NANOBAC
June 16, 2005
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
Mail Stop 6010
United States Securities and Exchange Commission
Division of Corporate Finance
450 Fifth Street N.W.
Washington, D.C. 20549
Re: Nanobac Pharmaceuticals, Incorporated
Annual Report on Form 10-KSB for the fiscal year ended
December 31, 2004
File No. 033-80612
Dear Mr. Rosenberg and Ms. Allen:
Pursuant to your request and in connection with the Staff's comment letter dated
June3, 2005 (the "Comment Letter") regarding the above-referenced annual report,
we respectfully submit to you a supplemental response and supporting
documentation regarding the matters described below. Please be advised that we
have simultaneously filed this response on EDGAR under the form type label
CORRESP together with an Amendment to Annual Report (Form 10-KSB/A) for the year
ended December 31, 2004.
Comment 1: Selling, General and Administrative ("SG&A") (page 22)
As noted, the Registrant included within SG&A expenses for the years ended
December 31, 2004 and 2003, $2.6 million and $.75 million, respectively, in
charges for stock issued as part of the Plan of Reorganization, which was
confirmed by the Bankruptcy Court in 2002.
When the Registrant emerged from bankruptcy in November 2002, the stockholders
before the bankruptcy filing were essentially the same as the stockholders of
the emerging entity. Fresh-start accounting is only applicable if the
stockholders before the bankruptcy filing lose control of the entity by
receiving less than 50% of the voting shares of the emerging entity. Accordingly
fresh-start accounting was not utilized.
In December 2002, Registrant acquired 100% of HealthCentrics, Inc. The former
stockholders of HealthCentrics, Inc. were issued approximately 89% of the
outstanding shares of the Registrant. In accordance with GAAP. The Registrant's
acquisition of HealthCentrics, Inc. was accounted for as a reverse merger.
During January 2003, the Registrant's Board of Directors the issuance of 75
million shares of the Registrant's common stock with an aggregate value of
$750,000 to certain
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 2 of 9
Registrant officers in accordance with Plan of Reorganization confirmed by the
Bankruptcy Court. However, this 2003 authorization was subsequent to the
December 2002 reverse merger with HealthCentrics. As a result, management
concluded that a charge for stock issuance should be recorded in the year that
the final authorization was received (2003) and should not predate the reverse
accounting treatment utilized with the 2002 acquisition of HealthCentrics.
During 2004, the bankruptcy attorneys noted that pursuant to the Plan of
Reorganization approved by the Bankruptcy Court, an additional 4.5 million
shares should have been issued to certain stockholders of the Registrant. The
ministerial task of issuing these shares occurred in January 2004. As these
shares were not included in the shares authorized in January 2003 by the Board
of Directors, a separate charge was incurred for this 4.5 million share issuance
based on the value of the shares issued in January 2004.
Based on the above facts and circumstances, management believes that the charges
for stock were appropriately included in 2004 and 2003 Consolidated Statement of
Operations and fresh-start accounting was not applicable to for these charges
when the Registrant emerged from bankruptcy in 2002.
Comment 2: Selling, General and Administrative (page 22)
Management of the Registrant is in agreement with Regulation G and specifically
Question 8 of Frequently Asked questions Regarding the Use of Non-GAAP Financial
Matters, which notes that companies should never use a non-GAAP financial
measure to smooth earnings. Mr. Rosenberg's letter of June 3, 2005 notes the use
of Non-GAAP financial measures in two sections of our Management Discussion and
Analysis of Financial Condition and Results of Operation ("MD&A"). We have
addressed both of these instances below.
SG&A expenses net of charges for stock issuance
The purpose for this disclosure was to provide investors with an explanation for
the nature of SG&A for 2004 and 2003 and an explanation of the large increase
between these two years. The Registrant was not attempting to provide a non-GAAP
financial measure. This reasoning is discussed below.
SG&A expenses increased $2.6 million to 2004 from 2003. The largest component of
this increase was the charge for stock issuances. This charge represented (a)
54% of the 2004 SG&A expense; (b) 35% of the 2003 SG&A expense and (c) 69% of
the increase of SG&A from 2003 to 2004. Accordingly, we concluded that the
disclosure of this large expense in SG&A is necessary in some form. The
Registrant decided the most useful manner to disclose this large, unusual item
was to provide a table including (a) total SG&A, (b) the amount of the charge
for stock issuances in connection with the bankruptcy and (c) SG&A without this
charge. Further, by removing the amount of the bankruptcy stock issuance charge,
the Registrant was more clearly able to disclose the nature of the other SG&A
expenses.
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 3 of 9
Although the charges for stock issuance occurred in 2003 and 2004, these charges
were related to the 2002 bankruptcy and are not expected to recur in the future.
These charges have the following additional attributes:
o The financial impact of these items will disappear in the future -
There will be no further stock issued for the 2002 bankruptcy. The
issuance of stock for other (i.e. non-bankruptcy) services may be
disclosed as a matter of interest, but these transactions would
generally not be considered non-recurring in nature.
o There is an unusual reason to identify the special nature of these
items. The stock issuances related to the 2002 bankruptcy, which was
an unusual and hopefully, a unique event for the Registrant.
Furthermore, as noted above, these expenses were unusually large in
relation to total SG&A expenses.
For the above reason, management believes it is appropriate to highlight these
charges to provide investors with a clear understanding of the nature of SG&A
expenses for 2004 and 2003.
It is important to note that in addition to the above charges for services, the
Registrant settled $269,539 of accrued professional services with stock
issuances in 2004 and an additional $30,175 of stock was issued for services not
connected to the bankruptcy in 2003. These amounts were not included in the
non-GAAP financial measure for SG&A described above as the Registrant does not
consider these items as being non-recurring or unusual in nature.
In order to clarify the above, management has amended the SG&A table and the
related explanations in Form 10-KSB to more clearly show the stock issuance
charge as a component of SG&A and eliminate the appearance of a non-GAAP
financial measure.
Loss from continuing operations excluding non-cash items
The primary reason for separately disclosing this non-GAAP financial measure is
to provide investors with the approximate loss that was settled or will be
settled with cash resources. The following sections of Form 10-KSB note that the
Registrant's continuation as a going concern is dependent on receiving
financing:
o Liquidity and Capital Resources (page 26)
o Risk factors (pages 30 and 31)
o Note 1 to the Financial Statements - Liquidity and Management Plans
(page F-7)
o Independent Auditors' Report (Page F-1)
As the Registrant's cash requirements is a primary issue of the Registrant, many
investors are interested in the amount of cash being used by the Registrant
during each reporting period (i.e. "Burn Rate"). The consolidated statements of
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 4 of 9
cash flows provide significant information in this regard. However, management
attempted to enhance this disclosure by disclosing the approximate amount of the
continuing loss that was settled or will be settled with cash resources.
Management believes this was particularly appropriate for 2004 as the cash used
for investing and financing activities was not significant.
Management believes the disclosure of the above non-GAAP financial measure is
appropriate at this point of the Registrant's existence. However, the Registrant
has amended Form 10-KSB to provide the following additional disclosures:
o The economic substance behind the decision to use such a measure
o The material limitations associated with the use of non-GAAP
financial measure as compared to the use of the most directly
comparable GAAP financial measure
o The substantive reasons why this non-GAAP financial measure provides
useful information to investors.
Comment 3: Intangible Assets and Goodwill (page 7)
As noted, the Registrant has a significant amount of intangible assets
consisting of patents and product rights. The details of these two assets are
provided in Note 5, Intangible Assets. Each of these two assets consists of a
single component and a disaggregation is not applicable.
Product Rights
For the June 2004 acquisition of NanobacLabs, the Registrant engaged an
independent valuation firm to assist in the valuation of the assets acquired. As
a result of this valuation, $1,350,000 of the purchase price was assigned to
Product Rights. This valuation assigned this value to a single product
identified as Nanobac TX. This product was reconstituted in 2004 as Nanobac
Supplement as described on page 21 of the MD&A. As the value of product rights
is for a single product, disaggregation is not applicable.
Patents
During November 2003 the Registrant acquired a majority interest in Nanobac OY.
The minority interests in Nanobac OY were acquired in January and March 2004. At
the time of acquisition, Nanobac OY's operations were minimal and the value of
this company was deemed to be in their patents. Upon closer examination it was
noted that only one patent had significant market value for the eradication of
nanobacteria. This patent was assigned a value of $5.2 million as a result of
the acquisition of Nanobac OY. This patent has significant value and management
believes it will be the cornerstone for the Registrant's future success.
Two other patents were owned by Nanobac OY at the time of acquisition. One of
these patents is not being used or supported by the Registrant. The other patent
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 5 of 9
for the detection of nanobacteria expires in 2009. At the time of acquisition,
management did not believe that this patent would generate funds prior to its
expiration.
Based on the above, the patent value is assigned to a single patent. Being a
small company with less than 15 employees, the Registrant had a single research
program to utilize the value of this patent for the eradication of nanobacteria.
Accordingly, disaggregation is not applicable.
Comment 4: Net Loss per Share (page F-8)
Management believes the Registrant's financial statements should not include
"Treasury stock which could be purchased" in Note 1 on Page F-8. Form 10-KSB has
been amended to eliminate this presentation.
Comment 5: Nanobac OY (page F-12)
In our November 11, 2003 Form 8-K, the Registrant noted that financial
statements for Nanobac OY would be filed as soon as practical. After this Form
8-K was filed, the Registrant discovered that financial statements were not
required to be filed for Nanobac OY as the investment, total assets and income
from continuing operations of Nanobac OY were less than 20% of the Registrant's
assets and income from continuing operations (as applicable) as follows: Total
Assets
Nanobac OY @ Dec 31, 2002 $477,455
Registrant @ Dec 31, 2002 (*) $6,127,449
Nanobac OY's assets as a percentage
----------------
of Registrant's assets 7.8%
================
Income from Continuing Operations
Nanobac OY for year ended Dec 31, 2002 ($348,819)
Registrant for year ended Dec 31, 2002 (*) ($1,803,903)
Nanobac OY's income as a percentage
----------------
of Registrant's income 19.3%
================
Investment
Investment in Nanobac OY $818,045
Total assets of Registrant @ Dec 31, 2002 (*) $6,127,449
Investment in Nanobac OY as a percentage
----------------
of Registrant's assets 13.4%
================
(*) Includes the acquisition of NanobacLabs Pharmaceuticals, inc. in June 2003
for which financial statements were filed on Form 8-K dated June 4, 2003.
Based on the above, financial statements were not required pursuant to Item
9.01.
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 6 of 9
Comment 6: Common Stock, Preferred Stock and Warrant Issues (page F-18)
The Registrant's support for the accounting treatment of the stock issued upon
entering into the 2004 Subscription agreements is as follows:
Facts:
The Registrant entered into four stock subscription agreements in 2004. These
agreements provide for investments of an aggregate of $1,000,000, $250,000
$300,000 and $1,000,000 from four investors, one of whom is a related party.
The number of shares to be issued equals a fixed purchase price of the lesser
of:
a) $.12
b) 52% of the average closing price 5 days prior to the date on which a
registration statement becomes effective (the "Effective Date").
The lesser of a) or b) is referred to as the fixed price.
The purchase price is payable in two traunches:
o 50% immediately (aggregate proceeds received through December 31,
2004 were t 6 12 $1,275,000)
o The balance within 5 days of the Effective date.
Authoritative Guidance:
EITF 00-19, Accounting for derivative financial instruments indexed to, and
potentially settled in, a Company's own stock and SFAS 150, Accounting for
certain financial instruments with characteristics of both liabilities and
equity
Contracts would initially be classified as equity or as either assets or
liabilities, in the following situations.
Equity
o Contracts that require a net-share settlement
o Contracts that give the Company the choice of net-cash or settlement
in its own shares presuming all equity criteria met.
Assets or liabilities
o Contracts that require net-cash settlement (including a requirement
to net cash settle the contract if an event occurs and if that event
is outside company control).
For public companies, contracts that require the Company deliver cash as part of
a physical settlement should be initially measured at fair value and reported in
permanent equity with the cash redemption amount transferred to temporary
equity. However, certain equity conditions must be present.
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 7 of 9
While several criteria for equity classification are met, all must be met to
classify as equity.
1. Settlement in unregistered shares permitted (P. 14)
2. The contract provides for Refund provisions in the event the Company
is unable to deliver registered shares (P. 17)
3. Sufficient authorized and unissued shares
4. Contract contains an explicit limit on the shares to be delivered in
a share settlement. (P. 20)
If the number of shares that could be required to be delivered to net share
settle the Contract is indeterminate, a company will be unable to conclude that
it has sufficient available authorized and unissued shares and, therefore, net
share settlement is not within the control of the Company.
The above statement is specifically on point as the number of shares to be
delivered is the lesser of $.12 or 52% of the 5-day trading average preceding
the effective date. If the market price of the stock were to fall to $.01 the
Registrant would be required to deliver 245 million shares as opposed to 10.625
million shares for traunch one alone.
The EITF clearly states that the liability should be stated at fair value. As
transactions in a company's own stock cannot be recorded in the income
statement, the alternative is other comprehensive income. When settled, the
additional share issuance is equivalent to a constructive dividend.
There should be no accounting for the shares potentially issuable as such shares
are only issuable upon 5 days of the effective date of a registration statement.
This triggering event is out of the control of the company and should therefore
only be recorded when such shares are actually issued.
Based on the above, the amounts received for the subscription agreements through
December 31, 2004 are included as a liability ($1,275,000). In addition, the
fair value of this liability was increased at December 31, 2004 as follows:
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 8 of 9
Shares issued calculation: $ 1,275,000 Proceeds
0.12 Ceiling
Shares issued at subscription 10,625,000
Re-evaluation at December 31, 2004
price of stock 5 days prior $ 0.150
At 52% $ 0.078
Total shares issuable based on Dec 31, 2004
stock price 16,346,154
Additional shares issuable 5,721,154
Fair value:
Stock price for registered trading shares $ 0.150
Applicable discount (based on independent
valuation) 25%
Discount to apply for unregistered securities 0.04
Additional liability $ 643,630
This liability is revalued at each balance sheet date and increases and
decreases will flow through other comprehensive income. When settled, the
amounts will be accounted for as a constructive dividend.
Acknowledgements
The Registrant and its management acknowledge the following:
o The Registrant is responsible for the adequacy and accuracy of the
disclosure in its filings;
o Staff comments or changes to disclosures in response to Staff
comments in the filings reviewed by the staff do not foreclose the
Commission from taking any action with respect to the filing; and
o The Registrant may not assert Staff comments as a defense in any
proceedings initiated by the Commission or any person under the
federal securities laws of the United States.
Nanobac Life Sciences, Inc.
Mr. Jim B Rosenberg, Senior Assistant Chief Accountant
Ms. Christine Allen, Staff Accountant
June 16, 2005
Page 9 of 9
We thank the Staff in advance for its consideration of the foregoing. We would
greatly appreciate the opportunity to discuss this response with you at your
convenience.
Sincerely,
/s/ Michael J Dean
Michael J Dean
Vice President - Finance
Cc: John Stanton, CEO
Darren Ocasio, Sichenzia Ross Friedman Ference LLP
Stacy Patrick, CPA, Aidman, Piser & Company, P.A.