (79) (79)
------- --------
Loss available to common stockholders ($2,389) ($ 2,449)
======= ========
NET (LOSS) PER SHARE
BASIC ($ 0.28) ($ 0.22)
======= ========
DILUTED ($ 0.28) ($ 0.22)
======= ========
WEIGHTED AVERAGE
COMMON SHARES OUTSTANDING
BASIC 8,512 11,202
======= ========
DILUTED 8,512 11,202
======= ========
The accompanying notes are an integral part of the financial statements.
SPECTRX, INC.
UNAUDITED CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS
ENDED
MARCH 31,
2001 2002
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,310) $(2,370)
------- -------
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 95 118
Amortization of deferred compensation 0 6
Changes in assets and liabilities:
Accounts receivable 510 360
Inventory (62) (45)
Other current assets 136 (761)
Accounts payable (197) (416)
Accrued liabilities (220) (642)
------- -------
Total adjustments 262 (1,328)
------- -------
Net cash used in operating activities (2,048) (3,705)
------- -------
CASH FLOW FROM INVESTING ACTIVITIES:
Additions to property and equipment (47) (13)
------- -------
Net cash used in investing activities (47) (13)
------- -------
CASH FLOW FROM FINANCING ACTIVITIES:
Issuance of common stock (net of issuance costs) 78 29
Issuance of redeemable convertible preferred stock 0 0
------- -------
Net cash provided by financing activities 78 29
------- -------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS (2,017) (3,689)
CASH AND CASH EQUIVALENTS, beginning of period 3,609 9,458
------- -------
CASH AND CASH EQUIVALENTS, end of period $ 1,592 $ 5,769
======= =======
The accompanying notes are an integral part of the financial statements.
SPECTRX, INC.
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
1. BASIS OF PRESENTATION
The unaudited interim financial statements included herein have been
prepared by SpectRx. These statements reflect all adjustments, all of which are
of a normal, recurring nature, and which are, in the opinion of management,
necessary to present fairly the financial position as of March 31, 2002, the
results of operations for the three months ended March 31, 2001 and 2002, and
the cash flows for the three months ended March 31, 2001 and 2002. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted in the
United States have been condensed or omitted. Preparing financial statements
requires our management to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses. Actual results
could differ from those estimates. Our accounting policies continue unchanged
from December 31, 2001. These financial statements should be read in conjunction
with the financial statements and notes thereto included in our Annual Report on
Form 10-K for the year ended December 31, 2001.
The results of operations for the three months ended March 31, 2001 and
2002 are not necessarily indicative of the results for a full fiscal year.
2. FLUORRX
In December 1996, we sublicensed certain technology to and acquired a
64.8% interest in FluorRx, Inc., a corporation organized for the purpose of
developing and commercializing technology related to fluorescence spectroscopy.
Our interest in FluorRx is represented by two seats on the board of directors
and 129,000 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 our ownership (on an as converted basis) to 43%. Effective with the
August 1998 funding, we began accounting for our investment in FluorRx under the
equity method of accounting. In connection therewith, we began suspending the
equity losses from our investment in FluorRx. The accompanying statement of
operations for the three months ended March 31, 2002 excludes $20,521 in
income, which represents our 43% equity in the income of FluorRx. Cumulative
suspended equity losses as of March 31, 2002 amounted to $1,385,362.
3. STERLING MEDIVATIONS
On December 31, 2001, we purchased the outstanding shares of Sterling
Medivations, Inc. Sterling Medivations is a developer of innovative insulin
delivery products for people with diabetes. The acquisition of Sterling
Medivations expands our diabetes business by adding a portfolio of FDA-cleared
insulin delivery products,
including consumables for the rapidly growing insulin pump market. As a result
of the merger, we issued 548,056 shares of Company common stock in exchange for
all of the outstanding Sterling common stock and preferred stock and reserved
22,086 shares for issuance upon exercise of stock options assumed in the merger
with an estimated fair market value of $62,159, plus 63,337 shares related to
cash balances following the merger. Sterling stockholders and option holders
will also be entitled to up to an aggregate of 1,234,567 additional shares of
Company common stock in the future if the Sterling Medivations product line
achieves specified financial goals. In connection with the acquisition of
Sterling Medivations, we entered into employment agreements with four employees
for terms expiring June 2003. The excess of the cost over the estimated fair
value of net tangible assets acquired amounts to approximately $4.1 million and
has been included in intangibles in the accompanying consolidated balance
sheets. The $4.1 million purchase price excess has been allocated between
patents and non-compete agreements. In addition, goodwill and a related deferred
tax liability of approximately $1.6 million have been recorded to reflect
taxable temporary differences existing at December 31, 2001. The acquisition has
been accounted for as a purchase in accordance with SFAS No. 141, "Accounting
for Business Combinations."
4. COMPREHENSIVE INCOME
We currently have no other comprehensive income items as defined by
Statement of Financial Accounting Standards ("SFAS") No. 130.
5. RECENT ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board ("FASB") issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," in June 1998,
SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FASB Statement No. 133," in June 1999 and SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FASB Statement No. 133," in June 2000. SFAS No. 133
establishes accounting and reporting standards for derivatives and hedges. It
requires that all derivatives be recognized as other assets or liabilities at
fair value and established specific criteria for the use of hedge accounting.
SFAS No. 138 amends accounting and reporting standards for SFAS No. 133 for
certain derivative instruments and certain hedging activities. We adopted these
statements with no material impact to our results of operations or financial
position as we do not have any material derivative instruments.
The FASB issued SFAS No. 141, "Accounting for Business Combinations,"
on June 30, 2001. It requires that all business combinations initiated after
June 30, 2001 be accounted for using the purchase method of accounting, when
adopted.
The FASB issued SFAS No. 142, "Accounting for Goodwill and Other
Intangible Assets," on June 30, 2001. It provides that goodwill and certain
intangible assets will no longer be subject to amortization, but instead will be
subject to a periodic impairment assessment by applying a fair-value based test.
We adopted SFAS No. 142 on January 1, 2002, which did not have a material impact
on our results of operations or financial position.
6. LITIGATION
We are involved in certain litigation arising in the ordinary course of
business. In management's opinion, the ultimate resolution of these matters will
not have a material adverse effect on our financial position or results of
operations. See Part II, Item 1, "Legal Proceedings," for disclosure of
significant litigation matters.
7. STOCKHOLDERS' EQUITY
In June 2001, we announced that we had completed two private
placements. On June 4, 2001, we entered into an agreement with affiliates of
SAFECO Corporation, which invested about $9.5 million in SpectRx before
transaction expenses. On June 13, 2001, we entered into an agreement with
affiliates of Special Situations Fund, which invested about $2.5 million in
SpectRx before transaction expenses. The financings consisted, in total, of
sales of about 1.9 million shares of common stock and warrants to purchase
379,127 shares of common stock. Under the terms of the agreements, each share of
common stock was sold at a price of $6.319 per share, which represented a
discount from the market price of our common stock on the dates these
transactions closed. The first transaction, funded on June 4, 2001, involved the
private placement of 1.5 million shares of common stock. The second transaction,
funded on June 13, 2001, involved the private placement of 395,633 shares of
common stock. The combination of these two transactions resulted in proceeds to
SpectRx of about $12 million before transaction expenses. The 1,895,633 shares
issued in these transactions constituted 22.2% of our common stock outstanding
prior to the first private placement transaction. In addition, the purchasers of
common stock also received warrants to purchase an aggregate of 379,127 shares
of common stock for $9.8874 per share. These warrants expire on the fifth
anniversary of their issuance date. The warrants are valued at $1.7 million and
are included in additional paid-in capital in the accompanying balance sheet. On
August 30, 2001, the common stockholders of SpectRx, excluding the shares held
by SAFECO and Special Situations Fund, approved these transactions.
In October 2001, Abbott invested an additional $1 million in SpectRx
common stock, acquiring 126,199 shares at $7.92 per share, which is subject to
SpectRx maintaining certain rights to sublicense technology to Abbott. The
purchase was associated with a milestone under a program to commercialize our
continuous glucose monitoring technology for people with diabetes. The purchase
raised Abbott's common stock ownership in SpectRx and is approximately 5.9%, as
of March 31, 2002.
On September 19, 2001, we announced that our board of directors had
approved a stock repurchase program for up to $1 million of our common stock. As
of March 31, 2002, we had purchased 6,700 shares of common stock at an average
price of $5.66 per share.
8. 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. We issued $5.25
million of redeemable convertible preferred stock in November 1999 in
conjunction with the execution of an amendment to our agreement with Abbott, of
which $2,750,000 was received in November 1999 and $2,500,000 was received in
January 2000.
In September 2001, we entered into an agreement with Abbott whereby
Abbott waived its right to redeem 100,000 shares of its redeemable convertible
preferred stock plus the related accrued dividends. Dividends are accrued on the
redeemable convertible preferred stock at a rate of 6% per year and total
$63,750 for the first quarter of 2002, and $582,500 since issuance. The related
dividends are included in redeemable convertible preferred stock in the
accompanying balance sheets. The preferred shares, together with any accrued but
unpaid dividends, are convertible into shares of common stock at a conversion
rate equal to the greater of $9.39 per share or the average of the closing sales
price for 30 trading days that begin on the 15th trading day prior to our
receipt of a conversion notice sent by the holder of such shares. Also, the
shares of preferred stock automatically convert into shares of common stock on
December 31, 2004 at such conversion rate. The shares of preferred stock are
mandatorily redeemable, except with respect to 100,000 shares, by us at $10 per
share, plus accrued but unpaid dividends, beginning on December 31, 2002, if we
receive a written notice from the holders of at least a majority of the shares
of preferred stock on or before the later of September 30, 2002 or 60 days
subsequent to the date that we give notice to the holders of preferred stock of
our right to redeem the shares (which notice may not be given prior to June 1,
2002). If this written election to be mandatorily redeemed is made, one-half
less 100,000 shares of the shares of preferred stock are to be mandatorily
redeemed on December 31, 2002, and the remaining one-half on or prior to January
31, 2004, if we achieve a revenue goal of $20 million during the year 2003. If
we do not achieve this goal, then of such shares of preferred stock outstanding,
one-half must be redeemed prior to January 31, 2004, and the balance by December
31, 2004. Additionally, we have the option to redeem the shares of any holder
of the redeemable convertible preferred stock at $10 per share, plus accrued
and unpaid dividends, after receiving a notice from such holder electing to
convert such holder's shares of preferred stock into common stock. The
preferred stock also has a liquidation of $10 per share, plus all accrued but
unpaid dividends.
Dividends are accrued on the non-redeemable preferred stock at a rate
of 6% per year and total $15,000 for the first quarter of 2002, and $140,000
since issuance. The related dividends are included in preferred stock in the
accompanying balance sheets.
ITEM 2. 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 facts 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 these uncertainties and risks include, but are not limited to:
- whether our products in development will prove safe and
effective;
- whether and when we or our strategic partners will obtain
approval from the Food and Drug Administration, or FDA, and
corresponding foreign agencies;
- our need to achieve manufacturing scale-up in a timely manner,
and our need to provide for the efficient manufacturing of
sufficient quantities of our products;
- the lack of immediate alternate sources of supply for some
critical components of our products;
- our patent and intellectual property position;
- the need to fully develop the marketing, distribution,
customer service and technical support and other functions
critical to the success of our potential product lines;
- the effectiveness and ultimate market acceptance of our
products;
- access to sufficient debt or equity capital to meet our
operating and financial needs;
- the dependence on our strategic partners for funding,
development assistance, clinical trials, distribution and
marketing of products developed by us; and
- other risks and uncertainties described from time to time in
our reports filed with the Securities and Exchange Commission,
including those contained in our Annual Report on Form 10-K
for the year ended December 31, 2001.
The following discussion should be read in conjunction with our
financial statements and notes thereto included elsewhere in this report.
OVERVIEW
We were incorporated on October 27, 1992, and since that date we raised
capital through the sale of preferred stock, issuance of debt securities, public
and private sales of common stock and funding from collaborative arrangements.
Following our initial funding in early 1993, we immediately began research and
development activities with the objective of commercializing less invasive
diagnostic, screening and monitoring products. As part of our business strategy,
we have established arrangements with leading medical device companies for the
development, commercialization and introduction of some of our products. We have
entered into collaborative arrangements with Abbott Laboratories, Respironics,
Inc., Welch Allyn, Inc., and Roche Diagnostics BMC to develop and commercialize
many of our products. We may seek to establish strategic relationships with
other leading companies for the development, commercialization, and introduction
of additional products, if it is the best path to commercialization for those
products.
In December 1996, we sublicensed specified 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, 2001, as a result of subsequent financings, our
interest in FluorRx was 43%. In December 2001, we acquired 100% of the common
stock of Sterling Medivations, Inc., a company formed for the purpose of
developing and marketing insulin-delivery products.
We have a limited operating history upon which our prospects can be
evaluated. Our prospects must be considered in light of the substantial risks,
expenses and difficulties encountered by entrants into the medical device
industry. This industry is characterized by an increasing number of
participants, intense competition and a high failure rate. We have experienced
operating losses since our inception, and, as of March 31, 2002, we have an
accumulated deficit of about $41.7 million. To date, we have engaged primarily
in research and development efforts. We first generated revenues from product
sales in 1998, but do not have significant experience in manufacturing,
marketing or selling our products. Our development efforts may not result in
commercially viable products, and we may not be successful in introducing our
products. Moreover, required regulatory clearances or approvals may not be
obtained in a timely manner, or at all. Our products may not ever gain market
acceptance, and we may not ever generate significant revenues or achieve
profitability. The development and commercialization of our products will
require substantial development, regulatory, sales and marketing, manufacturing
and other expenditures. We expect our operating losses to continue through at
least 2002 as we continue to expend substantial resources to introduce our
Simple Choice(TM) product line, complete development of our products, obtain
regulatory clearances or approvals, build our marketing, sales, manufacturing
and finance organizations and conduct further research and development.
We expect that most of our near term revenues will come from our sales
of our new diabetes product line that Sterling Medivations brought us. In
addition, we expect to receive revenues that will be derived from royalties and
manufacturing profits that we will receive from Abbott and Respironics resulting
from sales of the products for which we have collaborative arrangements with
each of these companies. The royalties and manufacturing profits that we expect
to receive from each of our collaborative partners depend on sales of these
products. We and our collaborative partners may not be able to sell sufficient
volumes of our products to generate substantial revenues or profits for us.
We have entered into collaborative arrangements with Respironics, Welch
Allyn, Abbott and Roche. The agreements evidencing these collaborative
arrangements grant a substantial amount of discretion to each collaborative
partner. If one or more of our collaborative partners were to terminate their
arrangement with us, we would either need to reach agreement with a replacement
collaborative partner or undertake, at our own expense, the activities
previously handled by our collaborative partner. This would require us to
develop expertise we do not currently possess, would significantly increase our
capital requirements and would limit the programs we could pursue. We would
likely encounter significant delays in introducing our products, and the
development, manufacture and sales of our products would be adversely affected
by the absence of collaborative arrangements.
CRITICAL ACCOUNTING POLICIES
In accordance with recent Securities and Exchange Commission guidance,
those material accounting policies that we believe are the most critical to an
investor's understanding of our financial results and condition have been
expanded and are discussed below. Because we are still early in our enterprise
development, the number of these policies requiring explanation are limited. As
we begin to generate increased revenue from different sources, we expect that
the number of applicable policies and complexity of the judgments required will
increase.
Currently our policies that could require critical management judgment
are in the areas of revenue recognition, reserves for accounts receivable,
accruals of product warranties and inventory evaluation.
- Revenue recognition: We recognize revenue from sales of
products or services upon shipment of products or services. We
also recognize milestone revenue from our collaborative
partners when a milestone has been accomplished or when we and
our partner agree that a milestone is due.
- Reserve for Accounts Receivable: We estimate losses from the
inability of our customers or subsidiaries to make required
payments and periodically review the payment history of each
of our customers or subsidiaries, as well as their financial
condition, and revise our reserves as a result.
- Accruals of Product Warranties: We book a cost for warranty
work on each of our products at the time of sale and match
actual warranty work against that accrual, as the work is
performed. We periodically review the level of warranty
accrual and the actual warranty work incurred and adjust these
as needed.
- Inventory Valuation: Inventories are valued at the lower of
cost or market value and have been reduced by an allowance for
excess and obsolete inventories.
QUARTER OVERVIEW
On January 2, 2002, we announced the acquisition of Sterling
Medivations, a privately held developer of innovative insulin delivery products
for people with diabetes. The acquisition provides us with a portfolio of
FDA-cleared insulin delivery products, including consumables for the insulin
pump market. We plan to introduce the first of these products, insulin pump
infusion sets trademarked SimpleChoice, into market in the third quarter of
2002.
On February 1, 2002, we announced that we had reached an out of court
settlement with Molecular Diagnostics, Inc. regarding intellectual property
litigation. Under the settlement, we agreed to make a lump sum cash payment to
Molecular Diagnostics and Molecular Diagnostics granted us an option to license
specific technology. Under the settlement, neither party admitted any liability
or wrongdoing.
On February 4, 2002, we announced that we received FDA clearance to
market a new minimally invasive insulin infusion patch set for use with insulin
pumps. We expect to introduce our new insulin patch infusion set to the market
in 2003. Insulin infusion sets, when attached to external pumps, provide a
steady stream of insulin for people with diabetes, helping them to better
control their disease. The disposable infusion sets are changed about every
three days. This is a growing market, with about 160,000 people with diabetes
using insulin pumps in the U.S. in 2001. That number is expected to increase to
about 225,000 in 2002. Our patch infusion set, designed for use with all major
brands of insulin pumps, delivers insulin through five microneedles that are
less than half the length of ordinary insulin pump infusion needles. The reduced
penetration is designed to improve comfort and wearability.
On April 15, 2002, we announced that data from a developmental clinical
study, funded in part by the National Cancer Institute, show that our
non-invasive cervical cancer detection prototypes detect 17% more high-grade
precancer than thin-layer Pap tests and 28% more than traditional Pap tests.
Analysis of results from the first 71 patients of a study of 250 women also
showed that the point-of-care test had the ability to indicate the location of
diseased tissue on the cervix of women for all ages studied. Also, the initial
results of the developmental clinical study showed that our prototypes produced
a sensitivity of 93% and specificity of 80% versus a sensitivity of 76% and
specificity of 80% for the thin-layer Pap test when compared to colposcopy and
histopathology. Sensitivity is the ability to correctly identify disease and
specificity is the ability to correctly identify the absence of disease. Of the
71 patients on whom our prototypes have been tested, so far in the study, 12 had
high-grade precancer, 13 had low-grade precancer, 13 had other diseases or scar
tissue and 33 were considered normal. As a result of the encouraging data from
the on-going clinical studies and a positive meeting with the FDA regarding a
path to regulatory filing, we announced that we expect to begin pivotal clinical
trials for an FDA submission of our cervical cancer detection device in late
2002 or early 2003.
On April 16, 2002, we announced receipt of FDA clearance to market an
improved, minimally invasive insulin infusion patch set for use with all major
brands of insulin pumps. The new insulin patch infusion set, which is expected
to be introduced to the market in 2003, uses soft micro-catheters, rather than
micro-needles, to reduce the pain associated with insulin pump infusion. The
soft micro-cannula patch infusion set delivers insulin through five tiny
flexible cannulas that are much smaller than ordinary insulin pump infusion
needles. As a result, we believe that this improved patch design and reduced
skin penetration will provide people who use insulin pumps with an even more
comfortable experience because the patch will better move and flex with the
body. We have a total of 23 FDA clearances for our insulin delivery business
products, including soft catheter insulin pump infusion sets, an insulin pump
reservoir and a multi-purpose insulin pen.
On April 23, 2002, we announced that we had entered into agreements
with five distribution partners and had received our first orders for the
SimpleChoice(TM) easy disposable insulin pump infusion sets. Our first
SimpleChoice(TM) distribution partners are GEMCO Medical, a national supplier of
diabetes products to durable medical equipment dealers and consumers; National
Diabetic Pharmacies, a nation-wide one-stop-shop for people with diabetes;
Diabetic Promotions, a national discount online source of diabetes supplies;
Pumps It, Inc., a full service insulin pump sales and service organization; and,
Diabetic Express, a national source for diabetes supplies providing telephone
and on-line ordering capabilities. These distributors' customers include
approximately 10,000 insulin pump users, 4,000 durable medical equipment dealers
and more than 60 insurance plans in the U.S. We also announced that we plan to
ship our initial orders of the SimpleChoice(TM) easy in support of its expected
launch in the third quarter of 2002.
RESULTS OF OPERATIONS
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2002 AND 2001.
General. Net loss available to common stockholders remained constant at
$2.4 million during the three months ended March 31, 2002 as compared to the
same period in 2001. Increased spending associated with the SimpleChoice(TM)
product line was offset by reductions in excess capacity costs and higher
reimbursements from Abbott.
Revenue. We have historically received the majority of our revenue from
development milestone payments from one or more of our strategic partners.
Product revenue increased to $652,000 for the quarter ended March 31, 2002 from
$621,000 for the same period in 2001. Product revenue is higher for the 2002
quarter than for the comparable period in 2001, due to the increase in revenues
from our BiliChek products. We did achieve a milestone of $100,000 in March 2002
and in March 2001, relating to FDA approval of expanded claims for BiliChek
during and after phototherapy.
Cost of Sales. Cost of sales decreased to $424,000 for the three months
ended March 31, 2002 from $501,000 during the same period in 2001. This decrease
is due to excess capacity production charges, which were lower for this period
than in 2001, partially offset by cost of sales increases directly related to
increased product revenue. We expect cost of sales to increase in the future
with the ramp up and sales of products associated with our SimpleChoice(TM)
product line.
Research and Development Expenses. Research and development expenses
decreased to $1.5 million for the three months ended March 31, 2002 compared to
$1.6 million for the same period in 2001. The decrease in research and
development expenses was primarily due to Abbott's reimbursement of expenses
associated with our continuous glucose monitoring product at a higher level for
the quarter ended March 31, 2002 as compared to the same period in 2001. We
expect research and development expenses to remain at a high level this year as
we continue development and expand clinical trials for products in both our
non-invasive business and our diabetes management business.
Sales and Marketing Expenses. Sales and marketing expenses increased to
$305,000 during the three months ended March 31, 2002 from $177,000 during the
same period in 2001, due mainly to increased marketing relating to our
introduction of the SimpleChoice(TM) products. Marketing expenses are expected
to increase in the future as we continue to market and sell our SimpleChoice(TM)
product line.
General and Administrative Expenses. General and administrative
expenses increased to $876,000 during the three months ended March 31, 2002
compared to $717,000 incurred during the same period in 2001. The increase is
primarily due to an increase in costs associated with management of the
SimpleChoice(TM) products. General and administrative expenses are expected to
increase in the future with increases in SimpleChoice administrative needs.
Net Interest and Other Income. Net interest and other income remained
constant at about $35,000 for the three months ended March 31, 2002 and during
the same period in 2001. Although our cash balances were higher during the three
months ended March 31, 2002 versus the same period in 2001, interest rates
obtained are at a substantially reduced rate.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations since inception primarily through
private sales of debt and private and public sales of our equity securities.
From October 27, 1992 (inception) through March 31, 2002, we received
approximately $48.0 million in proceeds from sales of our debt and equity
securities. At March 31, 2002, we had cash of approximately $5.8 million and
working capital of approximately $7.1 million.
We completed an initial public offering of our common stock on July 7,
1997, which resulted in net proceeds received by us, before expenses related to
the transaction, of approximately $14.0 million. We issued $5.25 million of
redeemable convertible preferred stock in November 1999 in conjunction with the
execution of amendment to our agreement with Abbott. We issued common stock in a
private placement in February 2000, which resulted in gross proceeds of $5.0
million. We issued common stock and warrants in two private placements in June
2001, which resulted in net proceeds of approximately $11.2 million. We issued
common stock to Abbott in October 2001 in a private placement, which resulted in
gross proceeds of $1 million.
Our major cash flows in the three months ended March 31, 2002 consisted
of cash out-flow of $3.7 million from operations and $13,000 in additions to
property and equipment. $1.3 million of the cash out-flow resulted from a
prepayment of royalties relating to our agreement with Altea Technologies, Inc.
In addition to funds that we expect to be provided by our collaborative
partners and the funds we recently raised, we may be required to raise
additional funds through public or private financing, additional collaborative
relationships or other arrangements. We believe our existing and available
capital resources plus anticipated milestone payments will be sufficient to
satisfy our funding requirements through 2002.
We currently invest our excess cash balances primarily in short-term,
investment-grade, interest-bearing obligations or direct or guaranteed
obligations of the U.S. government until such funds are utilized in operations.
Substantial capital will be required to develop our products, including
completing product testing and clinical trials, obtaining all required United
States and foreign regulatory approvals and clearances, and commencing and
scaling up manufacturing and marketing our products. Any failure of our
collaborative partners to fund our development expenditures, or our inability to
obtain capital through other sources, would have a material adverse effect on
our 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. Our 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:
WE HAVE A SHORT OPERATING HISTORY, WHICH MAKES IT DIFFICULT FOR YOU TO EVALUATE
OUR BUSINESS.
Because limited historical information is available on our operations,
it will be difficult for you to evaluate our business. Our prospects must be
considered in light of the substantial risks, expenses, uncertainties and
difficulties encountered by entrants into the medical device industry, which is
characterized by increasing intense competition and a high failure rate.
WE HAVE A HISTORY OF LOSSES, AND WE EXPECT LOSSES TO CONTINUE.
We have never been profitable, and we have had operating losses since
our inception. We expect our operating losses to continue as we continue to
expend substantial resources to integrate the recently acquired operations of
Sterling Medivations and launch the new product line we acquired, to complete
development of our products, obtain regulatory clearances or approvals, build
our marketing, sales, manufacturing and finance organizations, and conduct
further research and development. To date, we have engaged primarily in research
and development efforts. The further development and commercialization of our
products will require substantial development, regulatory, sales and marketing,
manufacturing and other expenditures. We have only generated limited revenues
from product sales. Our accumulated deficit was about $42 million at March 31,
2002.
STERLING MEDIVATIONS HAS AN UNPROVEN BUSINESS THAT IS DIFFERENT FROM OUR FORMER
FOCUS ON NON-INVASIVE PRODUCTS, AND WE WILL BE REQUIRED TO DEVELOP NEW
CAPABILITIES TO SUCCESSFULLY INTEGRATE STERLING MEDIVATIONS.
We recently acquired Sterling Medivations, a start-up medical device
company that has developed a portfolio of diabetes products, in December 2001.
Sterling Medivations currently has no revenues or significant assets. The
product line that Sterling Medivations brought us is also significantly
different from our existing product line, which focuses on non-invasive and
minimally invasive products. Sterling Medivations' future business will depend
on our ability to develop various functions that will enable it to operate as
planned, including manufacturing, marketing, and distribution capabilities.
There can be no assurance that we or Sterling Medivations will be able to
successfully develop or implement these functions.
We cannot be sure that we will be able to successfully integrate the
Sterling Medivations business into our operations without substantial costs,
delays or other problems. The difficulties of combining operations may be
magnified by integrating personnel with differing business backgrounds and
corporate cultures. The integration of Sterling Medivations may take longer and
be more disruptive to our company than originally anticipated and may result in
a significant diversion of management attention and operational and financial
resources. We and Sterling Medivations may not be able to realize the benefits
that are expected to be realized. Difficulties encountered in the integration
process could have an adverse effect on our business, operations and financial
condition.
OUR ABILITY TO SELL OUR PRODUCTS IS CONTROLLED BY GOVERNMENT REGULATIONS, AND WE
MAY NOT BE ABLE TO OBTAIN ANY NECESSARY CLEARANCES OR APPROVALS.
The design, manufacturing, labeling, distribution and marketing of our
products are and will be subject to extensive and rigorous government
regulation, which can be expensive and uncertain and can cause lengthy delays
before we can begin selling our products.
IN THE UNITED STATES, THE FOOD AND DRUG ADMINISTRATION'S ACTIONS COULD
DELAY OR PREVENT OUR ABILITY TO SELL OUR PRODUCTS, WHICH WOULD
ADVERSELY AFFECT OUR GROWTH AND STRATEGY PLANS.
In order for us to market our products in the United States, we must
obtain clearance or approval from the Food and Drug Administration, or FDA. We
cannot be sure:
- that we or our collaborative partners will make timely filings
with the FDA;
- that the FDA will act favorably or quickly on these
submissions;
- that we will not be required to submit additional information
or perform additional clinical studies;
- that we would not be required to submit an application for
premarket approval, rather than a premarket notification
submission as described below; or
- that other significant difficulties and costs will not be
encountered to obtain FDA clearance or approval.
The premarket approval process is more rigorous and lengthier than
the clearance process for premarket notifications; it can take several years
from initial filing and require the submission of extensive supporting data and
clinical information. For example, Roche previously filed a premarket
notification for our diabetes detection product, which was withdrawn when the
FDA indicated that this product should be submitted for premarket approval,
including submission of clinical study data. We do not have any premarket
approval applications pending, but we currently believe our cervical cancer
detection product and our glucose monitoring products will require submission of
applications for premarket approval.
The FDA may impose strict labeling or other requirements as a condition
of its clearance or approval, any of which could limit our ability to market our
products. Further, if we wish to modify a product after FDA clearance of a
premarket notification or approval of a premarket approval 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
we conduct additional clinical studies or submit to the more rigorous and
lengthier premarket approval process, could result in a significant delay in
bringing our products to market and substantial additional research and other
expenditures. Similarly, any labeling or other conditions or restrictions
imposed by the FDA on the marketing of our products could hinder our ability to
effectively market our products. Any of the above actions by the FDA could delay
or prevent altogether our ability to market and distribute our products.
Further, there may be new FDA policies or changes in FDA policies that could be
adverse to us.
IN FOREIGN COUNTRIES, INCLUDING EUROPEAN COUNTRIES, WE ARE
ALSO SUBJECT TO GOVERNMENT REGULATION, WHICH COULD DELAY OR
PREVENT OUR ABILITY TO SELL OUR PRODUCTS IN THOSE
JURISDICTIONS.
In order for us to market our products in Europe and some other
international jurisdictions, we and our distributors and agents must obtain
required regulatory registrations or approvals. We must also comply with
extensive regulations regarding safety, efficacy and quality in those
jurisdictions. We may not be able to obtain any required regulatory
registrations or approvals, or we may be required to incur significant costs in
obtaining or maintaining any regulatory registrations or approvals we receive.
Delays in obtaining any registrations or approvals required to market our
products, failure to receive these registrations or approvals, or future loss of
previously obtained registrations or approvals would limit our ability to sell
our products internationally. For example, international 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 sell
our products in Europe, we must maintain ISO 9001 certification and CE mark
certification, which is an international symbol of quality and compliance with
applicable European medical device directives. Failure to receive or maintain
ISO 9001 certification or CE mark certification or other international
regulatory approvals would prevent us from selling in Europe.
EVEN IF WE OBTAIN CLEARANCE OR APPROVAL TO SELL OUR PRODUCTS,
WE ARE SUBJECT TO ONGOING REQUIREMENTS AND INSPECTIONS THAT
COULD LEAD TO THE RESTRICTION, SUSPENSION OR REVOCATION OF OUR
CLEARANCE.
We and our collaborative partners will be required to adhere to
applicable FDA regulations regarding good manufacturing practice, which include
testing, control, and documentation requirements. We are subject to similar
regulations in foreign countries. Ongoing compliance with good manufacturing
practice 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 international jurisdictions by comparable agencies.
Failure to comply with these 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, failure to
obtain 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 limit our ability to operate and could
increase our costs.
SINCE WE WILL RELY SIGNIFICANTLY ON OUR COLLABORATIVE PARTNERS TO OBTAIN AND
MAINTAIN OUR REGULATORY APPROVALS, ANY FAILURE OF OUR COLLABORATIVE PARTNERS TO
PERFORM COULD HURT OUR OPERATIONS.
Because they have primary responsibility for regulatory compliance for
most of our product lines, the inability or failure of our collaborative
partners to comply with the varying regulations, or the imposition of new
regulations, would limit our ability to produce and sell many of our products.
We will solely rely upon Abbott, Roche and Respironics to obtain United States
and international regulatory approvals and clearances for our glucose
monitoring, diabetes detection and infant jaundice products. We and Welch Allyn
will jointly seek regulatory approvals for our cervical cancer detection
product, but we do not have control over the timing or amount of resources Welch
Allyn devotes to these activities, or that our other collaborative partners
devote to the activities for which they have responsibility.
OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO OBTAIN AND PROTECT THE PROPRIETARY
INFORMATION ON WHICH WE BASE OUR PRODUCTS.
Our success depends in large part upon our ability to establish and
maintain the proprietary nature of our technology through the patent process, as
well as our ability to license from others patents and patent applications
necessary to develop our products. If any of our patents are successfully
challenged, invalidated or circumvented, or our right or ability to manufacture
our products were to be proscribed or limited, our ability to continue to
manufacture and market our products could be adversely affected. In addition to
patents, we rely on trade secrets and proprietary know-how, which we seek to
protect, in part, through confidentiality and proprietary information
agreements. The other parties to these agreements may breach these provisions,
and we may not have adequate remedies for any breach. Additionally, our trade
secrets could otherwise become known to or be independently developed by
competitors.
We have been issued, or have rights to, 40 U.S. patents (including
those under license). In addition, we have filed for, or have rights to, 52 U.S.
patents (including those under license) that are still pending. There are
additional international patents and pending applications. One or more of the
patents we hold directly or licensed from third parties, including those for the
disposable components to be used with our glucose monitoring, infant jaundice
and insulin delivery products, may be successfully challenged, invalidated or
circumvented, or we may otherwise be unable to rely on these patents. These
risks are also present for the process we use or will use for manufacturing our
products. In addition, our competitors, many of whom have substantial resources
and have made substantial investments in competing technologies, may apply for
and obtain patents that prevent, limit or interfere with our ability to make,
use and sell our products, either in the United States or in international
markets.
The medical device industry has been characterized by extensive
litigation regarding patents and other intellectual property rights. In
addition, the United States Patent and Trademark Office may institute litigation
or interference proceedings. The defense and prosecution of intellectual
property suits, Patent and Trademark Office proceedings and related legal and
administrative proceedings are both costly and time consuming. Moreover, we may
need to litigate to enforce our patents, to protect our trade secrets or
know-how, or to determine the enforceability, scope and validity of the
proprietary rights of others. Any litigation or interference proceedings
involving us may
require us to incur substantial legal and other fees and expenses and may
require some of our employees to devote all or a substantial portion of their
time to the proceedings. An adverse determination in the proceedings could
subject us to significant liabilities to third parties, require us to seek
licenses from third parties or prevent us from selling our products in some or
all markets. We may not be able to reach a satisfactory settlement of any
dispute by licensing necessary patents or other intellectual property. Even if
we reached a settlement, the settlement process may be expensive and time
consuming, and the terms of the settlement may require us to pay substantial
royalties. An adverse determination in a judicial or administrative proceeding
or the failure to obtain a necessary license could prevent us from manufacturing
and selling our products.
MUCH OF OUR FUTURE REVENUES WILL BE DERIVED FROM SALES OF OUR PRODUCTS BY THIRD
PARTIES OVER WHOM WE HAVE LIMITED INFLUENCE, AND WE MAY NOT BE ABLE TO GENERATE
SUFFICIENT SALES REVENUES TO SUSTAIN OUR GROWTH AND STRATEGY PLANS.
We expect that most of our near term revenues will come from sales of
our new diabetes product line acquired from Sterling Medivations, which has not
been launched yet and some of which is still in development. In addition, the
revenues that we expect to receive from each of our collaborative partners
depend primarily on sales of our products, most of which are still in
development. We may not be able to successfully commercialize the products we
are developing. Even if we do, we, together with our collaborative partners with
respect to products being jointly developed, may not be able to sell sufficient
volumes of our products to generate profits for us. In addition, our profit
margins on some of our products are not likely to increase over time because
they are subject to predetermined royalty rates and manufacturing profit rates.
The majority of our revenues and profits are expected to be derived from sales
of the Simple Choice line of products, followed by royalties and manufacturing
profits that we will receive from Abbott and Respironics resulting from sales of
the products we have or are developing with each of these companies. Another
significant portion of our revenues and profits are expected to be derived from
the sale of our cervical cancer detection product, and we would share with Welch
Allyn in the revenues generated from sales of these products to distributors and
end users.
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 these discounts or rebates to
expand the use of their products, which increases the market for the disposable
strips they sell for use with their products. Because Abbott has discretion to
determine the prices at which they sell our glucose monitoring devices, they may
choose to adopt this marketing strategy. If Abbott adopts this marketing
strategy and discounts the prices at which they sell our glucose monitoring
devices, the amounts we earn for these sales will be less. In this case,
royalties we earn on sales of our disposable cartridges may be less than the
amounts we would have earned had our glucose monitoring devices not been sold at
a discount.
BECAUSE OUR PRODUCTS, WHICH USE DIFFERENT TECHNOLOGY OR APPLY TECHNOLOGY IN MORE
INNOVATIVE WAYS THAN OTHER MEDICAL
DEVICES, ARE OR WILL BE NEW TO THE MARKET, WE MAY NOT BE SUCCESSFUL IN LAUNCHING
OUR PRODUCTS AND OUR OPERATIONS AND GROWTH WOULD BE ADVERSELY AFFECTED.
Our products are based on new methods of glucose monitoring, diabetes
detection, infant jaundice and cervical cancer detection and new methods of
delivery for our diabetes products. If they do not achieve significant market
acceptance, our sales will be limited and our financial condition may suffer.
Physicians and individuals may not recommend or use our products unless they
determine that these products are an attractive alternative to current tests
that have a long history of safe and effective use. To date, our products have
been used by only a limited number of people, and few independent studies
regarding our products have been published. The lack of independent studies
limits the ability of doctors or consumers to compare our products to
conventional products.
IF WE ARE UNABLE TO COMPETE EFFECTIVELY IN THE HIGHLY COMPETITIVE MEDICAL DEVICE
INDUSTRY, OUR FUTURE GROWTH AND OPERATING RESULTS WILL SUFFER.
The medical device industry in general, and the markets in which we
expect to offer products in particular, are intensely competitive. Many of our
competitors have substantially greater financial, research, technical,
manufacturing, marketing and distribution resources than we do and have greater
name recognition and lengthier operating histories in the health care industry.
We may not be able to effectively compete against these and other competitors.
For example, a number of competitors are currently marketing traditional glucose
monitors. These monitors are widely accepted in the health care industry and
have a long history of accurate and effective use. Further, if our products are
not available at competitive prices, health care administrators who are subject
to increasing pressures to reduce costs may not elect to purchase them. Also, 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.
Furthermore, our competitors may succeed in developing, either before
or after the development and commercialization of our products, devices and
technologies that permit more efficient, less expensive non-invasive and less
invasive glucose monitoring, insulin delivery, diabetes detection, infant
jaundice or 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 our products obsolete.
In addition, one or more of our collaborative partners may, for
competitive reasons, reduce their support of their collaborative arrangement
with us or support, directly or indirectly, a company or product that competes
with our products. This would limit our ability to compete with others.
WE HAVE LITTLE MANUFACTURING EXPERIENCE, WHICH COULD LIMIT OUR GROWTH.
We do not have manufacturing experience that would enable us to make
products in the volumes that would be necessary for us to achieve significant
commercial sales. In addition, we may not be able to establish and maintain
reliable, efficient, full scale manufacturing at commercially reasonable costs,
in a timely fashion. Difficulties we encounter in manufacturing scale-up, or our
failure to implement and maintain our manufacturing facilities in accordance
with good manufacturing practice regulations, international quality standards or
other regulatory requirements, could result in a delay or termination of
production. To date, our manufacturing activities have only included our
BiliChek and BiliCal products, as well as the diabetes detection product on a
limited scale. We plan to have our initial product offerings in the insulin
delivery area manufactured by a third party. We may decide to manufacture these
products ourselves in the future or may decide to manufacture products that are
currently under development in this market segment. We have the right to
manufacture certain glucose monitoring products under our agreement with Abbott,
and if we and Roche determine to seek approval for and market a diabetes
detection product, we will undertake to manufacture these products in
significant volumes. Companies often encounter difficulties in scaling up
production, including problems involving production yield, quality control and
assurance, and shortages of qualified personnel.
SINCE WE RELY ON SOLE SOURCE SUPPLIERS FOR SEVERAL OF OUR PRODUCTS, ANY FAILURE
OF THOSE SUPPLIERS TO PERFORM WOULD HURT OUR OPERATIONS.
Several of the components used in our products are available from only
one supplier, and substitutes for these components are infeasible or would
require substantial modifications to our products. Any significant problem
experienced by one of our sole source suppliers may result in a delay or
interruption in the supply of components to us until that 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 our
manufacturing operations. The microspectrometer and disposable calibration
element, components of our infant jaundice product, are each available from only
one supplier. For our products which require premarket approval, the inclusion
of substitute components could require us to qualify the new supplier with the
appropriate government regulatory authorities. Alternatively, for our products
which qualify for premarket notification, the substitute components must meet
our product specifications.
OUR LIMITED MARKETING AND SALES EXPERIENCE MAKES OUR INTERNATIONAL REVENUE
UNCERTAIN.
We are responsible for marketing our infant jaundice product in
countries other than the United States and Canada. In addition, we will be
responsible for marketing our diabetes product line. We have relatively limited
experience in marketing or selling medical device products and only have a ten
person marketing and sales staff. In order to successfully continue to market
and sell our products, we must either develop a marketing and sales force or
expand our arrangements with third parties to market and sell our products. We
may not be able to successfully develop an effective marketing and sales force,
and we may not be able to enter into and maintain marketing and sales
agreements with third parties on acceptable terms. If we develop our own
marketing and sales capabilities, we will compete with other companies that have
experienced and well-funded marketing and sales operations. If we enter into a
marketing arrangement with a third party, any revenues we would receive will be
dependent on this third party, and we will likely be required to pay a sales
commission or similar compensation to this party. Furthermore, we are currently
dependent on the efforts of Abbott and Roche for any revenues to be received
from our glucose monitoring and diabetes detection products. The efforts of
these third parties for the marketing and sale of our products may not be
successful.
BECAUSE WE OPERATE IN AN INDUSTRY WITH SIGNIFICANT PRODUCT LIABILITY RISK, AND
WE HAVE NOT SPECIFICALLY INSURED AGAINST THIS RISK, WE MAY BE SUBJECT TO
SUBSTANTIAL CLAIMS AGAINST OUR PRODUCTS.
The development, manufacture and sale of medical products entail
significant risks of product liability claims. We currently have no product
liability insurance coverage beyond that provided by our general liability
insurance. Accordingly, we may not be adequately protected from any liabilities,
including any adverse judgments or settlements, we might incur in connection
with the development, clinical testing, manufacture and sale of our products. A
successful product liability claim or series of claims brought against us that
results in an adverse judgment against or settlement by us in excess of any
insurance coverage could seriously harm our financial condition or reputation.
In addition, product liability insurance is expensive and may not be available
to us on acceptable terms, if at all.
IF WE CANNOT OBTAIN ADDITIONAL FUNDS WHEN NEEDED, WE WILL NOT BE ABLE TO
IMPLEMENT OUR BUSINESS PLAN.
We will require substantial additional capital to develop our products,
including completing product testing and clinical trials, obtaining all required
regulatory approvals and clearances, beginning and scaling up manufacturing, and
marketing our products. Any failure of our collaborative partners to fund our
capital expenditures, or our inability to obtain capital through other sources,
would limit our ability to grow and operate as planned. Under our collaborative
arrangements with Abbott, Roche, Respironics and Welch Allyn, these
collaborative partners will either directly undertake the activities to develop
specified products or will fund a substantial portion of the relevant
expenditures for the relevant product. The obligations of our collaborative
partners to fund our expenditures is largely discretionary and depends on a
number of factors, including our ability to meet specified milestones in the
development and testing of the relevant product. We may not be able to meet
these milestones, or our collaborative partners may not continue to fund our
expenditures.
We bear responsibility for all aspects of our Simple Choice product
line, which is not being developed with a collaborative partner. In addition to
funds that we expect to be provided by our collaborative partners, we may be
required to raise additional funds through public or private financing,
additional collaborative relationships or other arrangements. We believe that
our existing capital resources and the funding from our
collaborative partners will be sufficient to satisfy our funding requirements
through 2002, but may not be sufficient to fund our operations to the point of
commercial introduction of our glucose monitoring products, our cervical cancer
detection product or our full line of diabetes products. Any required additional
funding may not be available on terms attractive to us, or at all. To the extent
we cannot obtain additional funding, our ability to continue to develop and
introduce products to market will be limited. Any additional equity financing
may be dilutive to stockholders, and debt financing, if available, may involve
restrictive covenants that would limit how we conduct our business or finance
our operations.
THE AVAILABILITY OF THIRD-PARTY REIMBURSEMENT FOR OUR PRODUCTS IS UNCERTAIN,
WHICH MAY LIMIT CONSUMER USE AND THE MARKET FOR OUR PRODUCTS.
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. Any inability of patients, hospitals,
physicians and other users of our products to obtain sufficient reimbursement
from third-party payors for our products, or adverse changes in relevant
governmental policies or the policies of private third-party payors regarding
reimbursement for these products, could limit our ability to sell our products
on a competitive basis. We are unable to predict what changes will be made in
the reimbursement methods used by third-party health care payors. Moreover,
third-party payors are increasingly challenging the prices charged for medical
products and services, and some health care providers are gradually adopting a
managed care system in which the providers contract to provide comprehensive
health care services for a fixed cost per person. Patients, hospitals and
physicians may not be able to justify the use of our products by the attendant
cost savings and clinical benefits that we believe will be derived from the use
of our products, and therefore may not be able to obtain third-party
reimbursement.
Reimbursement and health care payment systems in international markets
vary significantly by country and include both government sponsored health care
and private insurance. We may not be able to obtain approvals for reimbursement
from these international third-party payors in a timely manner, if at all. Any
failure to receive international reimbursement approvals could have an adverse
effect on market acceptance of our products in the international markets in
which approvals are sought.
OUR SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN SCIENTIFIC, TECHNICAL,
MANAGERIAL AND FINANCE PERSONNEL.
Our ability to operate successfully and manage our future growth
depends in significant part upon the continued service of key scientific,
technical, managerial and finance personnel, as well as our ability to attract
and retain additional highly qualified personnel in these fields. We may not be
able to attract and retain key employees when necessary, which would limit our
operations and growth. None of our key employees have an employment contract
with us, nor are any of these employees, except our chief executive officer,
covered by key person or similar insurance. In addition, if we are able
to successfully develop and commercialize our products, we will need to hire
additional scientific, technical, marketing, managerial and finance personnel.
We face intense competition for qualified personnel in these areas, many of whom
are often subject to competing employment offers.
WE ARE CONTROLLED BY OUR DIRECTORS, EXECUTIVE OFFICERS AND THEIR AFFILIATED
ENTITIES.
Our directors, executive officers and entities affiliated with them
beneficially owned an aggregate of about 28% of our outstanding common stock as
of March 31, 2002. These stockholders, acting together, would be able to control
substantially all matters requiring approval by our stockholders, including the
election of directors and the approval of mergers and other business combination
transactions.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We have not entered into any transactions using derivative financial
instruments and believe our exposure to interest rate risk, foreign currency
exchange rate risk and other relevant market risks is not material.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 16, 2000, SpectRx filed a complaint for Declaratory Judgment
against Ampersand Medical Corp. ("Ampersand") seeking a declaration that SpectRx
has not misappropriated or improperly disclosed any alleged confidential
information or alleged trade secrets disclosed to it by Ampersand. Ampersand
subsequently filed a counter-suit in Illinois against SpectRx alleging that
SpectRx had misappropriated trade secrets belonging to Ampersand. The parties
announced that they had agreed to a settlement on February 1, 2002 releasing the
parties from all claims.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - Not Applicable
(b) Reports on Form 8-K
The registrant filed a Form 8-K on January 2, 2002 announcing under
Item 5 that it had reached an agreement with Altea Technologies Inc. to modify
its License and Joint Development Agreement with Altea and settle its
arbitration dispute with Altea.
The registrant filed a Form 8-K on January 2, 2002 announcing under
Item 5 that it had acquired Sterling Medivations, Inc., on December 31, 2001.
The registrant filed a Form 8-K on January 14, 2002 announcing under
Item 2 that it had acquired Sterling Medivations, Inc. on December 31, 2001.
Such Form 8-K was amended and filed on March 14, 2002 to include the financial
statements and proforma financial information of Sterling Medivations.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in Norcross, Georgia.
SPECTRX, INC.
Date: May 15, 2002 By: /s/ THOMAS H. MULLER, JR.
----------------------------------------------------
Thomas H. Muller, Jr.
Executive Vice President and Chief Financial Officer
(Duly Authorized Officer and Principal
Financial and Accounting Officer)