SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-QSB/A
(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended September 30, 2003
|_| TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT
For the transition period from ___________ to ___________.
Commission File number 0-935
MOLECULAR DIAGNOSTICS, INC.
(Exact name of Small Business Issuer as Specified in Its Charter)
Ampersand Medical Corporation
(Former Name of Small Business Issuer)
Delaware 36-4296006
- ------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
414 North Orleans Street, Suite 510
Chicago, IL 60610
----------------------------------------
(Address of Principal Executive Offices)
(312) 222-9550
---------------------------
(Issuer's Telephone Number)
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes |X| No |_|
APPLICABLE ONLY TO CORPORATE ISSUERS
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
Common Stock, $0.001 par value 39,640,532
- ------------------------------ -----------------------------------------
(Class) Outstanding shares as of October 31, 2003
Transitional Small Business Disclosure Format (Check One): Yes |_| No |X|
MOLECULAR DIAGNOSTICS, INC.
QUARTERLY REPORT ON FORM 10-QSB
September 30, 2003
TABLE OF CONTENTS
Page
----
PART I. -- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
a) Consolidated Balance Sheets - September 30, 2003 and
December 31, 2002 .................................................. 3
b) Consolidated Statements of Operations -- Three months and
nine months ended September 30, 2003 and 2002 ...................... 4
c) Consolidated Statements of Cash Flows -- Nine months ended
September 30, 2003 and 2002 ........................................ 5
d) Notes to Consolidated Financial Statements - September 30, 2003 ...... 6
Item 2. Management's Discussion and Analysis or Plan of Operation ......... 17
Item 3. Controls and Procedures ........................................... 22
PART II.-- OTHER INFORMATION
Item 1. Legal Proceedings ................................................. 23
Item 2. Changes In Securities and Use of Proceeds ......................... 25
Item 3. Defaults Upon Senior Securities ................................... 26
Item 4. Submission of Matters to a Vote of Security Holders ............... 26
Item 5. Other Information ................................................. 26
Item 6. Exhibits and Reports on Form 8-K .................................. 26
SIGNATURES ................................................................ 27
EXHIBIT INDEX ............................................................. 28
2
Part I. -- Financial Information
Item 1. Financial Statements
MOLECULAR DIAGNOSTICS, INC. AND SUBSIDIARIES
(Formerly Ampersand Medical Corporation)
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
September 30, December 31,
2003 2002
------------- ------------
(Unaudited)
Assets
Current Assets:
Cash and cash equivalents .......................................................... $ 124 $ 42
Accounts receivables, net of allowance for doubtful accounts of $ 65 and $ 145 at
September 30, 2003 and December 31, 2002, respectively .......................... 335 307
Inventories ........................................................................ 181 427
Refundable taxes ................................................................... 50 56
Prepaid financings costs ........................................................... 326 288
Prepaid expenses and other current assets .......................................... 35 69
-------- --------
Total current assets .................................................... 1,051 1,189
Fixed Assets, net ..................................................................... 477 666
Other Assets
Licenses, patents, and technology, net of amortization ............................. 7,038 7,521
Goodwill, net of amortization ...................................................... 283 283
-------- --------
Total assets ............................................................ $ 8,849 $ 9,659
======== ========
Liabilities and Stockholders' Equity (Deficit)
Current Liabilities:
Accounts payable ................................................................... $ 5,241 $ 5,202
Customer and other deposits ........................................................ 24
Accrued payroll costs .............................................................. 2,027 1,856
Accrued expenses ................................................................... 1,433 1,143
Deferred revenue ................................................................... 542 630
Revolving line of credit ........................................................... 280 207
Due to stockholder ................................................................. 140 127
Lease obligation ................................................................... 279 279
Notes payable--related party ....................................................... 596 65
Notes payable ...................................................................... 6,358 4,585
-------- --------
Total current liabilities ............................................... 16,896 14,118
Deferred revenue, less current portion ................................................ 75 120
-------- --------
Total liabilities ....................................................... 16,971 14,238
-------- --------
Stockholders' Equity (Deficit):
Preferred stock, $0.001 par value; shares authorized - 10,000,000; shares issued and
outstanding - 2,511,621 and 2,781,024, at September 30, 2003 and December 31, 2002,
respectively ........................................................................ 12,905 16,958
Common stock, $0.001 par value; shares authorized - 100,000,000; shares issued and
outstanding - 39,196,699 and 36,440,700, at September 30, 2003 and December 31, 2002,
respectively ........................................................................ 39 37
Additional paid-in-capital ............................................................ 28,705 19,557
Treasury stock; 192,088 shares at September 30, 2003 and December 31, 2002 ............ (327) (327)
Deferred compensation ................................................................. -- (11)
Accumulated deficit ................................................................... (49,207) (40,642)
Accumulated comprehensive loss--
Cumulative translation adjustment ............................................ (237) (151)
-------- --------
Total stockholders' equity (deficit) .................................... (8,122) (4,579)
-------- --------
Total liabilities and stockholders' equity (deficit) .................... $ 8,849 $ 9,659
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
3
MOLECULAR DIAGNOSTICS, INC.
(Formerly Ampersand Medical Corporation)
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
For the nine Months For the three Months
Ended September 30, Ended September 30,
------------------------- -------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
(Unaudited) (Unaudited)
Net revenues ...................................... $ 1,280 $ 1,453 $ 262 $ 295
Operating expenses
Cost of revenues .............................. 667 644 159 162
Research and development ...................... 448 3,402 129 867
Selling, general, and administrative expenses . 5,699 6,162 2,489 1,740
---------- ---------- ---------- ----------
Total operating expenses ................. 6,814 10,208 2,777 2,769
---------- ---------- ---------- ----------
Operating loss .................................... (5,534) (8,755) (2,515) (2,474)
Other income (expense):
Interest (expense) -related party ............. (67) (16) (32) (7)
Interest (expense) ............................ (2,568) (1,447) (1,311) (575)
Gain on litigation settlement ................. -- 151 -- --
Other, net .................................... 47 -- 41 --
---------- ---------- ---------- ----------
Total other income (expense) ............. (2,588) (1,312) (1,302) (582)
---------- ---------- ---------- ----------
Loss before income taxes .......................... (8,122) (10,067) (3,817) (3,056)
Income tax expense ................................ -- -- -- --
---------- ---------- ---------- ----------
Net loss .......................................... $ (8,122) $ (10,067) $ (3,817) $ (3,056)
========== ========== ========== ==========
Preferred stock dividend .......................... (1,113) (996) (361) (582)
---------- ---------- ---------- ----------
Net loss applicable to common stockholders ........ $ (9,235) $ (11,063) $ (4,178) $ (3,638)
========== ========== ========== ==========
Basic and fully diluted net loss per common share . $ (0.23) $ (0.43) $ (0.11) $ (0.14)
========== ========== ========== ==========
Weighed average number of common shares outstanding 40,191,128 25,956,783 38,858,622 26,550,822
========== ========== ========== ==========
The accompanying notes are an integral part of
these consolidated financial statements.
4
MOLECULAR DIAGNOSTICS, INC.
(Formerly Ampersand Medical Corporation)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
Nine Months Ended
September 30,
--------------------
2003 2002
------- --------
(Unaudited)
Operating Activities:
Net loss ....................................................................... $(8,122) $(10,067)
Adjustments to reconcile net loss to net cash used for operating activities:
Amortization of debt discount ............................................. 2,139 1,162
Depreciation and amortization ............................................. 683 725
Amortization of fees ...................................................... 350 --
Loss on sale of fixed assets .............................................. 1 --
Fixed assets exchanged for services ....................................... 8 --
Stock, warrants, and options issued to non-employees for services ......... 1,984 677
Licensing fees recognized on preferred stock sale ......................... -- (298)
Compensation expense related to stock appreciation rights, stock options,
and restricted stock ................................................. 12 87
Interest expense paid with stock .......................................... -- 116
Changes in assets and liabilities:
Accounts receivable, net ............................................. 1 124
Inventories .......................................................... 262 4
Refundable taxes ..................................................... 11 78
Due from (to) stockholder ............................................ 13 69
Prepaid expenses and other current assets ............................ (468) (14)
Accounts payable ..................................................... 122 2,539
Deposits ............................................................. (24) (28)
Deferred revenue ..................................................... (153) 276
Accrued expenses ..................................................... 401 829
------- --------
Net cash used for operating activities (2,780) (3,721)
------- --------
Cash used in investing activities:
Expenditures for license, patents, and technology .............................. -- (4)
Capital purchases .............................................................. (18) (88)
------- --------
Net cash used for investing activities ......................................... (18) (92)
------- --------
Cash flows from financing activities:
Proceeds from issuance of convertible notes payable ............................ 1,843 2,549
Proceeds from issuance of senior debt note payable ............................. 650
Proceeds from issuance of convertible notes payable, related party ............. 1,015 25
Note issued in payment of an expense ........................................... 339 --
Payment of notes payable ....................................................... (373) (290)
Proceeds (Payment) of revolving line of credit, net ............................ 49 (64)
Proceeds from sale of fixed assets ............................................. -- --
------- --------
Net cash provided by financing activities .......................................... 2,873 2,870
------- --------
Effect of exchange rate changes on cash and cash equivalents ....................... 7 (80)
------- --------
Net increase (decrease) in cash and cash equivalents ............................... 82 (1,023)
Cash and cash equivalents at the beginning of period ............................... 42 1,025
------- --------
Cash and cash equivalents at end of period ......................................... $ 124 $ 2
======= ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest .................................................................. $ 18 $ 19
Non-cash transactions during the period for:
Deferred financing costs .................................................. $ 1,652 $ --
Preferred stock and cumulative dividends converted into common stock ...... $ 4,495 $ 613
The accompanying notes are an integral part of
these consolidated financial statements.
5
MOLECULAR DIAGNOSTICS, INC.
(Formerly Ampersand Medical Corporation)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited - September 30, 2003)
Note 1. Organization
Molecular Diagnostics, Inc, ("MDI") was incorporated as Ampersand Medical
Corporation in Delaware on December 15, 1998, as the successor to Bell National
Corporation ("Bell National"). Bell National was incorporated in California in
1958.
On September 25, 2001, the Company changed its corporate name to Molecular
Diagnostics, Inc. in order to better represent its operations and products. The
name change was effected through a merger with a wholly-owned subsidiary.
Molecular Diagnostics, Inc. has retained its Certificate of Incorporation,
except as amended to reflect the new name, bylaws and capitalization.
On December 4, 1998, Bell National (then a shell corporation without any
business activity) acquired InPath, LLC, a development-stage company engaged in
the design and development of medical instruments and related tests. In the
acquisition, Bell National issued 4,288,790 shares of common stock and warrants
to purchase 3,175,850 shares of common stock to the members of InPath in
exchange for their units of membership interest in InPath and the senior
executives of InPath assumed management control of MDI.
Based upon the terms of the acquisition agreement, for financial reporting
and accounting purposes the acquisition was accounted for as a reverse
acquisition whereby InPath is deemed to have acquired Bell National. However,
Bell National was the continuing legal entity and registrant for both Securities
and Exchange Commission filing purposes and income tax filing purposes, until
its merger into MDI in May 1999. Because Bell National was a non-operating
public shell company with nominal assets and InPath was a private operating
company, the acquisition was recorded as the issuance of stock for the net
monetary assets of Bell National, accompanied by a recapitalization and no
goodwill or other intangible assets were recorded.
On September 17, 2001, Molecular Diagnostics, Inc. completed an
acquisition transaction whereby AccuMed International, Inc. was merged into a
wholly-owned subsidiary of MDI. The value of the transaction was approximately
$14,178,000. Accordingly, the consolidated financial statements presented
hereunder include the operations of InPath from March 16, 1998 (inception), the
operations of Bell National and Molecular Diagnostics, Inc. from December 4,
1998, and the operations of AccuMed International, Inc. from September 17, 2001,
the date of acquisition.
Molecular Diagnostics, Inc. has another wholly owned subsidiary, Samba
Technologies, Sarl ("Samba"). MDI acquired all of the assets of Samba in January
1999 from Unilog Regions, SA for approximately $500,000. Samba designs,
develops, and markets web-enabled software based systems for image analysis,
image capture, and image transmission and management for clinical and industrial
applications. Samba is also developing software used in the InPath System. A
majority of reported revenues prior to 2002 and since inception of Molecular
Diagnostics, Inc. have been generated by Samba. Since December 20, 2002, Samba
has operated under the protection of the French Commercial Court in compliance
with the bankruptcy laws of France. Samba continues to maintain normal
operations under the supervision of an Administrator appointed by the French
Commercial Court. Samba will continue to operate under the current format until
the Commercial Court approves a plan of reorganization and continuation. The
Court must act by December 2003 unless an extension of time is granted. MDI has
retained French legal counsel, who is working with the court and Samba
management to develop a plan to submit to the courts by the end of November
2003.
Molecular Diagnostics, Inc. is focused on the design, development and
marketing of the InPath System, Samba software and related image analysis
systems, including the AcCell instrument platforms. The InPath System and
related products are intended to detect cancer and cancer related diseases.
These products may be used in a laboratory, clinic, or doctor's office.
Molecular Diagnostics, Inc. has incurred significant operating losses
since its inception. Management expects that significant on-going operating
expenditures will be necessary to successfully implement MDI's business plan and
6
develop, manufacture and market its products. These circumstances raise
substantial doubt about MDI's ability to continue as a going concern.
Implementation of its plans and its ability to continue as a going concern
depend upon its securing substantial additional financing. During the first nine
months of 2003, MDI raised a net cash investment of $1,858,200 in promissory
notes and $1,000,000 in related party promissory notes. Management's continuing
plans include substantial efforts to obtain additional capital. If Molecular
Diagnostics, Inc. is unable to obtain adequate additional financing or generate
profitable sales revenues, management may be required to curtail its product
development and other activities and may be forced to cease operations.
Note 2. Basis of Presentation
The consolidated financial statements included herein were prepared by us
without audit according to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been omitted pursuant to
such rules and regulations. The consolidated financial statements reflect, in
the opinion of management, all adjustments necessary to present fairly the
consolidated financial position and results of operations as of and for the
periods indicated. The results of operations for the nine months and three
months ended September 30, 2003, are not necessarily indicative of the results
to be expected for the full year or for any other period. The consolidated
financial statements include Molecular Diagnostics, Inc. and its wholly owned
subsidiaries. All inter-company balances and transactions have been eliminated.
These financial statements should be read in conjunction with the audited
financial statements and the notes thereto included in our 2002 Annual Report on
Form 10-K, as filed with the Securities and Exchange Commission.
Note 3. Licenses, Patents, Technology, and Goodwill
(in thousands)
September 30, December 31,
2003 2002
------- -------
Licenses .......................................... $1,029 $1,028
Patent costs ...................................... 133 133
MDI Technology Agreement .......................... 7,230 7,230
Dianon Technology Agreement ....................... 260 260
------- -------
Subtotal .......................................... 8,652 8,651
Less accumulated amortization ..................... (1,614) (1,130)
------- -------
Total .................................... $ 7,038 $ 7,521
======= =======
Goodwill .......................................... $ 283 $ 283
======= =======
Aggregate Amortization Expense
For the nine months ended September 30, 2003 .. $484
====
Note 4. Accrued Expenses
Accrued expenses include the following at September 30, 2003 and December
31, 2002 (in thousands):
2003 2002
------ ------
Accrued interest ....................................... $ 587 $ 155
Accrued interest--related party ........................ 79 111
Accrued professional fees .............................. 2 146
Accrued taxes .......................................... 444 412
Reserve for warranty ................................... 18 21
Other accrued expenses ................................. 303 298
------ ------
Total ......................................... $1,433 $1,143
====== ======
MDI is delinquent in filing certain Federal and State Income Tax returns
for 2002 and 2001. MDI is also delinquent in paying a portion of Federal and
State employee and employer payroll taxes for 2003, 2002 and 2001.
7
The Company owed $736,000 and $678,000 as of September 30, 2003 and December 31,
2002, respectively, in past-due payroll taxes, including $241,000 and $250,000
respectively in assessed and estimated statutory penalties and interest. The
Internal Revenue Service has filed a lien against the Company's assets to secure
the unpaid payroll taxes. MDI is currently in the process of communicating
through counsel with the Internal Revenue Service to resolve this matter. The
amount is included in accrued payroll costs in the accompanying balance sheet.
MDI is also delinquent in paying various state franchise taxes.
Note 5. Notes Payable--Related Parties
Notes payable to related parties at September 30, 2003 and December 31,
2002 (in thousands) consisted of:
2003 2002
---- ----
Northlea Partners, Ltd., $25,000 Promissory Note issued August 6, 2001;
interest rate 15% per annum ................................................... $ 25 $25
Northlea Partners, Ltd., $15,000 Promissory Note issued September 20, 2001;
interest rate 9% per annum .................................................... 15 15
Northlea Partners, Ltd., $15,000 Bridge II convertible promissory note
Issued May 1, 2003; interest rate 12% per annum; (see description under
Bridge II notes in Note 6 - Notes payable, for other terms and conditions ..... 15 --
Robert Shaw, $25,000 Promissory Note issued September 20, 2001; interest rate
9% per annum .................................................................. 25 25
Suzanne M. Gombrich, $1,000,000 convertible promissory note issued April 2, 2003;
maturity date April 2, 2004 or earlier; interest rate 12% per annum;
convertible into common stock at $0.10 per share; beneficial conversion
feature valued at $970,000; 1,000,000 warrants at exercise
price of $0.15 per share; first priority security interest in all MDI assets .. 516 --
---- ---
$596 $65
==== ===
On April 2, 2003, MDI issued a $1,000,000 Convertible Promissory Note to
an affiliate, Suzanne M. Gombrich, the wife of Peter Gombrich, MDI's Chairman
and CEO, in exchange for cash. The note bears interest at the rate of 12% per
annum and is convertible into the common stock of MDI at a conversion price of
$0.10 per share. As additional consideration, MDI granted the holder a warrant
to purchase 1,000,000 shares of the common stock of MDI at an exercise price of
$0.15 per share. MDI also granted the holder a first priority security interest
in all of the Company's assets. The conversion price of the note was less than
the market price of the common stock when the note was issued; therefore, the
holder is considered to have a beneficial conversion feature. MDI determined the
value of the beneficial conversion feature to be $970,000 using the fair value
interest method. The value was recorded as a reduction of the debt and will be
amortized as additional interest over the life of the note. MDI recorded
additional interest expense of $486,000 to reflect amortization of the discount
from the time the note was issued until September 30, 2003. The initial $100,000
of cash proceeds of the note was received in March 2003 and was used to fund the
cost of an option to repurchase all of its assets from Round Valley Capital,
LLC. The remaining proceeds received on April 2, 2003 were used to make the
$900,000 payment required to exercise the purchase option in conjunction with
the final settlement of the loan with Round Valley Capital, LLC.
See Footnote 6 - Notes Payable, regarding events of default.
The carrying amount of notes payable - related parties approximates fair
value at September 30, 2003 and December 31, 2002.
8
Note 6. Notes Payable
Notes payable to unrelated parties at September 30, 2003 and December 31,
2002 (in thousands) consisted of:
2003 2002
------ ------
Bridge I Convertible Promissory Notes; due December 31, 2002; interest
rate 7% per annum; convertible into common stock at 75% of the market price
on date of conversion; beneficial conversion feature valued at $1,041,066;
Bridge Warrants at an exercise price of $0.25 per share; Private Warrants
at an exercise price equal to 150% of note conversion price ............................... $2,125 $3,185
Bridge II Convertible Secured Promissory Notes; due July 31, 2003; interest rate
12% per annum; convertible into common stock at $0.10 or $0.15 per share;
beneficial conversion feature valued at $2,036,200 and $330,000 at
September 30, 2003 and December 31, 2002, respectively;
Bridge II warrants at an exercise price of $0.15 or $0.20 per share ....................... 3,127 293
Round Valley Capital, LLC $825,500 Promissory Note, including unearned
interest dated August 30,2002; interest rate 36% per annum; warrants at
an exercise price of $0.20 per share; 711,364 shares of common stock ...................... -- 300
Monsun, AS, $500,000 Promissory Note issued November 1, 2000; interest rate 15% per
annum, compounded into principal amount; beneficial conversion feature valued
at $125,000; 1st extension of maturity date for issuance of 100,000 warrants at an
exercise price of $0.60 per share; 2nd extension of maturity date for the issuance
of 200,000 warrants at an exercise price of $0.30 per share; 3rd extension of
maturity date for the issuance of 200,000 warrants at an exercise price of $0.70
per share; stock issuance of 200,000 shares of common stock in lieu of default
penalty ................................................................................... 618 552
Trek Diagnostic Systems $80,000 Promissory Note issued July 31, 2002; due in equal
installments on September 1, 2002 and December 1, 2002 .................................... 40 40
O.P., LLC $29,390 Promissory Note issued May 12, 2003; interest at 7% per annum; monthly
principal payment of $1,316 plus interest ................................................. 24 --
Ungaretti and Harris $211,368 Secured Promissory Note issued May 8, 2003; interest at 12%
per annum; due September 30, 2003 ......................................................... 145 --
Ernst & Young $30,800 Promissory Note issued July 17, 2003; due December 31, 2003 ............. 31 --
Xillix Technologies Corporation $361,000 Promissory Note issued June 26, 1998; interest
rate Canadian Prime plus 6% per annum; represents a debt of AccuMed International ......... 34 34
Western Economic Diversification, $221,000 Promissory Note issued June 1989; no interest;
represents a debt of Oncometrics .......................................................... 214 182
------ ------
$6,358 $4,585
====== ======
Between March 22, 2002 and June 28, 2002, MDI issued $3,185,000 in series
Bridge I Convertible Promissory Notes to accredited investors. The notes bear
interest at the rate of 7% per annum and are convertible at any time into the
common stock of MDI at a conversion price equal to 75% of the market price of
the common stock on the date of conversion. In addition, MDI issued a warrant,
which entitled each holder to purchase one share of common stock, at an exercise
price of $0.25 per share, for each dollar principal amount of notes. MDI
calculated a fair value of $99,950 for these warrants using the fair value
interest rate method and recorded this amount as additional interest expense
during 2002. At the time of conversion of the note, the holder is entitled to
receive a warrant to purchase one share of common stock for each four shares of
common stock into which the note converts at an exercise price equal to 150% of
the conversion price of the note. MDI has not determined a value for the
warrants as of June 30, 2003. Since the conversion price of the note is at a 25%
discount to the market price of the common stock of MDI, the holder is
considered to have a beneficial conversion feature. MDI determined the value of
the beneficial conversion feature to be $1,041,666 and recorded this amount as
additional interest expense during 2002. In February 2003, a note holder, NeoMed
Innovations III, converted $1,060,000 in principal amount of Bridge I notes into
Bridge II notes. The remaining $2,125,000 in principal Bridge I notes remains
unconverted and outstanding at September 30, 2003. Management has extended a
written offer, dated October 10, 2003, to the Bridge I noteholders to convert
their Convertible Promissory Notes and accrued interest into common shares at
$0.15 per share. In addition, the Bridge I holders were also offered warrants to
purchase one new share for every four shares acquired by the Bridge noteholder
upon exercise of such holder's conversion rights under the note. As of November
10, 2003, this offer remained outstanding.
9
Beginning in October 2002, MDI began an issue of up to $4,000,000 in
series Bridge II Convertible Promissory Notes to accredited investors. MDI
issued $550,000 in Bridge II notes as of December 31, 2002. During the first
nine months of 2003, MDI issued an additional $1,858,200 in principal amount of
Bridge II notes. The notes bear interest at a rate of 12% per annum payable at
the maturity date in kind in the form of shares of common stock of MDI. The
Company granted the holders a junior security position in all of its assets. The
notes are convertible at any time into the common stock of MDI. The note
conversion price and the value of common shares paid in kind as interest for the
first $1,000,000 in principal amount of cash subscriptions, determined on a
"first come - first served basis," is $0.10 per share. The note conversion price
and the value of common shares paid in kind as interest for the remaining
$3,000,000 of principal amount of notes in the series is $0.15 per share. The
conversion price of the notes issued during 2002 and those issued during the
first nine months of 2003 was less than the market price of the common stock
when the notes were issued; therefore, the holders are considered to have a
beneficial conversion feature. MDI determined the value of the beneficial
conversion feature to be $1,706,200 and $330,000 at September 30, 2003 and
December 31, 2002, respectively. The value was recorded as a reduction of the
debt and will be amortized as additional interest over the life of the note. MDI
recorded additional interest expense of $1,652,708 to reflect amortization of
the discount during the nine months ended September 30, 2003. The Bridge II
notes automatically convert into shares of Common Stock (subject to adjustments
for stock splits, etc.) upon a "Qualified Financing Transaction," which means a
transaction in which the Company closes a new debt or equity financing prior to
the maturity date that results in net proceeds to the Company of at least four
million dollars ($4,000,000). At the time MDI completes significant additional
funding plans, as outlined in the subscription agreement, each holder of Bridge
II notes is entitled to receive a warrant to purchase one share of the common
stock of the Company for each four shares of common stock into which the note is
convertible at an exercise price of $0.15 per share for notes in the class
pertaining to the first $1,000,000 in subscriptions and $0.20 for the remaining
$3,000,000 in note principal subscriptions. In September 2003 an amendment to
the Bridge II Convertible Promissory Notes was sent to holders requesting an
extension of the notes to July 31, 2004. As additional consideration for the
extension, holders were offered an increase in the interest rate from 12% to
15%. In addition, an amendment to the indenture also offered an increase in the
warrant coverage ratio from 25% to 33%. Subsequent to September 30, 2003, MDI
issued additional notes in the Bridge II series. (See Footnote 9: Subsequent
Events)
On August 30, 2002, MDI issued a Promissory note to Round Valley Capital,
LLC ("RVC") in the amount of $825,500 representing $650,000 in cash received by
MDI and $175,500 in unearned interest. The note bears a calculated effective
interest rate of 36% per annum and is due June 1, 2003. The note is secured by
all of the assets of MDI. MDI issued a certificate representing 5,750,000 shares
of the common stock of the Company to RVC as collateral for the loan and paid
transaction fees including: cash payments of $147,063; 711,364 shares of common
stock of MDI; and warrants to purchase 681,818 shares of common stock of MDI at
an exercise price of $0.20 per share. MDI recorded the note at a value, net of
unearned interest, of $650,000. A fair value of $362,795 was calculated for the
shares of common stock of MDI issued to RVC using the market price of the common
stock on the date the shares were issued. A fair value of $156,000 was
calculated for the warrants using the Black-Scholes valuation method. The total
value of the transaction fees was recorded as prepaid financing costs and is
being amortized over the life of the note. During 2002, MDI made principal
payments against the note of $350,000. RVC declared MDI to be in default under
the terms of the note during 2002 and the parties were engaged in litigation and
subsequently, settlement negotiations. On April 2, 2003, MDI paid RVC $900,000
in cash in final settlement of the loan, default penalties and to exercise its
rights under the asset purchase option agreement. RVC returned the 5,750,000
shares of common stock issued as collateral under the note, 711,364 shares of
common stock issued as financing fees, and warrants to purchase 531,818 shares
of common stock also issued as financing fees. MDI cancelled the shares of
common stock and the warrants. On February 17, 2003, MDI made additional
principal payments amounting to $250,000. MDI recorded interest expense of
$16,900 and financing costs, including amortization of accrued financing costs,
of $1,009,000 during the six-months ended June 30, 2003.
In July 2002, MDI agreed to settle a claim brought by Trek Diagnostic
Systems, Inc. ("Trek") against AccuMed regarding breach of representation and
warranties in a certain agreement under which Trek purchased the microbiology
business of AccuMed in 2000. MDI issued a promissory note to Trek in the amount
of $80,000, payable in two equal installments on September 1, 2002 and December
1, 2002. MDI made the first payment due on September 1, 2002. MDI did not make
the second payment causing a default on the note. Trek has instituted legal
action against MDI to obtain payment of the remaining amount due under the note.
The unpaid portion of the note accrues interest at the rate of 8% per annum. MDI
recorded interest expense related to this note of $2,665 for the nine-months
ended September 30, 2003.
10
Specific events of default have occurred on a significant majority of the
outstanding notes payable, including the Bridge I, Bridge II and Suzanne M.
Gombrich convertible promissory notes, issued by MDI, ranging from failure to
make principal payments when due to breach of certain warranties and
representations. The notes payable require the holder to notify MDI in writing
of a declaration of default at which time a cure period, as specified in each
individual note, would commence. There is no guarantee that MDI would be able to
cure any event of default if, or when, the holder provides the required written
notice. Other than the $618,000 Monsun AS convertible promissory note and the
Trek Diagnostics $40,000 note payable, which are the subject of legal actions
described in Footnote 10 - Legal Proceedings, MDI has not received any written
declarations of default from holders of its outstanding notes payable.
The carrying amounts of notes payable approximates fair value at September
30, 2003 and December 31, 2002.
Note 7.Stockholders' Equity
Summary of the Company's preferred stock capital table as of:
September 30, December 31,
2003 2002
--------------- ---------------
Shares Issued & Shares Issued &
Offering Outstanding Outstanding
- -------- --------------- ---------------
Series A convertible ....................... 82,655 118,092
Series B convertible, 10% cumulative ....... 799,856 799,856
Series C convertible, 10% cumulative ....... 1,192,833 1,258,833
Series D convertible, 10% cumulative ....... 175,000 175,000
Series E convertible, 10% cumulative ....... 261,277 429,243
--------- ---------
Total Preferred Stock ...................... 2,511,621 2,781,024
========= =========
During the first nine months of 2003 a holder converted 66,000 shares of
Series C convertible preferred stock, including cumulative dividends due
thereon, into 380,403 shares of common stock.
In June 2003, two holders converted 35,437 shares of Series A convertible
preferred stock into 15,478 shares of common stock.
During the first nine months of 2003 several holders converted 167,966.76
shares of Series E convertible preferred stock, including cumulative dividends
due thereon, into 5,133,927 shares of common stock.
Summary of Preferred Stock Terms
Series A Convertible Preferred Stock
Liquidation Value: $4.50 per share
Conversion Price: $10.3034 per share
Conversion Rate: 0.4367--Liquidation Value divided by Conversion Price
($4.50/$10.3034)
Voting Rights: None
Dividends: None
Conversion Period: Any time--3 years
Series B Convertible Preferred Stock
Liquidation Value: $4.00 per share
Conversion Price: $1.00 per share
Conversion Rate: 4.00--Liquidation Value divided by Conversion Price
($4.00/$1.00)
Voting Rights: None
Dividends: 10%--Quarterly--Commencing March 31, 2001
Conversion Period: Any time
Cumulative dividends in arrears at September 30, 2003 were $828,851
11
Series C Convertible Preferred Stock
Liquidation Value: $3.00 per share
Conversion Price: $0.60 per share
Conversion Rate: 5.00--Liquidation Value divided by Conversion Price
($3.00/$0.60)
Voting Rights: None
Dividends: 10%--Quarterly--Commencing March 31, 2002
Conversion Period: Any time
Cumulative dividends in arrears at September 30, 2003 were $685,307
Series D Convertible Preferred Stock
Liquidation Value: $10.00 per share
Conversion Price: $1.00 per share
Conversion Rate: 10.00--Liquidation Value divided by Conversion Price
($10.00/$1.00)
Voting Rights: None
Dividends: 10%--Quarterly--Commencing April 30, 2002
Conversion Period: Any time--After April 1, 2002
Cumulative dividends in arrears at September 30, 2003 were $335,137
Series E Convertible Preferred Stock
Liquidation Value: $22.00 per share
Conversion Price: $0.80 per share
Conversion Rate: 27.50--Liquidation Value divided by Conversion Price
($22.00/$0.80)
Voting Rights: Equal in all respects to holders of common shares
Dividends: 10%--Quarterly--Commencing May 31, 2002
Conversion Period: Any time--After December 1, 2002
Cumulative dividends in arrears at September 30, 2003 were $1,011,034
Issuance of Restricted Shares for Services
Beginning in 1999, the Company has, at various times, awarded restricted
shares of common stock to non-employee consultants for services. Some of the
share awards were made for past services and their value was fixed. Other share
awards were made as partial consideration for services to be performed under
three-year consulting agreements and vest over the life of the agreements. The
final measurement date of these shares was determined to be July 2003. A fair
value of these shares of $18,250 and $39,000 was calculated at September 30,
2003 and September 30, 2002, respectively, using the Black-Scholes valuation
model, and the Company recorded $1,007 as additional expense and $31,000 as
reduction of expense during the nine months ended September 30, 2003 and
September 30, 2002, respectively.
Issuance of Shares for Services
In January 2003, MDI issued 1,000,000 shares of common stock in exchange
for services to a non-employee professional services firm. MDI calculated a fair
value of $100,000 for these shares based on the value of the shares on the date
of the issuance and recorded the amount as investor relations expense as of
March 31, 2003.
In May 2003, MDI issued 875,000 shares of common stock in exchange for
services to a non-employee professional services firm. MDI calculated a fair
value of $218,750 for these shares based on the market value of the shares on
the date they were due and is amortizing the amount over the remainder of the
service contract.
In June 2003, MDI issued 83,642 shares of common stock to a non-employee
service vendor in lieu of payment for unpaid service invoices. MDI valued the
shares at $12,463 which represented the amount of the unpaid invoices.
In July 2003, MDI issued 1,375,000 shares of common stock to non-employees
for past and future financing and consulting services. MDI calculated a fair
value of $495,000 for these shares based on the fair market value of the shares
on the date they were issued. Of the total amount $207,000 is being amortized
over the life of the services contract. In August 2003, MDI issued 170,000
shares of common stock to a non-employee financial consultant for past financing
services. MDI valued the shares at $51,000.
12
Issuance of Warrants for Services
On April 2, 2003, MDI issued a warrant to Suzanne M. Gombrich, an
affiliate, entitling the holder to purchase 1,000,000 shares of common stock of
MDI at an exercise price of $0.15 per share. The warrant was issued as
additional consideration for a $1,000,000 convertible promissory note issued on
the same date. MDI valued the warrants at $270,000 using the Black-Scholes
valuation model and recorded the amount as a current quarter administrative
expense.
In August 2003, MDI issued 1,100,000 warrants with an exercise price of
$0.17 per share to a non-employee financial consultant for past financial
services. MDI valued the warrants at $341,000 using the Black-Scholes valuation
model and recorded the amount as a current quarter administrative expense.
In September 2003, MDI issued 1,335,000 warrants with an exercise price of
$0.20 per share to non-employee financial consultants for past financial
services. MDI valued the warrants at $347,100 using the Black-Scholes valuation
model and recorded the amount as a current quarter administrative expense.
In September 2003, MDI issued 500,000 warrants with an exercise price of
$0.17 per share to a non-employee consultant in lieu of payment for future
services. MDI valued the warrants at $150,000 using the Black-Scholes valuation
model and is amortizing the amount over the twelve month period of the
consulting term.
Application of Black-Scholes Valuation Model
In applying the Black-Scholes valuation model, the Company has used an
expected dividend yield of zero for both periods, a risk-free interest rate of
4.5% and 6% for the 2003 and 2002 periods, respectively, a volatility factor of
198% and 90% for the 2003 and 2002 periods, respectively, and a fair value of
the underlying common shares of closing market price on the date of the grant
for both periods. The expected life equaled the term of the warrants, options,
or restricted shares.
Note 8. Equity Incentive Plan and Employee Stock Purchase Plan
On May 25, 1999, stockholders approved the establishment of the 1999
Equity Incentive Plan effective as of June 1, 1999. The Plan provides that the
Board may grant various forms of equity incentives to directors, employees, and
consultants, including but not limited to Incentive Stock Options, Non-Qualified
Stock Options, Stock Appreciation Rights, and Restricted Stock Awards. Grants
under the Plan are exercisable at fair market value determined as of the date of
grant in accordance with the terms of the Plan. Grants vest to recipients
immediately or ratably over periods ranging from two to five years, and expire
five to ten years from the date of grant.
On May 23, 2000, stockholders approved Amendment No. 1 to the Plan, which
increased the number of shares of common stock allocated for use in the Plan
from 2,000,000 shares to 3,000,000 shares. On June 21, 2002, stockholders
approved an Amendment to the Plan, which increased the number of shares
allocated for use in the Plan from 3,000,000 shares to 5,500,000 shares.
The Board of Directors has also granted options to purchase common stock
of MDI, which are not covered by the terms of the Plan.
MDI applies APB Opinion No. 25 and related interpretations in accounting
for options granted to employees under the Equity Incentive Plan. No
compensation cost was recorded during 2003 or 2002 for options granted to
employees as the exercise price approximated the fair value of the underlying
common stock on the date of the grant. Had stock options been accounted for
under the fair value method recommended by FAS 123, the Company's net loss
applicable to common shareholders would have been changed to the pro forma
amounts indicated below:
13
For the nine months ended For the three months ended
September 30, September 30,
------------------------- --------------------------
2003 2002 2003 2002
------- -------- ------- -------
(in thousands except for per share amounts)
Net loss applicable to common
shareholders as reported .................... $(9,235) $(11,063) $(4,178) $(3,638)
Deduct: Total stock-based compensation
expense determined under the fair value based
method for all awards, net of related taxes . 33 (269) (16) (233)
------- -------- ------- -------
Pro forma net loss applicable to
common shareholders ......................... $(9,202) $(11,332) $(4,194) $(3,871)
======= ======== ======= =======
Basic loss per share applicable to common
shareholders - as reported .................. $ (0.23) $ (0.43) $ (0.11) $ (0.14)
======= ======== ======= =======
Basic loss per share applicable to
common shareholders - pro forma ............. $ (0.23) $ (0.44) $ (0.11) $ (0.15)
======= ======== ======= =======
The fair value for these options was estimated at the date of the grant
using a Black-Scholes option pricing model with the following weighted average
assumptions: risk-free interest rates of 4.5% and 6% for the 2003 and 2002
periods, respectively; dividend yields of zero; volatility factors of the
expected market price of the Company's common stock of 198% and 90% for both
years and a weighted average expected life of the options of 2.5 - 5 years.
A summary of the Company's stock option activity, during the nine-month
periods ended September 30, 2003 and 2002, and related information follows:
Option Plan Shares
--------------------------
2003 2002
--------- ---------
Outstanding: December 31, 2002 and 2001, respectively ...... 3,507,517 3,792,496
Granted through September 30, .......................... 600,000 286,833
Exercised through September 30, ........................ -- (361,000)
Forfeited - assumed in acquisition through September 30, (17,035) (311,220)
Forfeited through September 30, ........................ (353,500) (289,000)
--------- ---------
Outstanding: September 30, 2003 and 2002, respectively ..... 3,736,982 3,118,109
========= =========
Exercisable at September 30, 2003 .......................... 2,643,314
=========
Note 9.Subsequent Events
Bridge II Financing
Beginning in October 2002, MDI began an issue of up to $4,000,000 in
series Bridge II Convertible Promissory Notes to accredited investors. The notes
bear interest at 12 % per annum payable at maturity date in kind in the form of
shares of common stock and were due July 31, 2003. The notes are convertible at
any time into the common stock of MDI. The note conversion price and the value
of common shares paid in kind as interest for the first $1,000,000 in cash
subscriptions, determined on a "first come - first served basis," is $0.10 per
share. The note conversion price and the value of common shares paid in kind as
interest for the remaining $3,000,000 of principal amount of notes in the series
is $0.15 per share. MDI granted each note holder the right to receive a private
warrant to purchase one share of the common stock of MDI for each dollar of
principal amount of notes held at an exercise price of $0.15 per share. The
warrants are not issueable until such time as MDI completes significant
additional financing plans. MDI granted a junior security position in all of the
Company's assets to the holders of the Bridge II convertible promissory notes.
The Bridge II notes automatically convert into shares of Common Stock (subject
to adjustments for stock splits, etc.) upon a "Qualified Financing Transaction,"
which means a transaction in which the Company closes a new debt or equity
financing prior to the maturity date that results in net proceeds to the Company
of at least four million dollars ($4,000,000). Through September 30, 2003, MDI
issued $1,858,200 in principal amount of Bridge II convertible promissory notes
in exchange for cash. Between October 1, 2003 and November 10, 2003, MDI issued
an additional $122,000 in principal amount of Bridge II convertible promissory
notes in exchange for cash. In September 2003 an amendment to the Bridge II
Convertible Promissory Notes was sent to holders requesting an extension of the
notes to July 31, 2004. As additional consideration for the extension, holders
were offered an increase in the interest rate from 12% to 15%. In addition, an
amendment to the indenture offered an increase in the warrant coverage ratio
from 25% to 33%.
Warrants
On July 18, 2003, Mr. Milley, a director, Azimuth Corporation and Cadmus
Corporation, agreed to cancel seven warrants held by Azimuth and one warrant
held by Cadmus, which entitled the holders to purchase a total of 3,125,000
shares of common stock at various exercise prices between $0.01 and $1.25 per
share. The warrants, issued between
14
December 1999 and August 2001, contained anti-dilution clauses which required
MDI to increase the number of shares of common stock the holders were entitled
to purchase under the warrants by approximately 1,500,000 shares as of the date
of the agreement, with commensurate adjustments in individual exercise prices so
that gross proceeds to the Company from exercise of the warrants remained the
same. These anti-dilution provisions could have required the Company to make
additional adjustments in shares and exercise prices in the future based on the
Company's issuance of debt or equity instruments at prices below the adjusted
exercise prices of these warrants. In consideration for the parties' agreement
to cancel these warrants, including their individual anti-dilution clauses, and
the forgiveness of approximately $120,000 currently owing to Azimuth and Cadmus,
MDI agreed to issue a new five-year warrant entitling the holders to purchase
6,500,000 shares of common stock at an exercise price of $0.30 per share. MDI
also agreed to issue a 120- day warrant entitling the holder to purchase 500,000
shares of common stock at an exercise price of $0.30. Management believes that
the Company will derive significant additional benefits in the future as a
result of the elimination of the anti dilution provisions in the original
warrants. Although an agreement has been reached in principal between the
parties, no definitive agreement has yet been signed. MDI is currently awaiting
receipt of final signed documents.
Note 10. Legal Proceedings
On July 31, 2002, MDI entered into a settlement and mutual release
agreement with Trek Diagnostic Systems, Inc. ("Trek") related to a claim of
breach of representations and warranties included in an agreement under which
AccuMed sold its microbiology business and related assets to Trek in 1999. Under
the settlement agreement, MDI executed an $80,000 promissory note in favor of
Trek. The note required principal payments of $40,000 each on September 1 and
December 1, 2002. MDI made the initial payment and Trek filed suit against MDI
(Court of Common Pleas Cuyahoga County, Ohio (Case No. CV 03 492582)) on January
23, 2003 to collect the remaining $40,000 plus interest at 8% per annum and
legal and other costs. At December 31, 2002, MDI accrued the remaining amount
due on the note. On April 18, 2003, judgment was entered against MDI in the
amount of $40,000 plus interest. On November 5, 2003, the Circuit Court of Cook
County ordered that MDI's bank turn over to TREK $25,692.36, which had been
residing in that bank account. Management is currently negotiating with Trek on
the balance to resolve this matter.
On March 28, 2003 The Cleveland Clinic Foundation ("Clinic") filed suit
against MDI (United States District Court for the Northern District of Ohio,
Easter Division, (Case No. 1:03CV0561)) seeking approximately $315,000 plus
interest and attorney fees and costs. The sum in question pertains to remaining
unpaid fees for certain clinical trial work conducted by the Clinic in the
Peoples Republic of China ("China Study") on behalf of MDI. On December 31,
2002, MDI recorded the full amount owing to the Clinic as a liability in its
accounts. On October 22, 2003, MDI and the Clinic entered into a Revised
Settlement Agreement and Mutual Release. MDI agreed to pay the sum of $240,000
to the Clinic which will be held in escrow pending the return of MDI's
instruments and computer equipment used in the China Study and MDI's successful
ability to access available and uncorrupted clinical trial data contained
therein. If the China Study data is available, the Clinic agrees to provide all
hard copy documentation related to the China Study and to complete a review and
analysis of the data in a timely manner. If the data is not available, MDI's
payments will be returned to MDI and the lawsuit will go forward. At that point
MDI will actively defend itself based on the Clinic's failure to deliver the
data required under the original China Study agreement.
On January 2, 2003, Bowne of Chicago, Inc. ("Bowne") filed suit against
MDI (Circuit Court of Cook County, Illinois (Case No. 03 L 000009)) claiming
approximately $342,000, plus interest and costs, related to financial printing
service fees provided to MDI by Bowne during the period October 25, 2001 through
November 7, 2002. While MDI is actively defending itself against the suit
claiming the charges for printing services provided during the period mentioned
above were excessive, management has taken a conservative position and recorded
the entire amount of the Bowne invoices as outstanding accounts payable on the
records of MDI. As of December 31, 2002 and September 30, 2003, management and
its counsel are unable to determine what the outcome of this litigation might
be.
15
On January 9, 2003, Monsun, AS ("Monsun") filed suit against Peter
Gombrich, MDI's Chairman and CEO, (United States District Court for the Northern
District of Illinois Eastern Division (Case No. 03C 0184)) claiming damages in
excess of $500,000 plus attorneys' fees and costs, and alleging breach of a
Guaranty Agreement and a Letter Agreement signed by Mr. Gombrich in conjunction
with Monsun's grant of an extension in the maturity date of a convertible
promissory note in the principal amount of $500,000 issued by MDI on November 1,
2000. Monsun claims that Mr. Gombrich is obligated under the Guaranty Agreement
to pay all monies owed by MDI under the convertible promissory note. MDI has
recorded the principal amount of the note plus accrued and unpaid interest to
December 31, 2002 as a note payable on its records. Regarding the Letter
Agreement, Monsun claims that Mr. Gombrich was obligated to transfer to Monsun
200,000 registered shares of common stock of MDI held by Mr. Gombrich. Since Mr.
Gombrich's potential liability in the suit, including delivery of 200,000
registered shares of MDI's common stock, is the result of the failure of MDI to
pay the principal amount of its convertible promissory note when due, the Board
of Directors has agreed that MDI will assume responsibility for Mr. Gombrich's
obligations under the Guaranty Agreement and Letter Agreement, including legal
costs. Regarding the claim for breach of the Guaranty Agreement, counsel for Mr.
Gombrich has presented a settlement proposal. Monsun, counsel for Mr. Gombrich
and the Company's counsel continue to discuss a settlement proposal, and
management and counsel are unable to determine the result of this claim. With
respect to the claim for breach of the Letter Agreement, on November 2003 Monsun
and Mr. Gombrich reached a settlement agreement. In November 2002 and prior to
the litigation, the Board of Directors approved the issuance of 200,000 shares
of MDI's common stock to Monsun to satisfy Mr. Gombrich's alleged obligation
under the Letter Agreement. The terms of the Letter Agreement stated that Monsun
was to ultimately receive registered shares of MDI's common stock. However, MDI
issued the shares of its common stock to Monsun with a restrictive legend which
permits their sale only in compliance with Rule 144 of the Securities Act of
1933, as amended. Under the terms of the settlement agreement, Gombrich and/or
MDI must either register the 200,000 shares previously transferred to Monsun or
transfer 200,000 registered shares to Monsun on or before March 31, 2004. If Mr.
Gombrich or MDI transfer additional shares, Monsun is required to return the
previously transferred shares.
MDI is a defendant in several lawsuits brought by current or former
unsecured creditors to collect past due amounts for goods and services. MDI has
recorded the amounts due in its records and is attempting to settle these suits
and unfiled claims.
MDI is a defendant in several legal actions brought by former employees
seeking to collect amounts due for unpaid wages. MDI has recorded the amounts
due in its records and is attempting to settle these actions and in some cases
it is contesting such actions.
In May 2003, the Company, together with its subsidiaries, AccuMed
International, Inc. ("Accumed") and Oncometrics Imaging Corp. ("Oncometrics"),
filed suit against MonoGen, Inc. ("MonoGen") and Norman J. Pressman, Docket No.
03 CH 08532 (Circuit Court of Cook County, Illinois). This suit arose out of two
license agreements, one between AccuMed and MonoGen, and the other between
Oncometrics and MonoGen, in which the rights to limited use of certain
intellectual property were granted to MonoGen in return for one-time license fee
payments totaling $500,000 (the "Agreements"). At the time that the Agreements
were entered into, the Company had not yet acquired AccuMed and Oncometrics. A
portion of the intellectual property subject to the Agreements had originally
been licensed from the British Columbia Cancer Agency ("BCCA"). Pressman was the
President of AccuMed and Oncometrics when the Agreements were negotiated and
executed. Shortly after the Agreements were signed, Pressman became President of
MonoGen. The Complaint filed in this case alleged that certain rights to the
subject intellectual property were transferred to MonoGen at a below-market
price. The Complaint also asserted that AccuMed and Oncometrics may not have
obtained the requisite consent of BCCA to the Agreements. The Complaint also
claims that, to the extent BCCA's consent was required, Pressman breached his
fiduciary duties to AccuMed and Oncometrics by failing to obtain such consent,
and also by negotiating below-market license fees with his future employer.
The Company's claims against MonoGen were dismissed from this action.
However, the Company's claims against Pressman remain pending. In June 2003, the
Court dismissed the Company's request for an injunction against the defendants.
This denial does not affect the Company's rights to pursue permanent injuntive
relief at the conclusion of the case, if such is warranted. A Second Amended
Verified Complaint was filed in this case on November 14, 2003. On November 20,
2003, AccuMed and Oncometrics sent termination notices to MonoGen with respect
to the licenses previously granted by them to MonoGen. At the same time, the
Company advised BCCA of its plan to settle directly with BCCA any differences it
may have with BCCA in regard to the MonoGen licenses. The failure of the Company
to negotiate a favorable settlement with BCCA in regard to any such differences
could have adverse effect on certain limited aspects of the Company's business.
On April 14, 2003, the Company received a notification from the attorney
for Dr. Bruce Patterson, M.D., Ph.D, a licensor of the Company under the License
and Development Agreement covering certain HPV technology, which forms the basis
for our In-Cell HPV test, indicating that the licensor intended to terminate the
license in accordance with a specific clause of the license, which permits
termination in the event the Company makes an assignment for the benefit of
creditors or bankruptcy, or otherwise relinquishes or loses control of all its
assets. On April 15, 2003, we informed the attorney
16
that the facts used by the licensor to invoke the termination right were
incorrect and that we are still in control of all of our assets and that such
assets are pledged as security under debt instruments and that such pledges are
not included under events which would permit the licensor to terminate the
license. We, and our counsel, believe that MDI would prevail should the licensor
attempt to pursue a termination action. We are also engaged in a dispute with
the licensor over completion of the third milestone of the license under which
completion requires process and procedure verification by an independent third
party. This verification requirement has not been satisfied as yet. On July 2,
2003, the licensor and his business, Inviron, Inc., filed suit against MDI
(Circuit Court of Cook County, Illinois (Case No. 03 L007995)), claiming a total
of $143,556.97 due under two separate contracts. The parties are in settlement
discussions to resolve all outstanding issues.
17
Item 2. Management's Discussion and Analysis or Plan of Operation
Forward-Looking Statements
Certain statements contained in this discussion and analysis of financial
condition and results of operations that are not related to historical results
are "forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Statements that are predictive, that depend upon
or refer to future events or conditions, or that include words such as
"expects," "anticipates," "intends," "plans," "believes," "estimates," "hopes,"
and similar expressions constitute forward-looking statements. In addition, any
statements concerning future financial performance (including future revenues,
earnings or growth rates), ongoing business strategies or prospects, or possible
future actions by us are also forward-looking statements.
These forward-looking statements are based on beliefs of our management as
well as current expectations, projections and assumptions currently available to
the Company and are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical results or those
anticipated. These risks are described more fully in our most recent Annual
Report on Form 10-K under the caption of Risk factors Item 1 and in subsequent
reports filed with the Securities and Exchange Commission. Should one or more of
those risks or uncertainties materialize or should underlying expectations,
projections and assumptions prove incorrect, actual results may vary materially
from those described. Those events and uncertainties are difficult to predict
accurately and many are beyond our control. We assume no obligation to update
these forward-looking statements to reflect events or circumstances that occur
after the date of these statements.
The following discussion and analysis should be read in conjunction with
our consolidated financial statements presented in Part I, Item 1 of this
quarterly report and our consolidated financial statements and Management'
Discussion and Analysis of Financial Condition and Results of Operations
contained in our Annual Report on Form 10-K for the year ended December 31,
2002.
Significant Accounting Policies
Use of Estimates. The preparation of the financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Revenue Recognition. The Company recognizes revenue upon shipment of a
product or license to customers and no remaining Company obligations or
contingencies exist, or in the case of sales of software by its wholly owned
subsidiary, Samba, upon shipment if persuasive evidence of an arrangement
exists; sufficient vendor-specific objective evidence exists to support
allocating the total fee to all elements of the arrangement; the fee is fixed or
determinable; and collection is probable.
Revenue from ongoing client maintenance is recognized ratably over the
post-contract support term, which is generally twelve months. Revenue from
training services and professional services is recognized when the service is
completed. Revenue from implementation and installation services is recognized
using the percentage of completion method. Revenue from prepayments under
licenses is recognized over the license period. Samba calculates percentage of
completion based on the estimated total number of hours of service required to
complete an implementation project and the number of actual hours of service
rendered. Implementation and installation services are generally completed
within 120 days.
Licenses, Patents, Technology and Goodwill. Licenses, patents, and
purchased technology are recorded at their acquisition cost. Costs to prepare
patent filings are expensed when incurred. Costs related to abandoned patents
are written off at the time of abandonment. Amortization is begun as of the date
of acquisition or upon the grant of the final patent. Costs are amortized over
the asset's useful life, which ranges from two to seventeen years. The Company
assesses licenses, patents, and technology quarterly for impairment.
18
Goodwill. The Company has adopted FAS 142, which sets forth guidelines for
discontinuing periodic goodwill amortization costs in results of operations and
for establishing an annual goodwill impairment review and related net realizable
value asset write-down methodology.
Research and Development Costs. Research and development costs are charged
to operations as incurred. Molecular Diagnostics, Inc. conducts a portion of its
research activities under contractual arrangements with scientists, researchers,
universities, and other independent third parties.
Foreign Currency Translation. The functional currency of the Company's
foreign operations is the local currency. Accordingly, all assets and
liabilities are translated into United States dollars using period-end exchange
rates, and all revenues and expenses are translated using average exchange rates
during the period. The amount of foreign currency translation is not material to
the results of operations and the financial position of the Company.
Other Comprehensive Income (Loss). Translation adjustments related to the
Company's foreign operations are included in other comprehensive loss and
reported separately in stockholders' equity (deficit).
Stock Compensation. As permitted by the Statement of Financial Accounting
Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), Molecular
Diagnostics, Inc. uses the intrinsic value method to account for stock options
as set forth in Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25).
Impairment. At each balance sheet date or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable, management of the Company evaluates recoverability of such assets.
An impairment loss is recognized if the amount of undiscounted cash flows is
less than the carrying amount of the asset in which case the asset is written
down to fair value. The fair value of the asset is measured by either quoted
market prices or the present value of estimated expected future cash flows using
a discount rate commensurate with the risks involved.
Application of Black-Scholes Valuation Model. In applying the
Black-Scholes valuation model, we have used an expected dividend yield of zero,
a risk-free interest rate of 4.5% and 6% for 2003 and 2002, respectively, a
volatility factor of 198% and 90% for 2003 and 2002, respectively, and the
closing market price of the underlying common stock on the date of the grant.
There were 600,000 in option grants during the first nine months of 2003. The
expected life equaled the term of the warrants, options, or restricted shares.
Overview of Molecular Diagnostics
The science of medical diagnostics has advanced significantly during the
past decade. Much of this advance has come as a result of new knowledge of the
human genome and related proteins, which form the foundation of cell biology and
the human body. Our goal is to utilize this research as a base to develop
screening and diagnostic testing products for cancer and cancer-related
diseases. We believe that the success of these products will improve patient
care through more accurate test performance, wider availability and cost
effective service delivery. We are developing an initial series of products to
address these criteria including sample collection devices, chemical and
biological tests, and analytical instruments and related software.
Our strategy is to develop products through internal development
processes, strategic partnerships, licenses and acquisitions of companies. This
strategy has required and will continue to require additional capital. As a
result, we will incur substantial operating losses until we are able to
successfully market some, or all, of our products.
Results of Operations
Revenue
Our revenue for the nine-month period ended September 30, 2003 totaled
$1,280,000, representing a decrease of $173,000, or 11.9%, over revenue of
$1,453,000 for the nine-month period ended September 30, 2002. The 2003
comparative revenue decrease results primarily from one-time revenue recognition
during the first quarter of 2002 of $298,000 from the sale of a three-year
irrevocable, worldwide, royalty-free license for full access to Samba's image
19
analysis software and development tools to Ventana Medical Systems, Inc. The
remaining increase represents gains in new customer AcCell instrument sales and
installations.
Revenue of $262,000 for the three months ended September 30, 2003
represented a decrease of $33,000, or 11.2%, over revenue for the same period in
2002. This resulted from a decrease in MDI instrument related revenues. Revenues
from our European subsidiary, Samba, are derived from the sale of proprietary
Telemedicine software and software consulting services. Samba conducts its
operations in local currency, the Euro. We convert the local currency into U.S.
Dollars for consolidated reporting purposes. Samba's revenue recognition is also
subject to the timing of receipt and completion of customer contracts from
period to period. We may experience quarter-to-quarter and year-to-year
variability in revenues as a result of these contract-timing issues until we
begin to market some or all of our other products.
Operating
Cost of Revenues
Cost of revenues for the nine months ended September 30, 2003 totaled
$667,000, an increase of $23,000 from the same period in 2002. No cost of
revenues attributable to the Ventana license sale was recorded since related
research and development costs related thereto were expensed as incurred in
prior years.
Cost of revenues for the three months ended September 30, 2003 totaled
$159,000, a decrease of $3,000 or 1.9%, from the same period in 2002. The
decrease was the result of a reduction in MDI instruments sold during the
period.
Research and Development
We devote a substantial amount of our resources to research and
development ("R&D") related to new products, including markers, tests,
instruments and software applications, as well as modifications and refinements
of our existing products.
R&D expenses decreased $2,954,000 and $738,000 for the nine-month and
three-month periods ended September 30, 2003 to $448,000 and $129,000, a
decrease of 86.8% and 85.1%, respectively, over the comparable prior year
periods. These reductions were the result of reduced operating capacity due to
capital and liquidity constraints. R&D expenses consist of the following:
o costs related to specific development programs with scientists and
researchers at universities and hospitals;
o full scale device development contracts begun during 1999 with
industrial design and manufacturing companies covering the
disposable and instrument components of the InPath System;
o payments to medical and engineering consultants for advice related
to the design and development of our products and their potential
uses in the medical technology marketplace;
o instrumentation, disposables, clinical consumables, clinical
supplies and regulatory costs to develop clinical trial reference
laboratories and to recruit and test patients in support of our
various Food and Drug Administration ("FDA") clinical trials, and
o payroll-related costs for in-house engineering, scientific,
laboratory, and software development activities; and research
management staff.
Selling, General and Administrative
Selling, general and administrative expenses ("SG&A") decreased $463,000
and increased $749,000 for the nine-month and three-month periods ended
September 30, 2003 to $5,699,000 and $2,489,000, a decrease of 7.5% and increase
of 43.0% over the same periods ended September 30, 2002, respectively. This
decrease is the result of reduced operating capacity due to capital and
liquidity constraints, and a reduction in legal expenses due to the one-time
recording of $675,000 in legal costs related to a litigation settlement during
the first quarter of 2002. The increase in the expenses for the three-month
period is related primarily to an increase of $1,299,000 in financing costs to
raise capital
20
Significant components of SG&A are compensation costs for executive, sales
and administrative personnel, professional fees primarily related to legal and
accounting and consulting services, travel costs, printing costs, fees for
public and/or investor relations services, insurance premiums, facilities and
office expenses, marketing related costs, and amortization/depreciation charges,
many of which showed significant declines due to the reduction in overall
operations, which began during the last quarter of 2002.
Other Income and Expense
Interest Expense
Interest expense, including interest expense to related parties, increased
$1,172,000 and $761,000 for the nine-month and three-month periods ended
September 30, 2003 to $2,635,000 and $1,343,00, an increase of 80.1% and 130.8%
over the same periods ended September 30, 2002, respectively. This increase was
mainly related to the issuance of the interest bearing Bridge I and Bridge II
convertible promissory notes. Bridge I convertible promissory notes, in
principal amounts totaling $2,125,000 and issued between March 22, 2002 and June
25, 2003, and Bridge II convertible promissory notes, in principal amounts
totaling $3,468,200, and issued between October 29, 2002 and September 30, 2003
were outstanding for all or some of the nine months ended September 30, 2003.
See further discussion in the preceding Notes To Consolidated Financial
Statements -- Note 6. Also, accrued interest expense resulting from related
party convertible notes payable is included in interest expense -- related
party.
Other Income and Expense, Net
For the nine months ended September 30, 2002, we recorded a $150,000 gain
from the settlement of the SpectRx litigation during the first quarter 2002.
Related SpectRx settlement legal expenses are included in selling, general and
administrative expenses for the period ended September 30, 2002. Other Income
for the nine months ended September 30, 2003 totaled $47,000 and relates to
vendor restructuring settlements during the period.
Net Loss
The net loss for the nine-month and three-month period ended September 30,
2003 before preferred dividends totaled $8,122,000 and $3,817,000 compared with
$10,067,000 and $3,056,000 for the same periods in 2002, a decrease of
$1,945,000 and a increase of $761,000 or a decrease of 19.3% and a increase of
24.9%, respectively. The decrease for the nine-month period was primarily the
result of reduced operating capacity due to capital and liquidity constraints.
The increase for the three-month period was primarily the result of an increase
in financing costs. In addition, cumulative dividends on the outstanding Series
B convertible preferred stock through Series E convertible preferred stock
totaled $1,113,000 and $361,000 for the nine-month and three-month periods ended
September 30, 2003 compared with $996,000 and $582,000 for the same periods in
2002, respectively. The combined net loss applicable to common stockholders for
the nine and three-month periods ended September 30, 2003 of $9,235,000 and
$4,178,000 or $0.23 and $0.11 per share, on 40,191,128 and 38,858,622 weighted
average common shares outstanding, respectively, compared with the net loss and
net loss available to common stockholders for the nine and three-month periods
ended September 30, 2002 of $11,063,000 and $3,638,000 or $0.43 and $0.14 per
share, on 25,956,783 and 26,550,822 weighted average common shares outstanding.
At September 30, 2003, cumulative dividends on the outstanding Series B
convertible preferred stock, Series C convertible preferred stock, Series D
convertible preferred stock and Series E convertible preferred stock totaled
$2,860,329.
The weighted average shares outstanding during the quarter ended September
30, 2003 reflect the conversion of Series B, Series C, and Series E convertible
preferred stock during 2002 and Series A, Series C, and Series E convertible
preferred shares during the nine months ended September 30, 2003. It also
reflects, 5,750,000 shares of common stock issued to RVC as additional loan
collateral in September 2002. The shares were returned to MDI and cancelled in
June 2003.
Liquidity and Capital Resources
R&D, clinical trials and other studies of the components of our InPath
System, conversions from designs and prototypes into product manufacturing,
initial sales and marketing efforts, medical consultants and advisors, and
research, administrative, and executive personnel are and will continue to be
the principal basis for our cash
21
requirements. We have provided operating funds for the business since its
inception through private offerings of debt and equity to U.S. and foreign
accredited investors. We will be required to make additional offerings in the
future to support the operations of the business until some or all of our
products are introduced into the market. We used $2,788,000 and $3,721,000 for
the nine months ended September 30, 2003 and 2002, respectively, in operating
activities.
At September 30, 2003 we had cash on hand of $124,000, an increase of
$82,000 compared to the $42,000 cash on hand at December 31, 2002. This increase
can be attributed to new capital funding from Bridge II notes issued during the
period and improved collection of Samba receivables offset by current operating
expenses and payments of certain liabiliites.
During the first quarter of 2003, we issued $350,000 in Bridge II
convertible notes in exchange for cash. The notes were issued under the same
terms as all other previous Bridge II notes. We used $250,000 of the proceeds to
make principal and interest payments on the RVC loan. During the second quarter
of 2003, we issued an additional $791,100 in Bridge II convertible notes in
exchange for cash or services. A Bridge II note in the amount of $15,000 was
issued to Northlea Partners, Ltd. on May 1, 2003. Dr. John Abeles, one of our
directors, serves as the managing partner of Northlea Partners, Ltd. The note
was issued under the same terms and conditions as all other Bridge II notes. We
used the proceeds of the notes issued during the second quarter to meet current
operating needs and to make payments to our previous independent auditors for
past services and to our current independent auditors for services related to
the audit of our financial statements for the year ended December 31, 2002 and
the preparation of our Annual Report on Form 10-K as filed with the Securities
and Exchange Commission at the end of the second quarter of 2003. During the
third quarter of 2003, we issued an additional $717,100 in Bridge II convertible
notes in exchange for cash or services. We used the proceeds of the notes issued
during the third quarter to meet current operating needs and to pay some vendor
past due amounts and settlements.
During the first quarter of 2003, Mr. Gombrich, our Chairman and CEO,
loaned the Company an additional $115,000 to meet some of our operating needs
and was owed $242,000 at the end of the quarter. During the second quarter of
2003, Mr. Gombrich loaned an additional amount of $20,000 and was repaid
$101,000 with an ending loan balance of $141,000. During the third quarter of
2003, Mr. Gombrich advanced an additional amount of $103,000 in expenses and was
repaid $104,000 with an ending balance of $140,000.
In March 2003, an affiliate, Suzanne M. Gombrich, the wife of our
Chairman, loaned the Company $100,000 in cash, reflecting the initial proceeds
of a $1,000,000 convertible promissory note described in the following
paragraph. We used the $100,000 to buy the purchase option related to the RVC
loan settlement.
On April 2, 2003, MDI issued a $1,000,000 Convertible Promissory Note to
Suzanne M. Gombrich, in exchange for $900,000 in cash. The April note included
the $100,000 advance loan proceeds described in the preceding paragraph. The
note bears interest at the rate of 12% per annum and is convertible into our
common stock at a conversion price of $0.10 per share. As additional
consideration, we granted the holder a warrant to purchase 1,000,000 shares of
our common stock at an exercise price of $0.15 per share. We also granted the
holder a first priority security interest in all of our assets. We used the
$900,000 cash proceeds to make the required payment to exercise the purchase
option in conjunction with the final settlement of the loan with Round Valley
Capital, LLC.
On August 30, 2002, we issued a promissory note to Round Valley Capital,
LLC ("RVC") in the amount of $825,500 representing $650,000 in cash received in
exchange for the note and $175,500 in unearned interest. The note was due June
1, 2003 and bore interest at a calculated rate of 36% per annum. The note was
secured by all of our assets. We paid transaction fees in cash of $147,063,
issued RVC 711,364 shares of our common stock and warrants to purchase 681,818
shares of our common stock at an exercise price of $0.20 per share. We also
issued a certificate representing 5,750,000 shares of our common stock as
additional collateral for the loan. As of December 31, 2002, we had made
principal and interest payments against the note of $350,000 and $59,500,
respectively. As a result of issues over the value of collateral, RVC declared
the note to be in default and attempted to foreclose on our assets and sell them
at auction. We instituted legal action against RVC, halting the foreclosure and
asset sale, and immediately entered into settlement negotiations. In early
December of 2002, we reached a settlement agreement with RVC under which we were
required to pay the remaining $300,000 principal balance of the note plus an
additional amount of $115,000, representing the remaining unearned interest on
the note, by January 4, 2003. The agreement provided that if the payment due on
January 4, 2003 was not made in a timely manner, a default penalty would be
assessed each week payment was not made until a final payment amounting to
$950,000 would be due on February 19, 2003. Because of capital and liquidity
constraints, we were not able to make the payment due on January 4, 2003 and
made no further payments until February
22
17, 2003, when we paid RVC $250,000 leaving a remaining balance due under the
settlement agreement of $700,000. At the end of February RVC proceeded with
foreclosure against our assets. At that time we agreed to pay RVC $100,000 for
an option to repurchase our assets at any time prior to the close of business on
April 2, 2003. The option prevented RVC from selling the assets to any party
other than us before that date. We used the proceeds of Bridge II convertible
promissory notes issued in February, as described above, to make the $250,000
payment to RVC. On April 2, 2003, we paid RVC $900,000 as a final settlement and
to exercise the purchase option to reacquire all of our assets. We used the
proceeds of a convertible promissory note issued to an affiliate, as described
above, to make the final payment to RVC. In conjunction with this final payment,
RVC returned 5,750,000 shares of our common stock issued as collateral, 711,364
shares of our common stock and warrants to purchase 531,818 shares of our common
stock issued to RVC as payment for transaction fees. We cancelled the returned
shares of common stock and warrants.
Our capital expenditures were approximately $18,000 for the nine months
ended September 30, 2003, a reduction of $70,000, or 79.5% from the prior year
period's $88,000. Capital expenditures are defined as disbursements for
laboratory equipment, leasehold improvements, software, and furniture/fixtures
with a purchase price in excess of $1,000 per item and useful life in excess of
one year. The decrease in 2003 capital expenditures resulted from a reduction of
laboratory and computer equipment and software purchases in support of our
product development and research efforts in order to conserve cash through our
private placement and bridge financings.
Specific events of default have occurred on a significant majority of our
outstanding notes payable, including $2,125,000 of Bridge I convertible
promissory notes, $3,468,200 of Bridge II convertible promissory notes and the
$1,000,000 Suzanne M. Gombrich convertible promissory note, ranging from failure
to make principal payments when due to breach of certain warranties and
representations. The notes payable require the holder to notify us in writing of
a declaration of default at which time a cure period, as specified in each
individual note, would commence. There is no guarantee that we would be able to
cure any event of default if, or when, the holder provides the required written
notice. Other than the $618,000 Monsun AS convertible promissory note and the
$40,000 Trek Diagnostics note payable, which are the subject of legal actions
described in Footnote 10 - Legal Proceedings, we have not received any written
declarations of default from holders of our outstanding notes payable.
Our operations have been, and will continue to be, dependent upon
management's ability to raise operating capital in the form of debt or equity.
We have incurred significant operating losses since the inception of our
business. We expect that significant ongoing operating expenditures will be
necessary to successfully implement our business plan and develop, manufacture
and market our products. As a result of capital and liquidity constraints, we
significantly reduced our staff and all other operating expenditures beginning
in the last quarter of 2002 and continuing through most of the second quarter of
2003. We began to reestablish our operations at the end of the second quarter of
2003. These circumstances raise substantial doubt about our ability to continue
as a going concern. There can be no assurance that we will be able to obtain
additional capital to meet our current operating needs or to complete pending or
contemplated licenses or acquisitions of technologies. If we are unable to raise
sufficient adequate additional capital or generate profitable sales revenues, we
may be forced to continue our operations at a reduced level, substantially
delaying product research and development, clinical trials, market introduction
of some of our products and other activities and may even be forced to cease
operations.
ITEM 3. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our principal executive officer and principal financial officer have
concluded, based upon their evaluation as of September 30, 2003, that our
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)
under the Securities Exchange Act of 1934, as amended) are effective to ensure
that information required to be disclosed by MDI in the reports filed or
submitted by us under the Securities Exchange Act of 1934, as amended, is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms.
There have been no significant changes in our internal controls or in
other factors that could significantly affect our internal controls subsequent
to the date we completed our evaluation. There were no discoveries of any
significant deficiencies or material weaknesses in such controls that would
require the Company to take corrective action.
23
Part II. Other Information
Item 1. Legal Proceedings
On July 31, 2002, MDI entered into a settlement and mutual release
agreement with Trek Diagnostic Systems, Inc. ("Trek") related to a claim of
breach of representations and warranties included in an agreement under which
AccuMed sold its microbiology business and related assets to Trek in 1999. Under
the settlement agreement, MDI executed an $80,000 promissory note in favor of
Trek. The note required principal payments of $40,000 each on September 1 and
December 1, 2002. MDI made the initial payment and Trek filed suit against MDI
(Court of Common Pleas Cuyahoga County, Ohio (Case No. CV 03 492582)) on January
23, 2003 to collect the remaining $40,000 plus interest at 8% per annum and
legal and other costs. At December 31, 2002, MDI accrued the remaining amount
due on the note. On April 18, 2003, judgment was entered against MDI in the
amount of $40,000 plus interest. On November 5, 2003, the Circuit Court of Cook
County ordered that MDI's bank turn over to TREK $25,692.36, which had been
residing in that bank account. Management is currently negotiating with Trek on
the balance to resolve this matter.
On March 28, 2003 The Cleveland Clinic Foundation ("Clinic") filed suit
against MDI (United States District Court for the Northern District of Ohio,
Easter Division, (Case No. 1:03CV0561)) seeking approximately $315,000 plus
interest and attorney fees and costs. The sum in question pertains to remaining
unpaid fees for certain clinical trial work conducted by the Clinic in the
Peoples Republic of China ("China Study") on behalf of MDI. On December 31,
2002, MDI recorded the full amount owing to the Clinic as a liability in its
accounts. On October 22, 2003, MDI and the Clinic entered into a Revised
Settlement Agreement and Mutual Release. MDI agreed to pay the sum of $240,000
to the Clinic which will be held in escrow pending the return of MDI's
instruments and computer equipment used in the China Study and MDI's successful
ability to access available and uncorrupted clinical trial data contained
therein. If the China Study data is available, the Clinic agrees to provide all
hard copy documentation related to the China Study and to complete a review and
analysis of the data in a timely manner. If the data is not available, MDI's
payments will be returned to MDI and the lawsuit will go forward. At that point
MDI will actively defend itself based on the Clinic's failure to deliver the
data required under the original China Study agreement.
On January 2, 2003, Bowne of Chicago, Inc. ("Bowne") filed suit against
MDI (Circuit Court of Cook County, Illinois (Case No. 03 L 000009)) claiming
approximately $342,000, plus interest and costs, related to financial printing
service fees provided to MDI by Bowne during the period October 25, 2001 through
November 7, 2002. While MDI is actively defending itself against the suit
claiming the charges for printing services provided during the period mentioned
above were excessive, management has taken a conservative position and recorded
the entire amount of the Bowne invoices as outstanding accounts payable on the
records of MDI. As of December 31, 2002 and September 30, 2003, management and
its counsel are unable to determine what the outcome of this litigation might
be.
24
On January 9, 2003, Monsun, AS ("Monsun") filed suit against Peter
Gombrich, MDI's Chairman and CEO, (United States District Court for the Northern
District of Illinois Eastern Division (Case No. 03C 0184)) claiming damages in
excess of $500,000 plus attorneys' fees and costs, and alleging breach of a
Guaranty Agreement and a Letter Agreement signed by Mr. Gombrich in conjunction
with Monsun's grant of an extension in the maturity date of a convertible
promissory note in the principal amount of $500,000 issued by MDI on November 1,
2000. Monsun claims that Mr. Gombrich is obligated under the Guaranty Agreement
to pay all monies owed by MDI under the convertible promissory note. MDI has
recorded the principal amount of the note plus accrued and unpaid interest to
December 31, 2002 as a note payable on its records. Regarding the Letter
Agreement, Monsun claims that Mr. Gombrich was obligated to transfer to Monsun
200,000 registered shares of common stock of MDI held by Mr. Gombrich. Since Mr.
Gombrich's potential liability in the suit, including delivery of 200,000
registered shares of MDI's common stock, is the result of the failure of MDI to
pay the principal amount of its convertible promissory note when due, the Board
of Directors has agreed that MDI will assume responsibility for Mr. Gombrich's
obligations under the Guaranty Agreement and Letter Agreement, including legal
costs. Regarding the claim for breach of the Guaranty Agreement, counsel for Mr.
Gombrich has presented a settlement proposal. Monsun, counsel for Mr. Gombrich
and the Company's counsel continue to discuss a settlement proposal, and
management and counsel are unable to determine the result of this claim. With
respect to the claim for breach of the Letter Agreement, on November 2003 Monsun
and Mr. Gombrich reached a settlement agreement. In November 2002 and prior to
the litigation, the Board of Directors approved the issuance of 200,000 shares
of MDI's common stock to Monsun to satisfy Mr. Gombrich's alleged obligation
under the Letter Agreement. The terms of the Letter Agreement stated that Monsun
was to ultimately receive registered shares of MDI's common stock. However, MDI
issued the shares of its common stock to Monsun with a restrictive legend which
permits their sale only in compliance with Rule 144 of the Securities Act of
1933, as amended. Under the terms of the settlement agreement, Gombrich and/or
MDI must either register the 200,000 shares previously transferred to Monsun or
transfer 200,000 registered shares to Monsun on or before March 31, 2004. If Mr.
Gombrich or MDI transfer additional shares, Monsun is required to return the
previously transferred shares.
MDI is a defendant in several lawsuits brought by current or former
unsecured creditors to collect past due amounts for goods and services. MDI has
recorded the amounts due in its records and is attempting to settle these suits
and unfiled claims.
MDI is a defendant in several legal actions brought by former employees
seeking to collect amounts due for unpaid wages. MDI has recorded the amounts
due in its records and is attempting to settle these actions and in some cases
it is contesting such actions.
In May 2003, the Company, together with its subsidiaries, AccuMed
International, Inc. ("Accumed") and Oncometrics Imaging Corp. ("Oncometrics"),
filed suit against MonoGen, Inc. ("MonoGen") and Norman J. Pressman, Docket No.
03 CH 08532 (Circuit Court of Cook County, Illinois). This suit arose out of two
license agreements, one between AccuMed and MonoGen, and the other between
Oncometrics and MonoGen, in which the rights to limited use of certain
intellectual property were granted to MonoGen in return for one-time license fee
payments totaling $500,000 (the "Agreements"). At the time that the Agreements
were entered into, the Company had not yet acquired AccuMed and Oncometrics. A
portion of the intellectual property subject to the Agreements had originally
been licensed from the British Columbia Cancer Agency ("BCCA"). Pressman was the
President of AccuMed and Oncometrics when the Agreements were negotiated and
executed. Shortly after the Agreements were signed, Pressman became President of
MonoGen. The Complaint filed in this case alleged that certain rights to the
subject intellectual property were transferred to MonoGen at a below-market
price. The Complaint also asserted that AccuMed and Oncometrics may not have
obtained the requisite consent of BCCA to the Agreements. The Complaint also
claims that, to the extent BCCA's consent was required, Pressman breached his
fiduciary duties to AccuMed and Oncometrics by failing to obtain such consent,
and also by negotiating below-market license fees with his future employer.
The Company's claims against MonoGen were dismissed from this action.
However, the Company's claims against Pressman remain pending. In June 2003, the
Court dismissed the Company's request for an injunction against the defendants.
This denial does not affect the Company's rights to pursue permanent injuntive
relief at the conclusion of the case, if such is warranted. A Second Amended
Verified Complaint was filed in this case on November 14, 2003. On November 20,
2003, AccuMed and Oncometrics sent termination notices to MonoGen with respect
to the licenses previously granted by them to MonoGen. At the same time, the
Company advised BCCA of its plan to settle directly with BCCA any differences it
may have with BCCA in regard to the MonoGen licenses. The failure of the Company
to negotiate a favorable settlement with BCCA in regard to any such differences
could have adverse effect on certain limited aspects of the Company's business.
On April 14, 2003, the Company received a notification from the attorney
for Dr. Bruce Patterson, M.D., Ph.D, a licensor of the Company under the License
and Development Agreement covering certain HPV technology, which forms the basis
for our In-Cell HPV test, indicating that the licensor intended to terminate the
license in accordance with a specific clause of the license, which permits
termination in the event the Company makes an assignment for the benefit of
creditors or bankruptcy, or otherwise relinquishes or loses control of all its
assets. On April 15, 2003, we informed the attorney that the facts used by the
licensor to invoke the termination right were incorrect and that we are still in
control of all of our assets and that such assets are pledged as security under
debt instruments and that such pledges are not included under events which would
permit the licensor to terminate the license. We, and our counsel, believe that
MDI would prevail should the licensor attempt to pursue a termination action. We
are also engaged in a dispute with the licensor over completion of the third
milestone of the license under which completion requires process and procedure
verification by an independent third party. This verification requirement has
not been satisfied as yet. On July 2, 2003, the licensor and his business,
Inviron, Inc., filed suit against MDI (Circuit Court of Cook County, Illinois
(Case No. 03 L007995)), claiming a total of $143,556.97 due under two separate
contracts. The parties are in settlement discussions to resolve all outstanding
issues.
25
Item 2. Changes in Securities and Use of Proceeds
Beginning in October 2002, we began an issue of up to $4,000,000 in series
Bridge II Convertible Promissory Notes to accredited investors. We issued
$550,000 in Bridge II notes as of December 31, 2002. During the first nine
months of 2003, we issued an additional $2,918,200 in principal amount of Bridge
II notes. The notes bear interest at a rate of 12% per annum payable at the
maturity date in kind in the form of shares of our common stock. We granted the
holders a junior security position in all of our assets. The notes are
convertible at any time into our common stock. The note conversion price and the
value of common shares paid in kind as interest for the first $1,000,000 in
principal amount of cash subscriptions, determined on a "first come - first
served basis," is $0.10 per share. The note conversion price and the value of
common shares paid in kind as interest for the remaining $3,000,000 of principal
amount of notes in the series is $0.15 per share. The conversion price of the
notes issued during 2002 and those issued during the first nine months of 2003
was less than the market price of the common stock when the notes were issued;
therefore, the holder is considered to have a beneficial conversion feature. We
determined the value of the beneficial conversion feature to be $2,051,200 and
$330,000 at September 30, 2003 and December 31, 2002, respectively. The value
was recorded as a reduction of the debt and will be amortized as additional
interest over the life of the note. We recorded additional interest expense of
$1,652,708 to reflect amortization of the discount for the nine months ended
September 30, 2003. At the time we complete significant additional funding
plans, as outlined in the subscription agreement, each holder of Bridge II notes
is entitled to receive a warrant to purchase one share of our common stock for
each four shares of common stock into which the note is convertible at an
exercise price of $0.15 per share for notes in the class pertaining to the first
$1,000,000 in subscriptions and $0.20 for the remaining $3,000,000 in note
principal subscriptions. Subsequent to September 30, 2003, we issued additional
notes in the Bridge II series. In September 2003 an amendment to the Bridge II
Convertible Promissory Notes was sent to holders requesting an extension of the
notes to July 31, 2004. As additional consideration for the extension, holders
were offered an increase in the interest rate from 12% to 15%. In addition, an
amendment to the indenture offered an increase in the warrant coverage ratio
from 25% to 33%. (See Footnote 9: Subsequent Events)
In June 2003, MDI issued 83,642 shares of restricted common stock in lieu
of unpaid invoices for services owing to a non-employee vendor. MDI valued the
shares at $12,463, which represented the amount of the unpaid invoices.
In July 2003, MDI issued 1,375,000 shares of common stock to non-employees
for past and future financing and consulting services. MDI calculated a fair
value of $495,000 for these shares based on the fair market value of the shares
on the date they were paid. Of the total amount $207,000 is being amortized over
the life of the services contract. In August 2003, MDI issued 107,000 shares of
common stock to a non-employee financial consultant for past financing services.
MDI valued the shares at $51,000.
The above issuances are deemed to be exempt under Rule 506 of Regulation D
and Section 4(2) of the Securities Act of 1933, as amended. No advertising or
general solicitation was employed in offering the securities. The offerings and
sales or issuances were made to a limited number of persons, all of whom were
accredited investors, business associates of the Company or executive officers
of the Company, and transfer was restricted by the Company in accordance with
the requirements of the Securities Act of 1933. In addition to representations
by the above-referenced persons, the Company has made independent determinations
that all of the investors were accredited or sophisticated investors, and that
they were capable of analyzing the merits and risks of their investment, and
that they understood the speculative nature of their investment. Furthermore,
these investors were provided with access to our Securities and Exchange
Commission filings.
Item 3. Defaults upon Senior Securities
MDI has failed to make the required principal and interest payments,
constituting events of default, on the following notes payable:
26
o $2,125,000 in Bridge I convertible promissory notes;
o $3,468,200 in Bridge II convertible promissory notes;
o $618,000 Monsun AS convertible promissory note;
o $211,368 Ungaretti & Harris secured promissory note; and
o $40,000 Trek Diagnostics note payable
The notes payable require the holder to notify MDI in writing of a
declaration of default at which time a cure period, as specified in each
individual note, would commence. There is no guarantee that MDI would be able to
cure any event of default if, or when, the holder provides the required written
notice. Other than the Monsun AS convertible promissory note and the Trek
Diagnostics note payable, which are the subject of legal actions described under
Part II Item 1 above and in Notes to Consolidated Financial Statements, Footnote
10 - Legal Proceedings, MDI has not received any written declarations of default
from holders of outstanding notes payable.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
- ------- -----------
4.40 Form of common stock purchase warrant issued to Dan Burns on August 20,
2003 representing the right to purchase 1,100,000 shares of common
stock of the Company in connection with raising capital for the
Company.
4.41 Form of common stock purchase warrant issued to Dan Burns on September
16, 2003 representing the right to purchase 935,000 shares of common
stock of the Company in connection with raising capital for the
Company.
4.42 Form of common stock purchase warrant issued to David Weissberg on
September 16, 2003 representing the right to purchase 400,000 shares of
common stock of the Company in connection with raising capital for the
Company.
4.43 Form of common stock purchase warrant issued to Reid Jilek on September
2, 2003 representing the right to purchase 500,000 shares of common
stock of the Company in connection with raising capital for the
Company.
10.47 Amendment No.1 to the 12% Convertible Secured Promissory Note issued in
connection with certain Bridge Financing in October 2002.
10.48 Amendment No. 1 to the Indenture issued in connection with certain
Bridge Financing in October 2002
10.49 Form of consulting agreement with Dan Burns and Eugene Martineau for
the purpose of assisting the Company in certain investor relations and
other financial aspects of the Company.
10.50 Form of consulting agreement with Dr. Reid Jilek for the purpose of
assisting the Company with Joint Ventures, licensing agreements,
contracts, and equity and strategic funding sources.
31.1 Section 302 certification by principal executive officer.
27
31.2 Section 302 certification by principal financial officer.
32.1 Section 906 certification by principal executive officer.
32.2 Section 906 certification by principal financial officer.
(b) Reports on Form 8-K
None
28
Signatures
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Molecular Diagnostics, Inc.
/s/ Peter P. Gombrich
---------------------------------------
Peter P. Gombrich
Chairman and Chief Executive Officer
/s/ Dennis L. Bergquist
---------------------------------------
Dennis L. Bergquist
Chief Financial Officer
Date: November 20, 2003
29
EXHIBIT INDEX
30