10-Q 1 g71092e10-q.txt SPECTRX, INC. 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ___________ TO ___________ COMMISSION FILE NUMBER: 0-22179 SPECTRX, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 58-2029543 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 6025A UNITY DRIVE NORCROSS, GEORGIA 30071 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE) (770) 242-8723 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. YES [X] NO [ ] The number of outstanding shares of the Registrant's Common Stock, $0.001 par value, as of July 31, 2001, was 10,428,658. 2 SPECTRX, INC. INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION......................................................................... 3 ITEM 1. FINANCIAL STATEMENTS - UNAUDITED BALANCE SHEETS - DECEMBER 31, 2000 AND JUNE 30, 2001............................................ 3 STATEMENT OF OPERATIONS - THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2000 AND 2001....................... 4 STATEMENT OF CASH FLOWS - SIX MONTHS ENDED JUNE 30, 2000 AND 2001........................................ 5 NOTES TO FINANCIAL STATEMENTS............................................................ 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................................. 7 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK............................ 16 PART II. OTHER INFORMATION............................................................................. 17 ITEM 1. LEGAL PROCEEDINGS..................................................................... 17 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS............................................. 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................... 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................................................... 18 SIGNATURES............................................................................................. 19 EXHIBIT INDEX.......................................................................................... 20
3 PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SPECTRX, INC. BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, JUNE 30, 2000 2001 UNAUDITED ------------ --------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 3,609 $ 12,171 Accounts receivable 1,259 542 Inventory 481 581 Other current assets 377 369 -------- -------- Total Current Assets 5,726 13,663 -------- -------- PROPERTY & EQUIPMENT, Net 894 768 -------- -------- OTHER ASSETS 528 543 -------- -------- TOTAL ASSETS $ 7,148 $ 14,974 ======== ======== LIABILITIES & STOCKHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 1,020 $ 1,457 Accrued liabilities 1,262 1,062 -------- -------- Total Current Liabilities 2,282 2,519 -------- -------- COLLABORATIVE PARTNER ADVANCE 381 381 -------- -------- REDEEMABLE CONVERTIBLE PREFERRED STOCK 5,579 5,737 -------- -------- CONTINGENCIES (NOTE 5) STOCKHOLDERS' EQUITY (DEFICIT) Common stock 9 10 Additional paid-in-capital 30,927 42,185 Accumulated deficit (31,999) (35,827) Notes receivable from officers (31) (31) -------- -------- Total Stockholders' Equity (Deficit) (1,094) 6,337 -------- -------- TOTAL LIABILITIES & STOCKHOLDERS' EQUITY $ 7,148 $ 14,974 ======== ========
The accompanying notes are an integral part of the financial statements. 4 SPECTRX, INC. UNAUDITED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS SIX MONTHS ENDED JUNE 30 ENDED JUNE 30 2000 2001 2000 2001 -------- -------- -------- -------- REVENUE Product sales $ 552 $ 635 $ 1,113 $ 1,156 Collaborative agreements 249 0 749 100 -------- -------- -------- -------- 801 635 1,862 1,256 -------- -------- -------- -------- EXPENSES Cost of sales 410 506 940 1,007 Research & development 1,679 636 3,234 2,208 Sales & marketing 243 197 461 374 General & administrative 724 698 1,243 1,415 -------- -------- -------- -------- Total 3,056 2,037 5,878 5,004 -------- -------- -------- -------- Operating loss (2,255) (1,402) (4,016) (3,748) OTHER INCOME 0 2 21 2 INTEREST INCOME 101 40 170 76 -------- -------- -------- -------- NET LOSS (2,154) (1,360) (3,825) (3,670) PREFERRED STOCK DIVIDENDS (79) (79) (158) (158) -------- -------- -------- -------- Loss available to common stockholders $ (2,233) $ (1,439) $ (3,983) $ (3,828) ======== ======== ======== ======== NET (LOSS) PER SHARE BASIC $ (0.26) $ (0.16) $ (0.48) $ (0.44) ======== ======== ======== ======== DILUTED $ (0.26) $ (0.16) $ (0.48) $ (0.44) ======== ======== ======== ======== WEIGHTED AVERAGE COMMON STOCK OUTSTANDING BASIC 8,477 9,048 8,366 8,781 ======== ======== ======== ======== DILUTED 8,477 9,048 8,366 8,781 ======== ======== ======== ========
The accompanying notes are an integral part of the financial statements. 5 SPECTRX, INC. UNAUDITED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
SIX MONTHS ENDED JUNE 30, 2000 2001 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (3,825) $ (3,670) -------- -------- Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 199 183 Amortization of deferred compensation 38 0 Changes in assets and liabilities: Accounts receivable 521 717 Inventory 176 (100) Other current assets (207) 8 Other assets (15) (15) Accounts payable 123 437 Accrued liabilities 100 (200) -------- -------- Total adjustments 935 1,030 -------- -------- Net cash used in operating activities (2,890) (2,640) -------- -------- CASH FLOW FROM INVESTING ACTIVITIES: Additions to property and equipment (332) (57) -------- -------- Net cash used in investing activities (332) (57) -------- -------- CASH FLOW FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock (net of issuance costs) 4,912 11,259 Proceeds from issuance of redeemable convertible preferred stock 2,500 0 -------- -------- Net cash provided by financing activities 7,412 11,259 -------- -------- NET INCREASE IN CASH AND CASH EQUIVALENTS 4,190 8,562 CASH AND CASH EQUIVALENTS, beginning of period 2,143 3,609 -------- -------- CASH AND CASH EQUIVALENTS, end of period $ 6,333 $ 12,171 ======== ========
The accompanying notes are an integral part of the financial statements. 6 SPECTRX, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The unaudited interim financial statements included herein have been prepared by SpectRx. These statements reflect all adjustments, all of which are of a normal, recurring nature, which are, in the opinion of management, necessary to present fairly the consolidated financial position as of June 30, 2001, the consolidated results of operations for the three months and six months ended June 30, 2000 and 2001, and the consolidated cash flows for the six months ended June 30, 2000 and 2001. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. Preparing financial statements requires that our management make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results could differ from those estimates. Our accounting policies continue unchanged from December 31, 2000. These financial statements should be read in conjunction with the December 31, 2000 financial statements and notes thereto included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 2, 2001. The results of operations for the three and six months ended June 30, 2000 and 2001 are not necessarily indicative of the results for a full fiscal year. 2. FLUORRX In December 1996, we sublicensed certain technology to and acquired a 64.8% interest in FluorRx, Inc., a corporation organized for the purpose of developing and commercializing technology related to fluorescence spectroscopy. Our interest in FluorRx is represented by two seats on the board of directors and 129,000 shares of convertible preferred stock purchased for $250,000. In December 1997, March 1998, August 1998, and April 1999 FluorRx sold additional convertible preferred stock for net cash proceeds of $521,000, $429,000, $511,000 and $300,000 respectively. The issuance of additional preferred stock reduced our ownership (on an as converted basis) to 43%. Effective with the August 1998 funding, we began accounting for its investment in FluorRx under the equity method of accounting. In connection therewith, we began suspending the equity losses from our investment in FluorRx. The accompanying statement of operations for the three months and six months ended June 30, 2001 excludes $15,000 in income and $19,510 in losses respectively which represents our 43% equity in the losses of FluorRx. Cumulative suspended equity losses as of June 30, 2001 amounted to $1,519,906. 3. COMPREHENSIVE INCOME We currently have no other comprehensive income items as defined by Statement of Financial Accounting Standards ("SFAS") No. 130. 4. RECENT ACCOUNTING PRONOUNCEMENTS The Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," in June 1998, SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133," in June 1999 and SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities - an Amendment of FASB Statement No. 133," in June 2000. SFAS No. 133 establishes accounting and reporting standards for derivatives and hedges. It requires that all derivatives be recognized as other assets or liabilities at fair value and established specific criteria for the use of hedge accounting. SFAS No. 137 defers the effective date of SFAS No. 133 by one year to fiscal years beginning after June 15, 2000. SFAS No. 138 amends accounting and reporting standards for SFAS No. 133 for certain derivative instruments and certain hedging activities. We adopted these statements with no material impact to our results of operations or financial position as we do not have any material derivative instruments. The FASB issued SFAS No. 141, "Accounting for Business Combinations," on June 30, 2001. It requires that all business combinations initiated after June 30, 2001 be accounted for using the purchase method of accounting. The FASB issued SFAS No. 142, "Accounting for Goodwill and Other Intangible Assets," on June 30, 2001. It requires that goodwill and certain intangible assets will no longer be subject to amortization, but instead will be subject to a periodic impairment assessment by applying a fair-value based test. Our required adoption date is January 1, 2002. Adoption of SFAS No. 142 will not have a material impact on our results of operations or financial position. 5. LITIGATION We are involved in certain litigation arising in the ordinary course of business. In management's opinion, the ultimate resolution of these matters will not have a material adverse effect on our financial position or results of operations. See Part II, Item 1, "Legal Proceedings," for disclosure of significant litigation matters. 6. FINANCING In June 2001, we announced that we had completed two private placements. On June 4, 2001, we entered into an agreement with affiliates of SAFECO Corporation, which invested about $9.5 million in SpectRx before transaction expenses. On June 13, 2001, we entered into an agreement with affiliates of Special Situations Fund, which invested about $2.5 million in SpectRx before transaction expenses. The financings consisted, in total, of sales of about 1.9 million shares of common stock and warrants to purchase 379,127 shares of common stock. Under the terms of the agreements, each share of common stock was sold at a price of $6.319 per share, which represented a discount from the market price of our common stock on the dates these transactions closed. The first transaction, funded on June 4, 2001, involved the private placement of 1.5 million shares of common stock. The second transaction, funded on June 13, 2001, involved the private placement of 395,633 shares of common stock. The combination of these two transactions resulted in proceeds to SpectRx of about $12 million before transaction expenses. The 1,895,633 shares issued in these transactions constitute 22.2% of our common stock outstanding prior to the first private placement transaction. In addition, the purchasers of common stock also received warrants to purchase an aggregate of 379,127 shares of common stock for $9.8874 per share. These warrants expire on the fifth anniversary of their issuance date. The warrants are valued at $1.7 million and are included in additional paid-in capital in the accompanying balance sheet. Under Nasdaq Marketplace Rules, stockholder approval is required for a transaction that results in 20% or more of the common stock or voting power of SpectRx being sold for less than the greater of the book or market value of our common stock. Nasdaq has informed us that these two transactions should be aggregated for the purposes of this rule and that we should have received stockholder approval prior to closing the second transaction, which caused us to exceed the 20% threshold. To satisfy Nasdaq's requirements, we have entered into contracts to repurchase 198,905 of the shares sold in this transaction, as well as associated warrants to purchase 39,781 shares, including a return of about $1.3 million to the Special Situations Fund affiliates, unless we obtain stockholder approval. We are currently in the process of obtaining stockholder approval of those issuances and absent such approval will repurchase the shares and warrants subject to the agreements. It is the opinion of management that stockholder approval will be obtained. 7. REDEEMABLE CONVERTIBLE PREFERRED STOCK We issued $5.25 million of redeemable convertible preferred stock in November 1999 in conjunction with the execution of an amendment to our agreement with Abbott. Dividends are accrued on the preferred stock at a rate of 6% per year and total $79,000 for the second quarter of 2001, $158,000 for the six months ended June 30, 2001 and $512,000 since issuance. The related dividends are included in redeemable convertible preferred stock in the accompanying balance sheets. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements in this report which express "belief", "anticipation" or "expectation" as well as other statements which are not historical facts are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under "Risk Factors" in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in or incorporated by reference into this report. Examples of these uncertainties and risks include, but are not limited to: - whether our products in development will prove safe and effective; - whether and when we or our strategic partners will obtain approval from the Food and Drug Administration, or FDA, and corresponding foreign agencies; - our need to achieve manufacturing scale-up in a timely manner, and our need to provide for the efficient manufacturing of sufficient quantities of our products; - the lack of immediate alternate sources of supply for some critical components of our products; - our patent and intellectual property position; - the need to fully develop the marketing, distribution, customer service and technical support and other functions critical to the success of our potential product lines; - the effectiveness and ultimate market acceptance of our products; - the dependence on our strategic partners for funding, development assistance, clinical trials, distribution and marketing of products developed by us; and - other risks and uncertainties described from time to time in our reports filed with the Securities and Exchange Commission, including those contained in our Annual Report on Form 10-K for the year ended December 31, 2000, and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. The following discussion should be read in conjunction with our financial statements and notes thereto included elsewhere in this report. OVERVIEW We were incorporated on October 27, 1992, and since that date we have raised capital through the sale of preferred stock, issuance of debt securities, public and private sales of common stock and funding from collaborative arrangements. Following our initial funding in early 1993, we immediately began research and development activities with the objective of commercializing less invasive diagnostic, screening and monitoring products. As part of our business strategy, we have established arrangements with leading medical device companies for the development, commercialization and introduction of our products. We have entered into collaborative arrangements with Respironics, Inc. for our infant jaundice product, with Welch Allyn, Inc. for our cancer detection product, with Abbott Laboratories for our glucose monitoring products, and with Roche Diagnostics for our diabetes detection product. In December 1996, we sublicensed specified technology to and acquired a 64.8% interest in FluorRx, Inc., a Delaware corporation formed for the purpose of developing and commercializing technology related to fluorescence spectroscopy. At June 30, 2001, as a result of subsequent financings, our interest in FluorRx was 43%. We have a limited operating history upon which our prospects can be evaluated. Our prospects must be considered in light of the substantial risks, expenses and difficulties encountered by entrants into the medical device industry. This industry is characterized by an increasing number of participants, intense competition and a high failure rate. We have experienced operating losses since our inception, and, as of June 30, 2001, we had an accumulated deficit of about $35.8 million. To date, we have engaged primarily in research and development efforts. We first generated revenues from product sales in 1998, but do not have significant experience in manufacturing, marketing or selling our products. Our development efforts may not result in commercially viable products, and we may not be successful in introducing our products. Moreover, required regulatory clearances or approvals may not be obtained in a timely manner, or at all. Our products may not ever gain market acceptance, and we may not ever generate significant revenues or achieve profitability. The development and commercialization of our products will require substantial development, regulatory, sales and marketing, manufacturing and other expenditures. We expect our operating losses to continue through 2001 as we continue to expend substantial resources to complete development of our products, obtain regulatory clearances or approvals, build our marketing, sales, manufacturing and finance organizations and conduct further research and development. 8 The majority of our revenues and profits are expected to be derived from royalties and manufacturing profits that we will receive from Abbott, Roche and Respironics resulting from sales of the products for which we have collaborative arrangements with each of these companies. The royalties and manufacturing profits that we expect to receive from each of our collaborative partners depend on sales of these products. We and our collaborative partners may not be able to sell sufficient volumes of our products to generate substantial royalties and manufacturing profits for us. We have entered into collaborative arrangements with Respironics, Welch Allyn, Abbott and Roche. The agreements evidencing these collaborative arrangements grant a substantial amount of discretion to each collaborative partner. If one or more of our collaborative partners were to terminate their arrangement with us, we would either need to reach agreement with a replacement collaborative partner or undertake, at our own expense, the activities previously handled by our collaborative partner. This would require us to develop expertise we do not currently possess, would significantly increase our capital requirements and would limit the programs we could pursue. We would likely encounter significant delays in introducing our products, and the development, manufacture and sales of our products would be adversely affected by the absence of collaborative arrangements. QUARTER OVERVIEW In April 2001, we announced that Abbott Laboratories had assumed financial responsibility for the continuous glucose monitoring program. Prior to April 1, 2001, we had been paying part of the development costs for the program. Also in April 2001, we announced that we had received a grant of about $100,000 from the National Cancer Institute for our non-invasive cervical cancer detection program. In May 2001, we announced that a study had been published in the Journal of Lower Genital Tract Disease, which reported that a prototype of a non-invasive cervical cancer detection device being jointly developed by Welch-Allyn and us, detected 25% more disease than Pap tests. We also announced in May that there had been issued a warning by the Joint Commission on Accreditation of Healthcare Organizations, referred to as JCAHO, that severe cases of infant jaundice or kernicterus can threaten otherwise healthy babies. Among the recommendations JCAHO made were increases in screening infants before hospital discharge and allowing nurses to order non-invasive tests, like our BiliChek(TM), product for jaundiced newborns. In June 2001, we announced that we had completed two private placements of, in total, 1.9 million common shares and warrants for the purchase of 379,000 common shares for about $12 million in gross proceeds. We are currently in the process of obtaining stockholder approval of those issuances and absent such approval will repurchase a portion of the shares and warrants for about $1.3 million. We also announced in June 2001 that a study published in the journal Pediatrics showed that the BiliChek Non-invasive Bilirubin Analyzer, in a multi-site clinical study, performed as well as the blood test when measuring bilirubin in newborns. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED JUNE 30, 2001 AND 2000. General. Net loss available to common stockholders decreased to $1.4 million during the three months ended June 30, 2001 as compared to $2.2 million during the same period in 2000 due to a decrease in expenses primarily as a result of Abbott funding our continuous glucose monitoring product research during the second quarter in 2001. We expect net losses to continue. Revenue. We have historically received the majority of our revenue from achieving development milestones with one or more of our strategic partners. We began shipping our infant jaundice product to distributors outside of the United States and Canada during the quarter ended June 30, 1998, and were able to ship in the United States after FDA approval was received at the end of the first quarter of 1999. In March 2000, we shipped the first Accu-Check(TM) D-Tector(TM) units, which have been used in clinical trials. Product revenue increased to $635,000 for the quarter ended June 30, 2001 from $552,000 for the same period in 2000. Product revenue is higher for the 2001 quarter than for the comparable period in 2000, even though there were no Accu-Check D-Tector units shipped in 2001, due to the increase in revenues from our BiliChek products. There were increases in BiliChek sales, transdermal sales and licensing revenue. Collaborative agreements revenue, which is event-based rather than sales-based, decreased to $0 during the three months ended June 30, 2001 from $249,000 during the same period in 2000 primarily due to the milestones accomplished on our Bilirubin device and also the Accu-Check D-Tector in 2000. Cost of Sales. Cost of sales increased to $506,000 for the three months ended June 30, 2001 from $410,000 during the same period in 2000. While the cost of sales increase is directly related to increased product revenue, a portion of the cost of sales represents excess capacity production charges, which were slightly higher for this period than in 2000. Also, the product mix shifted more toward U.S. sales, which have a lower margin than international sales. We expect excess capacity to exist at least for the remainder of this year. 9 Research and Development Expenses. Research and development expenses decreased to $636,000 for the three months ended June 30, 2001 compared to $1,679,000 for the same period in 2000. The decrease in research and development expenses was primarily due to Abbott's reimbursement of expenses associated with our continuous glucose monitoring product. We expect research and development expenses to remain at a high level this year as we continue development and expand clinical trials for our products. Sales and Marketing Expenses. Sales and marketing expenses decreased to $197,000 during the three months ended June 30, 2001 from $243,000 during the same period in 2000, due mainly to the design and printing costs for a sales brochure in the 1st quarter of 2000 and limited costs associated with trade shows in 2001 versus 2000. Marketing expenses are expected to increase in the future as BiliChek sales expand geographically. General and Administrative Expenses. General and administrative expenses decreased to $698,000 during the three months ended June 30, 2001 compared to the $724,000 incurred during the same period in 2000. The decrease is primarily due to decreased legal fees. General and administrative expenses are expected to increase in the future. Net Interest and Other Income. Net interest and other income decreased to $42,000 during the three months ended June 30, 2001 from $101,000 during the same period in 2000. This decrease is due to a lesser amount of interest being earned on smaller cash average balances. COMPARISON OF THE SIX MONTHS ENDED JUNE 30, 2001 AND 2000. General. Net loss available to common stockholders decreased to $3.8 million during the six months ended June 30, 2001 as compared to $4.0 million during the same period in 2000 due to decreases in operating expenses and increases in product revenues, offset by decreases in collaborative agreement milestones. Revenue. We have historically received the majority of our revenue from achieving development milestones with one or more of our strategic partners. We began shipping our infant jaundice product to distributors outside of the United States and Canada during the quarter ended June 30, 1998, and were able to ship in the United States after FDA approval was received at the end of the first quarter of 1999. In March 2000, we shipped the first Accu-Check D-Tector units, which have been used in clinical trials. Product revenue increased to $1.2 million for the six months ended June 30, 2001 from $1.1 million for the same period in 2000. Product revenue increased for the six months of 2001 from the comparable period of 2000 even though we did not have any revenues from our Accu-Check D-Tector units which were used in clinical trials and totaled $211,000 in 2000. There were increases in BiliChek sales, transdermal sales and licensing revenue. Collaborative agreements revenue, which is event-based rather than sales-based, decreased to $100,000 during the six months ended June 30, 2001 from $749,000 during the same period in 2000. The milestones accomplished in the first six months of 2000 were on our continuous glucose monitoring device, a smaller milestone received on our Bilirubin device, and a milestone received on our Accu-Check D-Tector device. Cost of Sales. Cost of sales increased to $1.0 million for the six months ended June 30, 2001 from $940,000 during the same period in 2000. While the cost of sales increase is directly related to increased product revenue, it also reflects the growth of our U.S. market and BiliCal(TM) disposable sales, which have a lesser margin than the BiliChek device. Research and Development Expenses. Research and development expenses decreased to $2.2 million for the six months ended June 30, 2001 compared to $3.2 million for the same period in 2000. The research and development expenses primarily relate to research in glucose monitoring and cancer detection, including costs to conduct clinical trials, salaries, consulting and contracted research for our developmental products. Expenditures decreased mainly due to the reimbursement from Abbott for expenditures relating to our continuous glucose monitoring product. We expect research and development expenses to remain at a high level this year as we continue development and expand clinical trials for our products. Sales and Marketing Expenses. Sales and marketing expenses decreased to $374,000 during the six months ended June 30, 2001 from $461,000 during the same period in 2000, due mainly to the design and printing costs for a sales brochure in the first quarter of 2000 and reduction of trade show expenses in the second quarter of 2001. 10 General and Administrative Expenses. General and administrative expenses increased to $1.4 million during the six months ended June 30, 2001 compared to the $1.2 million during the same period in 2000. The increase is primarily due to increased public relations costs, increased legal fees and increased legal expenses made to maintain exclusivity of certain patents and were made during the first quarter of 2001. Net Interest and Other Income. Net interest and other income decreased to $78,000 during the six months ended June 30, 2001 from $191,000 during the same period in 2000. This decrease is due to a lesser amount of interest being earned on smaller average cash balances. LIQUIDITY AND CAPITAL RESOURCES We have financed our operations since inception primarily through private sales of debt and private and public sales of our equity securities. From October 27, 1992 (inception) through June 30, 2001, we received approximately $47.9 million in proceeds from sales of our debt and equity securities. At June 30, 2001, we had cash of approximately $12.2 million and working capital of approximately $11.1 million. We completed an initial public offering of our common stock on July 7, 1997, which resulted in net proceeds received by us, before expenses related to the transaction, of approximately $14.0 million. We issued $5.25 million of redeemable convertible preferred stock in November 1999 in conjunction with the execution of amendment to our agreement with Abbott. We issued common stock in a private placement in February 2000, which resulted in gross proceeds of $5.0 million. We issued common stock and warrants in two private placements in June 2001, which resulted in net proceeds of approximately $11.2 million, although we may repurchase a portion of these securities for $1.3 million. Our major cash flows in the year 2001 consisted of cash out-flow of $2.6 million from operations and $57,000 in additions to property and equipment, and cash inflow of $11.3 million from sales of our common stock. In addition to funds that we expect to be provided by our collaborative partners and the funds we recently raised, we may be required to raise additional funds through public or private financing, additional collaborative relationships or other arrangements. We believe our existing and available capital resources plus anticipated milestone payments will be sufficient to satisfy our funding requirements through 2002. We currently invest our excess cash balances primarily in short-term, investment-grade, interest-bearing obligations or direct or guaranteed obligations of the U.S. government until such funds are utilized in operations. Substantial capital will be required to develop our products, including completing product testing and clinical trials, obtaining all required United States and foreign regulatory approvals and clearances, and commencing and scaling up manufacturing and marketing our products. Any failure of our collaborative partners to fund our development expenditures would have a material adverse effect on our business, financial condition and results of operations. RISK FACTORS The following risk factors should be considered carefully in addition to the other information presented in this report. This report contains forward looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward looking statements. Factors that might cause such differences include, but are not limited to, the following risk factors: WE HAVE A SHORT OPERATING HISTORY, WHICH MAKES IT DIFFICULT FOR YOU TO EVALUATE OUR BUSINESS. Because limited historical information is available on our operations, it will be difficult for you to evaluate our business. Our prospects must be considered in light of the substantial risks, expenses, uncertainties and difficulties encountered by entrants into the medical device industry, which is characterized by increasing intense competition and a high failure rate. 11 WE HAVE A HISTORY OF LOSSES, AND WE EXPECT LOSSES TO CONTINUE FOR SEVERAL YEARS. We have never been profitable, and we have had operating losses since our inception. We expect our operating losses to continue as we continue to expend substantial resources to complete development of our products, obtain regulatory clearances or approvals, build our marketing, sales, manufacturing and finance organizations, and conduct further research and development. To date, we have engaged primarily in research and development efforts. The further development and commercialization of our products will require substantial development, regulatory, sales and marketing, manufacturing and other expenditures. We have only generated limited revenues from product sales. Our accumulated deficit was about $35.8 million at June 30, 2001. OUR ABILITY TO SELL OUR PRODUCTS IS CONTROLLED BY GOVERNMENT REGULATIONS, AND WE MAY NOT BE ABLE TO OBTAIN ANY NECESSARY CLEARANCES OR APPROVALS. The design, manufacturing, labeling, distribution and marketing of our products are and will be subject to extensive and rigorous government regulation, which can be expensive and uncertain and can cause lengthy delays before we can begin selling our products. IN THE UNITED STATES, THE FOOD AND DRUG ADMINISTRATION'S ACTIONS COULD DELAY OR PREVENT OUR ABILITY TO SELL OUR PRODUCTS, WHICH WOULD ADVERSELY AFFECT OUR GROWTH AND STRATEGY PLANS. In order for us to market our products in the United States, we must obtain clearance or approval from the Food and Drug Administration, or FDA. We cannot be sure: - that we or our collaborative partners will make timely filings with the FDA; - that the FDA will act favorably or quickly on these submissions; - that we will not be required to submit additional information or perform additional clinical studies; - that we would not be required to submit an application for premarket approval, rather than a premarket notification submission as described below; or - that other significant difficulties and costs will not be encountered to obtain FDA clearance or approval. The premarket approval process is more rigorous and lengthier than the clearance process for premarket notifications; it can take several years from initial filing and require the submission of extensive supporting data and clinical information. For example, Roche previously filed a premarket notification for our diabetes detection product, which was withdrawn when the FDA indicated that this product should be submitted for premarket approval, including submission of clinical study data. We do not have any other premarket notifications or premarket approval applications pending, but we currently believe our other cancer detection product and our glucose monitoring products will require submission of applications for premarket approval. The FDA may impose strict labeling or other requirements as a condition of its clearance or approval, any of which could limit our ability to market our products. Further, if we wish to modify a product after FDA clearance of a premarket notification or approval of a premarket approval application, including changes in indications or other modifications that could affect safety and efficacy, additional clearances or approvals will be required from the FDA. Any request by the FDA for additional data, or any requirement by the FDA that we conduct additional clinical studies or submit to the more rigorous and lengthier premarket approval process, could result in a significant delay in bringing our products to market and substantial additional research and other expenditures. Similarly, any labeling or other conditions or restrictions imposed by the FDA on the marketing of our products could hinder our ability to effectively market our products. Any of the above actions by the FDA could delay or prevent altogether our ability to market and distribute our products. Further, there may be new FDA policies or changes in FDA policies that could be adverse to us. IN FOREIGN COUNTRIES, INCLUDING EUROPEAN COUNTRIES, WE ARE ALSO SUBJECT TO GOVERNMENT REGULATION, WHICH COULD DELAY OR PREVENT OUR ABILITY TO SELL OUR PRODUCTS IN THOSE JURISDICTIONS. In order for us to market our products in Europe and some other international jurisdictions, we and our distributors and agents must obtain required regulatory registrations or approvals. We must also comply with extensive regulations regarding safety, efficacy and quality in those jurisdictions. We may not be able to obtain any required regulatory registrations or approvals, or we may be required to incur significant costs in obtaining or maintaining such regulatory registrations or approvals we receive. Delays in obtaining any registrations or approvals required to market our products, failure to receive these registrations or approvals, or future loss of previously obtained registrations or approvals would limit our ability to sell 12 our products internationally. For example, international regulatory bodies have adopted various regulations governing product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. These regulations vary from country to country. In order to sell our products in Europe, we must maintain ISO 9001 certification and CE mark certification, which is an international symbol of quality and compliance with applicable European medical device directives. Failure to receive or maintain ISO 9001 certification of meeting standards of quality or CE mark certification or other international regulatory approvals would prevent us from selling in Europe. EVEN IF WE OBTAIN CLEARANCE OR APPROVAL TO SELL OUR PRODUCTS, WE ARE SUBJECT TO ONGOING REQUIREMENTS AND INSPECTIONS THAT COULD LEAD TO THE RESTRICTION, SUSPENSION OR REVOCATION OF OUR CLEARANCE. We and our collaborative partners will be required to adhere to applicable FDA regulations regarding good manufacturing practice, which include testing, control, and documentation requirements. We are subject to similar regulations in foreign countries. Ongoing compliance with good manufacturing practice and other applicable regulatory requirements will be strictly enforced in the United States through periodic inspections by state and federal agencies, including the FDA, and in international jurisdictions by comparable agencies. Failure to comply with these regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure to obtain premarket clearance or premarket approval for devices, withdrawal of approvals previously obtained, and criminal prosecution. The restriction, suspension or revocation of regulatory approvals or any other failure to comply with regulatory requirements would limit our ability to operate and could increase our costs. SINCE WE WILL RELY PRINCIPALLY ON OUR COLLABORATIVE PARTNERS TO OBTAIN AND MAINTAIN OUR REGULATORY APPROVALS, ANY FAILURE OF OUR COLLABORATIVE PARTNERS TO PERFORM COULD HURT OUR OPERATIONS. Because they have primary responsibility for regulatory compliance, the inability or failure of our collaborative partners to comply with the varying regulations, or the imposition of new regulations, would limit our ability to produce and sell our products. We will solely rely upon Abbott, Roche and Respironics to obtain United States and international regulatory approvals and clearances for our glucose monitoring, diabetes detection and infant jaundice products. We and Welch Allyn will jointly seek regulatory approvals for our cervical cancer detection product, but we do not have control over the timing or amount of resources Welch Allyn devotes to these activities. OUR SUCCESS LARGELY DEPENDS ON OUR ABILITY TO OBTAIN AND PROTECT THE PROPRIETARY INFORMATION ON WHICH WE BASE OUR PRODUCTS. Our success depends in large part upon our ability to establish and maintain the proprietary nature of our technology through the patent process, as well as our ability to license from others patents and patent applications necessary to develop our products. If any of our patents are successfully challenged, invalidated or circumvented, or our right or ability to manufacture our products were to be proscribed or limited, our ability to continue to manufacture and market our products could be adversely affected. In addition to patents, we rely on trade secrets and proprietary know-how, which we seek to protect, in part, through confidentiality and proprietary information agreements. The other parties to these agreements may breach these provisions, and we may not have adequate remedies for any breach. Additionally, our trade secrets could otherwise become known to or be independently developed by competitors. We have been issued, or have rights to, 36 U.S. patents (including these under license). In addition, we have filed for, or have rights to, 39 U.S. patents (including those under license) that are still pending. One or more of the patents we hold directly or licensed from third parties, including those for the disposable components to be used with our glucose monitoring and infant jaundice products, may be successfully challenged, invalidated or circumvented, or we may otherwise be unable to rely on these patents. These risks are also present for the process we use or will use for manufacturing our products. In addition, our competitors, many of whom have substantial resources and have made substantial investments in competing technologies, may apply for and obtain patents that prevent, limit or interfere with our ability to make, use and sell our products, either in the United States or in international markets. The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights. In addition, the United States Patent and Trademark Office may institute litigation or interference proceedings. The defense and prosecution of intellectual property suits, Patent and Trademark Office proceedings and related legal and administrative proceedings are both costly and time consuming. Moreover, we may need to litigate to enforce our patents, to protect our trade secrets or know-how, or to determine the enforceability, scope and validity of the proprietary rights of others. Any litigation or interference proceedings involving us may require us to incur substantial legal and other fees and expenses and may require some of our employees to devote all or a substantial portion of their time to the proceedings. 13 An adverse determination in the proceedings could subject us to significant liabilities to third parties, require us to seek licenses from third parties or prevent us from selling our products in some or all markets. We may not be able to reach a satisfactory settlement of any dispute by licensing necessary patents or other intellectual property. Even if we reached a settlement, the settlement process may be expensive and time consuming, and the terms of the settlement may require us to pay substantial royalties. An adverse determination in a judicial or administrative proceeding or the failure to obtain a necessary license could prevent us from manufacturing and selling our products. OUR REVENUES WILL BE PRIMARILY DERIVED FROM SALES OF OUR PRODUCTS BY THIRD PARTIES OVER WHOM WE HAVE LIMITED INFLUENCE, AND THEY MAY NOT BE ABLE TO GENERATE SUFFICIENT SALES REVENUES TO SUSTAIN OUR GROWTH AND STRATEGY PLANS. The revenues that we expect to receive from each of our collaborative partners depend primarily on sales of our products, most of which are still in development. We may not be able to successfully commercialize the products we are developing. Even if we do, we, together with our collaborative partners, may not be able to sell sufficient volumes of our products to generate substantial profits for us. In addition, our profit margins on some of our products are not likely to increase over time because the royalty rates and manufacturing profit rates on those products are predetermined. The majority of our revenues and profits are expected to be derived from royalties and manufacturing profits that we will receive from Abbott, Roche and Respironics resulting from sales of the products we are developing with each of these companies. Another significant portion of our revenues and profits are expected to be derived from the sale of cervical cancer detection products and we would share with Welch Allyn in the revenues generated from sales of these products to distributors and end users. In addition, it is common practice in the glucose monitoring device industry for manufacturers to sell their glucose monitoring devices at substantial discounts to their list prices or to offer customers rebates on sales of their products. Manufacturers offer these discounts or rebates to expand the use of their products, which increases the market for the disposable strips they sell for use with their products. Because Abbott has discretion to determine the prices at which they sell our glucose monitoring devices, they may choose to adopt this marketing strategy. If Abbott adopts this marketing strategy and discounts the prices at which they sell our glucose monitoring devices, the amounts we earn for these sales will be less. In this case, royalties we earn on sales of our disposable cartridges may be less than the amounts we would have earned had our glucose monitoring devices not been sold at a discount. BECAUSE OUR PRODUCTS, WHICH USE DIFFERENT TECHNOLOGY THAN OTHER MEDICAL DEVICES, ARE OR WILL BE NEW TO THE MARKET, WE MAY NOT BE SUCCESSFUL IN LAUNCHING OUR PRODUCTS AND OUR OPERATIONS AND GROWTH WOULD BE ADVERSELY AFFECTED. Our products are based on new methods of glucose monitoring, diabetes detection, infant jaundice and cervical cancer detection. If they do not achieve significant market acceptance, our sales will be limited and our financial condition may suffer. Physicians and individuals may not recommend or use our products unless they determine that these products are an attractive alternative to current blood-based or other tests that have a long history of safe and effective use. To date, our products have been used by only a limited number of people, and few independent studies regarding our products have been published. The lack of independent studies limits the ability of doctors or consumers to compare our products to conventional products. IF WE ARE UNABLE TO COMPETE EFFECTIVELY IN THE HIGHLY COMPETITIVE MEDICAL DEVICE INDUSTRY, OUR FUTURE GROWTH AND OPERATING RESULTS WILL SUFFER. The medical device industry in general, and the markets in which we expect to offer products in particular, are intensely competitive. Many of our competitors have substantially greater financial, research, technical, manufacturing, marketing and distribution resources than we do and have greater name recognition and lengthier operating histories in the health care industry. We may not be able to effectively compete against these and other competitors. For example, a number of competitors are currently marketing traditional glucose monitors. These monitors are widely accepted in the health care industry and have a long history of accurate and effective use. Further, if our products are not available at competitive prices, health care administrators who are subject to increasing pressures to reduce costs may not elect to purchase them. Also, a number of companies have announced that they are developing products that permit non-invasive and less invasive glucose monitoring. Accordingly, competition in this area is expected to increase. Furthermore, our competitors may succeed in developing, either before or after the development and commercialization of our products, devices and technologies that permit more efficient, less expensive non-invasive and less invasive glucose monitoring, diabetes detection, infant jaundice or cancer detection. It is also possible that one or more 14 pharmaceutical or other health care companies will develop therapeutic drugs, treatments or other products that will substantially reduce the prevalence of diabetes or infant jaundice or otherwise render our products obsolete. In addition, one or more of our collaborative partners may, for competitive reasons, reduce their support of their collaborative arrangement with us or support, directly or indirectly, a company or product that competes with our products. This would limit our ability to compete with others. WE HAVE LITTLE MANUFACTURING EXPERIENCE, WHICH COULD LIMIT OUR GROWTH. We do not have manufacturing experience that would enable us to make products in the volumes that would be necessary for us to achieve significant commercial sales. In addition, we may not be able to establish and maintain reliable, efficient, full scale manufacturing at commercially reasonable costs, in a timely fashion. Difficulties we encounter in manufacturing scale-up, or our failure to implement and maintain our manufacturing facilities in accordance with good manufacturing practice regulations, international quality standards or other regulatory requirements, could result in a delay or termination of production. To date, our manufacturing activities have only included our BiliChek and BiliCal products, as well as the Accu-Chek D-Tector diabetes detection product on a limited scale. If we obtain the necessary regulatory approvals to market the diabetes detection product, we will undertake to manufacture this product in significant volumes. Companies often encounter difficulties in scaling up production, including problems involving production yield, quality control and assurance, and shortages of qualified personnel. SINCE WE RELY ON SOLE-SOURCE SUPPLIERS FOR SEVERAL OF OUR PRODUCTS, ANY FAILURE OF THOSE SUPPLIERS TO PERFORM WOULD HURT OUR OPERATIONS. Several of the components used in our products are available from only one supplier, and substitutes for these components are infeasible or would require substantial modifications to our products. Any significant problem experienced by one of our sole source suppliers may result in a delay or interruption in the supply of components to us until that supplier cures the problem or an alternative source of the component is located and qualified. Any delay or interruption would likely lead to a delay or interruption in our manufacturing operations. The microspectrometer and disposable calibration element, components of our infant jaundice product, and the blue light module and calibration element, components of our diabetes detection product, are each available from only one supplier. For our products which require premarket approval, the inclusion of substitute components could require us to qualify the new supplier with the appropriate government regulatory authorities. Alternatively, for our products which qualify for premarket notification, the substitute components must meet our product specifications. OUR LIMITED MARKETING AND SALES EXPERIENCE MAKES OUR INTERNATIONAL REVENUE UNCERTAIN. We are responsible for marketing our infant jaundice product in countries other than the United States and Canada. We have relatively limited experience in marketing or selling medical device products and only have a nine person marketing and sales staff. In order to successfully continue to market and sell our infant jaundice product outside the United States and Canada, we must either develop a marketing and sales force or expand our arrangements with third parties to market and sell this product. We may not be able to successfully develop an effective marketing and sales force, and we may not be able to enter into and maintain marketing and sales agreements with third parties on acceptable terms. If we develop our own marketing and sales capabilities, we will compete with other companies that have experienced and well-funded marketing and sales operations. If we enter into a marketing arrangement with a third party for the marketing and sale of our infant jaundice product outside the United States and Canada, any revenues we would receive from this product will be dependent on this third party, and we will likely be required to pay a sales commission or similar compensation to this party. Furthermore, we are currently dependent on the efforts of Abbott and Roche for any revenues to be received from our glucose monitoring and diabetes detection products. The efforts of these third parties for the marketing and sale of our products may not be successful. BECAUSE WE OPERATE IN AN INDUSTRY WITH SIGNIFICANT PRODUCT LIABILITY RISK, AND WE HAVE NOT SPECIFICALLY INSURED AGAINST THIS RISK, WE MAY BE SUBJECT TO SUBSTANTIAL CLAIMS AGAINST OUR PRODUCTS. The development, manufacture and sale of medical products entail significant risks of product liability claims. We currently have no product liability insurance coverage beyond that provided by our general liability insurance. Accordingly, we may not be adequately protected from any liabilities, including any adverse judgments or settlements, we might incur in connection with the development, clinical testing, manufacture and sale of our products. A successful product liability claim or series of claims brought against us that results in an adverse judgment against or settlement by us in excess of any insurance 15 coverage could seriously harm our financial condition or reputation. In addition, product liability insurance is expensive and may not be available to us on acceptable terms, if at all. IF WE CANNOT OBTAIN ADDITIONAL FUNDS WHEN NEEDED, WE WILL NOT BE ABLE TO IMPLEMENT OUR BUSINESS PLAN. We will require substantial additional capital to develop our products, including completing product testing and clinical trials, obtaining all required regulatory approvals and clearances, beginning and scaling up manufacturing, and marketing our products. Any failure of our collaborative partners to fund our capital expenditures, or our inability to obtain capital through other sources, would limit our ability to grow and operate as planned. Under our collaborative arrangements with Abbott, Roche, Respironics and Welch Allyn, these collaborative partners will either directly undertake the activities to develop our products or will fund a substantial portion of these expenditures. The obligations of our collaborative partners to fund our expenditures is largely discretionary and depends on a number of factors, including our ability to meet specified milestones in the development and testing of our products. We may not be able to meet these milestones, or our collaborative partners may not continue to fund our expenditures. In addition to funds that we expect to be provided by our collaborative partners, we may be required to raise additional funds through public or private financing, additional collaborative relationships or other arrangements. We believe that our existing capital resources and the funding from our collaborative partners will be sufficient to satisfy our funding requirements through 2002, but may not be sufficient to fund our operations to the point of commercial introduction of either of our glucose monitoring products or our cervical cancer product. Any required additional funding may not be available on terms attractive to us, or at all. To the extent we cannot obtain additional funding, our ability to continue to develop and introduce products to market will be limited. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants that would limit how we conduct our business or finance our operations. THE AVAILABILITY OF THIRD-PARTY REIMBURSEMENT FOR OUR PRODUCTS IS UNCERTAIN, WHICH MAY LIMIT CONSUMER USE AND THE MARKET FOR OUR PRODUCTS. In the United States and elsewhere, sales of medical products are dependent, in part, on the ability of consumers of these products to obtain reimbursement for all or a portion of their cost from third-party payors, such as government and private insurance plans. Any inability of patients, hospitals, physicians and other users of our products to obtain sufficient reimbursement from third-party payors for our products, or adverse changes in relevant governmental policies or the policies of private third-party payors regarding reimbursement for these products, could limit our ability to sell our products on a competitive basis. We are unable to predict what changes will be made in the reimbursement methods used by third-party health care payors. Moreover, third-party payors are increasingly challenging the prices charged for medical products and services, and some health care providers are gradually adopting a managed care system in which the providers contract to provide comprehensive health care services for a fixed cost per person. Patients, hospitals and physicians may not be able to justify the use of our products by the attendant cost savings and clinical benefits that we believe will be derived from the use of our products, and therefore may not be able to obtain third-party reimbursement. Reimbursement and health care payment systems in international markets vary significantly by country and include both government sponsored health care and private insurance. We may not be able to obtain approvals for reimbursement from these international third-party payors in a timely manner, if at all. Any failure to receive international reimbursement approvals could have an adverse effect on market acceptance of our products in the international markets in which approvals are sought. OUR SUCCESS DEPENDS ON OUR ABILITY TO ATTRACT AND RETAIN SCIENTIFIC, TECHNICAL, MANAGERIAL AND FINANCE PERSONNEL. Our ability to operate successfully and manage our future growth depends in significant part upon the continued service of key scientific, technical, managerial and finance personnel, as well as our ability to attract and retain additional highly qualified personnel in these fields. We may not be able to attract and retain key employees when necessary, which would limit our operations and growth. None of our key employees have an employment contract with us, nor are any of these employees, except our chief executive officer, covered by key person or similar insurance. In addition, if we are able to successfully develop and commercialize our products, we will need to hire additional scientific, technical, marketing, managerial and finance personnel. We face intense competition for qualified personnel in these areas, many of whom are often subject to competing employment offers. 16 WE ARE CONTROLLED BY OUR DIRECTORS, EXECUTIVE OFFICERS AND THEIR AFFILIATED ENTITIES. Our directors, executive officers and entities affiliated with them beneficially owned an aggregate of about 25% of our outstanding common stock as of June 30, 2001. These stockholders, acting together, would be able to control substantially all matters requiring approval by our stockholders, including the election of directors and the approval of mergers and other business combination transactions. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS We have not entered into any transactions using derivative financial instruments and believe our exposure to interest rate risk, foreign currency exchange rate risk and other relevant market risks is not material. 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On March 9, 2000, we filed a Demand for Arbitration of disputes arising under our license agreement with Altea Technologies, Inc., Non-Invasive Monitoring Company and our former vice president, Jonathan Eppstein, who is also a principal in Altea and Non-Invasive Monitoring. We sought an interpretation of portions of the license agreement relating to our obligation to assign future intellectual property rights and relief and damages for these and other issues. Altea had sent two letters to us purporting to give notice of our material breach of the license agreement for failure to assign specified intellectual property rights to Altea or Non-Invasive Monitoring and to participate in a joint development program and other items. Final arguments were held October 23, 2000 and a decision was entered on November 7, 2000 when the arbitration panel denied the claims for damages by both parties. They also denied the claims by Altea and Non-Invasive Monitoring that we were in breach due to our failure to continue a program of joint development and that we had breached the license and joint development agreement. The panel interpreted the scope of joint technology under the agreement as requested by Altea and as a result, said that two patent applications should be jointly assigned to Altea. The Panel also resolved a dispute over stock options in effect at the time Altea and Non-Invasive Monitoring principal Jonathan Eppstein's employment ended at SpectRx. The panel also denied the claims of both sides for attorney's fees and expenses of arbitration. On December 11, 2000, Altea and Non-Invasive Monitoring filed a new Demand for Arbitration of certain disputes arising under the licensing agreement with us. Altea and Non-Invasive Monitoring sought to require us to engage in future agreements with Altea for joint development, to obtain assignment of additional patents, to have us held liable for specified actions by a subcontractor and to receive a finding that commercialization has not occurred. Subsequently, we filed a Motion to Dismiss or Limit Issues for Arbitration. On March 13, 2001, the panel issued an order dismissing the issue regarding commercialization as premature because the alleged deadline for commercialization had not yet occurred. Almost four months later, on August 2, 2001, the Panel issued an order setting the date for the arbitration hearing in early 2002. The Panel further stated that as of December 31, 2002, the Panel will consider the commercialization issue, although additional discovery may be required in January 2002. We believe that Altea's claims are without merit but intend to abide by the decision of this second arbitration panel as to the proper scope of our duty to assign future intellectual property rights under the license agreement and to participate in a joint development program. On August 16, 2000, we filed a complaint for Declaratory Judgment against Ampersand Medical Corp. seeking a declaration that we have not misappropriated or improperly disclosed any alleged confidential information or alleged trade secrets disclosed to us by Ampersand. Ampersand subsequently filed a counter-suit in Illinois against us, alleging that we had misappropriated trade secrets belonging to Ampersand. The parties agreed to mediation earlier this year, and the counter-suit filed in Illinois by Ampersand was withdrawn but could be refiled in Gwinnett County, Georgia if mediation was unsuccessful. In July 2001, Ampersand terminated mediation discussions and the parties are now moving to trial, expected to be held in February 2002. We believe Ampersand's claims are without merit. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On June 4, 2001, we sold 1,500,000 shares of our common stock and issued warrants to purchase 300,000 shares of our common stock to institutional investors. On June 13, 2001, we sold 395,633 shares of our common stock and issued warrants to purchase 79,127 shares of our common stock to institutional investors. We received about $12 million from these sales before transaction expenses. The Robinson-Humphrey Company, LLC acted as placement agent in these transactions and received fees of about $719,000. These sales were made in reliance upon the exemption contained in Section 4(2) from the registration provisions of the Securities Act of 1933 and Regulation D thereunder in reliance upon the representations of the purchasers and the placement agent. 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 23, 2001, we held our annual meeting of stockholders to elect directors and take action upon the certification of the appointment of our independent auditors. The results of the votes were as follows:
BROKER NON-VOTERS DIRECTIONS FOR WITHHELD AND ABSTENTIONS --------- --- -------- ----------------- Mark A. Samuels 6,564,864 123,964 0 Keith D. Ignotz 6,565,364 123,464 0 Charles G. Hadley 6,648,938 39,890 0 Earl R. Lewis 6,634,438 54,390 0 William E. Zachary, Jr. 6,648,638 40,190 0 Chris Monahan 6,648,938 39,890 0
Ratification of the appointment of Arthur Andersen LLP as independent auditors for 2001:
FOR AGAINST ABSTAIN BROKER NON-VOTES --- ------- ------- ---------------- 6,673,315 13,913 1,600 0
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
EXHIBIT NO. DESCRIPTION ----------- ----------- 4.1* Registration Rights Agreement dated June 4, 2001 by and among SpectRx, Inc. and the purchasers listed on Schedule I thereto. 4.2* Registration Rights Agreement dated June 13, 2001 by and among SpectRx, Inc. and the purchasers listed on Schedule I thereto. 4.3* Third Amendment dated June 4, 2001 to Amended and Restated Registration Rights Agreement dated October 21, 1996 by and among SpectRX, Inc. and the holders of Registrable Securities named therein. 4.4* Fourth Amendment dated June 13, 2001 to Amended and Restated Registration Rights Agreement dated October 21, 1996 by and among SpectRx, Inc. and the holders of Registrable Securities named therein. 4.5 Form of Common Stock Warrant 10.1* Stock Purchase Agreement dated June 4, 2001 by and among SpectRx, Inc. and the purchasers listed on Schedule 1 thereto. 10.2* Stock Purchase Agreement dated June 13, 2001 by and among SpectRx., Inc. and the purchasers listed on Schedule 1 thereto.
---------------- *Incorporated by reference to the current report on Form 8-K filed June 26, 2001. (b) Reports on Form 8-K The registrant filed a Form 8-K on June 26, 2001 announcing under Item 5 the completion of two private placement financings, which resulted in the sale of approximately 1.9 million shares of common stock and warrants for the purchase of 379,127 shares of common stock for gross combined proceeds of approximately $12 million. 19 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in Norcross, Georgia. SPECTRX, INC. Date: August 14, 2001 By: /S/ THOMAS H. MULLER, JR. ---------------------------------------------------- Thomas H. Muller, Jr. Executive Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial and Accounting Officer) 20 EXHIBIT INDEX The exhibits listed below are filed herewith.
EXHIBIT NO. DESCRIPTION -------- ----------- 4.5 Form of Common Stock Warrant