-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PXiD14s0T1J4+NkjYNK+XpHeY7KuocOPrbyz5s/Na+zBy0XfwQGjVYrvY2V/cDyw T8Swq0TpU3iy/2rTWx+rFw== 0000950144-01-509179.txt : 20020410 0000950144-01-509179.hdr.sgml : 20020410 ACCESSION NUMBER: 0000950144-01-509179 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010930 FILED AS OF DATE: 20011114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SPECTRX INC CENTRAL INDEX KEY: 0000924515 STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845] IRS NUMBER: 582029543 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22179 FILM NUMBER: 1789760 BUSINESS ADDRESS: STREET 1: 6025 A UNITY DRIVE CITY: NORCROSS STATE: GA ZIP: 30071 BUSINESS PHONE: 7702428723 MAIL ADDRESS: STREET 1: 6025 A UNITY DRIVE CITY: NORCROSS STATE: GA ZIP: 30071 10-Q 1 g72781e10-q.txt SPECTRX, INC. ================================================================================ 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 SEPTEMBER 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 issued and outstanding shares of the Registrant's Common Stock, $0.001 par value, as of October 31, 2001, was 10,566,038. SPECTRX, INC. INDEX
PAGE NO. -------- PART I. FINANCIAL INFORMATION............................................................................ 3 ITEM 1. FINANCIAL STATEMENTS - UNAUDITED BALANCE SHEETS - DECEMBER 31, 2000 AND SEPTEMBER 30, 2001.......................................... 3 STATEMENTS OF OPERATIONS - THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001..................... 4 STATEMENTS OF CASH FLOWS - NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001..................................... 5 NOTES TO FINANCIAL STATEMENTS............................................................... 6 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................................................ 8 ITEM 3. QUANTITIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................................ 19 PART II. OTHER INFORMATION................................................................................ 20 ITEM 1. LEGAL PROCEEDINGS....................................................................... 20 ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS................................................ 20 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..................................... 21 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................................................ 21 SIGNATURES................................................................................................ 22 EXHIBIT INDEX............................................................................................. 22
PART 1. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SPECTRX, INC. BALANCE SHEETS (IN THOUSANDS)
DECEMBER 31, SEPTEMBER 30, 2000 2001 UNAUDITED UNAUDITED ---------- ---------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 3,609 $ 9,519 Accounts receivable 1,259 845 Inventory 481 625 Other current assets 377 496 ---------- ---------- Total current assets 5,726 11,485 ---------- ---------- PROPERTY & EQUIPMENT, Net 894 681 ---------- ---------- OTHER ASSETS 528 550 ---------- ---------- TOTAL ASSETS $ 7,148 $ 12,716 ========== ========== LIABILITIES & STOCKHOLDER'S EQUITY CURRENT LIABILITIES Accounts payable $ 1,020 $ 701 Accrued liabilities 1,262 1,089 ---------- ---------- Total current liabilities 2,282 1,790 ---------- ---------- COLLABORATIVE PARTNER ADVANCE 381 381 ---------- ---------- REDEEMABLE CONVERTIBLE PREFERRED STOCK 5,579 5,815 ---------- ---------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY (DEFICIT) Common stock 9 10 Additional paid-in-capital 30,927 42,216 Treasury stock, at cost 0 (33) Accumulated deficit (31,999) (37,432) Notes receivable from officers (31) (33) ---------- ---------- Total stockholders' equity (deficit) (1,094) 4,730 ---------- ---------- TOTAL LIABILITIES & EQUITY $ 7,148 $ 12,716 ========== ==========
The accompanying notes are an integral part of the financial statements. SPECTRX, INC. UNAUDITED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS NINE MONTHS ENDED SEPTEMBER 30 ENDED SEPTEMBER 30 2000 2001 2000 2001 ------- -------- ------- ------- REVENUE Product sales $ 529 $ 570 $ 1,642 $ 1,726 Collaborative agreements 0 0 749 100 ------- -------- ------- ------- TOTAL 529 570 2,391 1,826 ------- -------- ------- ------- EXPENSES Cost of sales 499 410 1,439 1,417 Research & development 1,374 781 4,608 2,989 Sales & marketing 239 337 700 711 General & administrative 900 675 2,143 2,090 ------- -------- ------- ------- Total 3,012 2,203 8,890 7,207 ------- -------- ------- ------- Operating loss (2,483) (1,633) (6,499) (5,381) OTHER INCOME 0 0 21 2 INTEREST INCOME 138 106 308 182 ------- -------- ------- ------- NET LOSS (2,345) (1,527) (6,170) (5,197) PREFERRED STOCK DIVIDENDS (78) (78) (236) (236) ------- -------- ------- ------- Loss available to common shareholders ($2,423) ($ 1,605) ($6,406) ($5,433) ======= ======== ======= ======= NET (LOSS) PER SHARE BASIC ($ 0.29) ($ 0.15) ($ 0.76) ($ 0.58) ======= ======== ======= ======= DILUTED ($ 0.29) ($ 0.15) ($ 0.76) ($ 0.58) ======= ======== ======= ======= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING BASIC 8,484 10,428 8,406 9,336 ======= ======== ======= ======= DILUTED 8,484 10,428 8,406 9,336 ======= ======== ======= =======
The accompanying notes are an integral part of the financial statements. SPECTRX, INC. UNAUDITED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30, 2000 2001 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $ (6,170) $ (5,197) --------- --------- Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 304 274 Amortization of deferred compensation 57 0 Changes in assets and liabilities: Accounts receivable 435 414 Inventory 101 (144) Due from related parties (22) (22) Other current assets (324) (119) Accounts payable (17) (319) Accrued liabilities 187 (173) --------- --------- Total adjustments 721 (89) --------- --------- Net cash used in operating activities (5,449) (5,286) --------- --------- CASH FLOW FROM INVESTING ACTIVITIES: Additions to property and equipment (434) (61) --------- --------- Net cash used in investing activities (434) (61) --------- --------- CASH FLOW FROM FINANCING ACTIVITIES: Issuance of common stock (net of issuance costs) 4,941 11,290 Issuance of redeemable convertible preferred stock 2,500 0 Purchase of treasury stock, at cost 0 (33) --------- --------- Net cash provided by financing activities 7,441 11,257 --------- --------- NET INCREASE IN CASH AND CASH EQUIVALENTS 1,558 5,910 CASH AND CASH EQUIVALENTS, beginning of period 2,143 3,609 --------- --------- CASH AND CASH EQUIVALENTS, end of period $ 3,701 $ 9,519 ========= =========
The accompanying notes are an integral part of the financial statements SPECTRX, INC. NOTES TO FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The unaudited interim financial statements included herein have been prepared by SpectRx. These statements reflect all adjustments, all of which are of a normal, recurring nature, which are, in the opinion of management, necessary to present fairly the financial position as of September 30, 2001, the results of operations for the three months and nine months ended September 30, 2000 and 2001, and the cash flows for the nine months ended September 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 financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2000 and our Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30, 2001. The results of operations for the three and nine months ended September 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 our investment in FluorRx under the equity method of accounting. In connection therewith, we began suspending the equity losses from our investment in FluorRx. The accompanying statement of operations for the three months and nine months ended September 30, 2001 excludes $21,465 and $40,975 in losses, respectively, which represents our 43% equity in the losses of FluorRx. Cumulative suspended equity losses as of September 30, 2001 amounted to $1,541,371. 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 provides that goodwill and certain intangible assets will no longer be subject to amortization, but instead will be subject to a periodic impairment assessment by applying a fair-value based test. 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. STOCKHOLDERS' EQUITY In June 2001, we announced that we had completed two private placements. On June 4, 2001, we entered into an agreement with affiliates of SAFECO Corporation, which invested about $9.5 million in SpectRx before transaction expenses. On June 13, 2001, we entered into an agreement with affiliates of Special Situations Fund, which invested about $2.5 million in SpectRx before transaction expenses. The financings consisted, in total, of sales of about 1.9 million shares of common stock and warrants to purchase 379,127 shares of common stock. Under the terms of the agreements, each share of common stock was sold at a price of $6.319 per share, which represented a discount from the market price of our common stock on the dates these transactions closed. The first transaction, funded on June 4, 2001, involved the private placement of 1.5 million shares of common stock. The second transaction, funded on June 13, 2001, involved the private placement of 395,633 shares of common stock. The combination of these two transactions resulted in proceeds to SpectRx of about $12 million before transaction expenses. The 1,895,633 shares issued in these transactions constituted 22.2% of our common stock outstanding prior to the first private placement transaction. In addition, the purchasers of common stock also received warrants to purchase an aggregate of 379,127 shares of common stock for $9.8874 per share. These warrants expire on the fifth anniversary of their issuance date. The warrants are valued at $1.7 million and are included in additional paid-in capital in the accompanying balance sheet. On August 30, 2001, the common stockholders of SpectRx, excluding the shares held by SAFECO and Special Situations Fund, approved these transactions. In October 2001, Abbott invested an additional $1 million in SpectRx common stock, acquiring 126,199 shares at $7.92 per share, which is subject to SpectRx maintaining certain rights to sublicense technology to Abbott. The purchase was associated with a milestone under a program to commercialize our continuous glucose monitoring technology for people with diabetes. The purchase raises Abbott's common stock ownership in SpectRx to approximately 5.9%. On September 19, 2001, we announced that our Board of Directors had approved a stock repurchase program for up to $1 million of our common stock. As of September 30, 2001, we had purchased 5,800 shares of common stock at an average price of $5.59 per share. 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 $78,750 for the third quarter of 2001, $236,000 for the nine months ended September 30, 2001 and $565,000 since issuance. The related dividends are included in redeemable convertible preferred stock in the accompanying balance sheets. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Statements in this report which express "belief", "anticipation" or "expectation" as well as other statements which are not historical facts are forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical results or anticipated results, including those set forth under "Risk Factors" in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in or incorporated by reference into this report. Examples of these uncertainties and risks include, but are not limited to: - whether our products in development will prove safe and effective; - whether and when we or our strategic partners will obtain approval from the Food and Drug Administration, or FDA, and corresponding foreign agencies; - our need to achieve manufacturing scale-up in a timely manner, and our need to provide for the efficient manufacturing of sufficient quantities of our products; - the lack of immediate alternate sources of supply for some critical components of our products; - our patent and intellectual property position; - the need to fully develop the marketing, distribution, customer service and technical support and other functions critical to the success of our potential product lines; - the effectiveness and ultimate market acceptance of our products; - access to sufficient debt or equity capital to meet our operating and financial needs; - the dependence on our strategic partners for funding, development assistance, clinical trials, distribution and marketing of products developed by us; and - other risks and uncertainties described from time to time in our reports filed with the Securities and Exchange Commission, including those contained in our Annual Report on Form 10-K for the year ended December 31, 2000, and our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2001 and June 30, 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 September 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 September 30, 2001, we had an accumulated deficit of about $37.4 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. Although we have historically received the majority of our revenues from development milestone payments, the majority of our revenues and profits in the future 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 August 2001, our stockholders approved previously announced private placements of common stock with institutional investors. The private placements resulted in gross proceeds to the company of approximately $12 million. Approximately 66% of eligible shares were represented at the special stockholders meeting, of which 99% of eligible shares voted for the transaction. The purchasers of the common stock were entities affiliated with SAFECO Asset Management and Special Situations Fund III, L.P. The proceeds of the sales will be used for research, development, clinical trials, regulatory efforts, sales and marketing activities, working capital and other general corporate purposes. In September 2001, we announced that Abbott Laboratories had given Development Program Notice to proceed with commercialization of our continuous glucose monitoring product. As part of that notice, Abbott was to purchase an additional $2 million in SpectRx common stock in satisfaction of its milestone payment to us. We agreed to a postponement of $1 million due for this milestone. We expect this payment before the end of 2002 upon the occurrence of certain events. The $1 million common stock purchase increased Abbott's common stock ownership in SpectRx to approximately 5.9%. The transaction was completed in October 2001. Both the second $1 million payment and a portion of the first payment are subject to our ability to maintain our rights to sublicense to Abbott certain technology that was licensed by Altea to us. We and Altea are currently in arbitration regarding various issues related to this license agreement. As part of the agreement to move forward with commercialization, Abbott granted rights to SpectRx to independently develop a single-use application of the glucose monitoring technology. Also, we and Abbott modified the terms related to the shares of convertible redeemable preferred stock held by Abbott to reduce the amount eligible for redemption by $1 million of the original $5.25 million. In September 2001, our Board of Directors approved a stock repurchase program for up to $1 million of our common stock. These purchases may be commenced or suspended at any time without prior notice depending on business or market conditions and other factors. As of October 31, 2001, we had approximately 10.5 million shares outstanding. As of September 30, 2001 we had purchased 5,800 shares on the open market at an average price of $5.64 per share. In October 2001, we announced that we had received a grant of $338,000 from the U.S. Centers for Disease Control and Prevention, or CDC, to expand research on our continuous glucose monitor. The grant raises the total amount of CDC funding for the project to just under $1 million. The grant is used to adapt our technology to monitor glucose levels of children and aging populations with diabetes. RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000. General. Net loss available to common stockholders decreased to $1.6 million during the three months ended September 30, 2001 as compared to $2.4 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 third quarter in 2001 and a decrease in legal fees. We expect net losses to continue. Revenue. We have historically received the majority of our revenue from development milestone payments from one or more of our strategic partners. We began shipping our infant jaundice product, the BiliChek(TM) 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 $570,000 for the quarter ended September 30, 2001 from $529,000 for the same period in 2000. Product revenue is higher for the 2001 quarter than for the comparable period in 2000, due to the increase in revenues from our BiliChek products. We did achieve a milestone in September, 2001 in our continuous glucose monitoring program from our collaborative partner, Abbott. Abbott had the right, as part of an agreement, to pay this milestone by purchasing common stock, which it elected to do, so there was not revenue recognition due to this milestone. Cost of Sales. Cost of sales decreased to $410,000 for the three months ended September 30, 2001 from $499,000 during the same period in 2000. This decrease is due to excess capacity production charges, which were lower for this period than in 2000, and less excess capacity, partially offset by cost of sales increases directly related to increased product revenue. Research and Development Expenses. Research and development expenses decreased to $781,000 for the three months ended September 30, 2001 compared to $1.4 million 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 increased to $337,000 during the three months ended September 30, 2001 from $239,000 during the same period in 2000, due mainly to increased marketing research on current and potential products. Marketing expenses are expected to increase in the future as BiliChek sales expand geographically. General and Administrative Expenses. General and administrative expenses decreased to $675,000 during the three months ended September 30, 2001 compared to the $900,000 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 $106,000 during the three months ended September 30, 2001 from $138,000 during the same period in 2000. This decrease is due to much lower interest rates on higher cash balances for the 2001 quarter versus the 2000 quarter. COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 2001 AND 2000. General. Net loss available to common stockholders decreased to $5.4 million during the nine months ended September 30, 2001 as compared to $6.4 million during the same period in 2000 primarily due to Abbott's reimbursement of expenses associated with our continuous glucose monitoring technology. Revenue. We have historically received the majority of our revenue from development milestone payments from one or more of our strategic partners. We began shipping the BiliChek 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 $1.7 million for the nine months ended September 30, 2001 from $1.6 million for the same period in 2000. Product revenue increased for the nine months of 2001 from the comparable period of 2000 even though we did not have any 2001 revenues from our Accu-Check D-Tector units which were used in clinical trials and totaled $225,000 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 nine months ended September 30, 2001 from $749,000 during the same period in 2000. The milestones accomplished in the first nine 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 remained relatively constant at $1.4 million for the nine months ended September 30, 2001 and for the same period in 2000. While the cost of sales increased in direct relationship to the increase in the BiliCheck product line sales, it was offset by the decrease in cost of goods related to sales of Accu-Check D-Tector units to Roche in 2000. Research and Development Expenses. Research and development expenses decreased to $3.0 million for the nine months ended September 30, 2001 compared to $4.6 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. Sales and Marketing Expenses. Sales and marketing expenses remained relatively constant at $700,000 during the nine months ended September 30, 2001 compared to the same period in 2000. General and Administrative Expenses. General and administrative expenses remained relatively constant at $2.1 million during the nine months ended September 30, 2001 and the same period in 2000. Net Interest and Other Income. Net interest and other income decreased to $184,000 during the nine months ended September 30, 2001 from $329,000 during the same period in 2000. This decrease is due to much lower interest rates on higher balances for the 2001 period versus the 2000 period. 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 September 30, 2001, we received approximately $48.0 million in proceeds from sales of our debt and equity securities. At September 30, 2001, we had cash of approximately $9.5 million and working capital of approximately $9.7 million. We completed an initial public offering of our common stock on July 7, 1997, which resulted in net proceeds received by us, before expenses related to the transaction, of approximately $14.0 million. We issued $5.25 million of redeemable convertible preferred stock in November 1999 in conjunction with the execution of amendment to our agreement with Abbott. We issued common stock in a private placement in February 2000, which resulted in gross proceeds of $5.0 million. We issued common stock and warrants in two private placements in June 2001, which resulted in net proceeds of approximately $11.2 million. We issued common stock to Abbott in September 2001 in a private placement, which resulted in gross proceeds of $1 million, as discussed above. See "Quarter Overview." Our major cash flows in the nine months ended September 30, 2001 consisted of cash out-flow of $5.3 million from operations and $61,000 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. 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 $37.4 million at September 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 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, 35 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. 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. Although we have historically received the majority of our revenue from development milestone payments, the revenues that we expect to receive from each of our collaborative partners in the future 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 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 five 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 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. 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 23% of our outstanding common stock as of September 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. 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 early 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 October 3, 2001, we sold 126,199 shares of our common stock to Abbott Laboratories for gross proceeds of $1 million. These sales were made in reliance upon the exemption contained in Section 4(2) from the registration provisions of the Securities Act of 1933 in reliance upon the representations of the purchaser. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On August 30, 2001, we held a special meeting of stockholders to approve the sale of securities to entities associated with SAFECO Corporation and Special Situations Fund, which in total exceeded 20% of the common stock outstanding prior to the transaction. The results of the votes were to approve the transaction; 99.8% of the votes cast eligible to vote on the transaction, voting for the approval. The total shares voted was 6,879,762, which was 66% of the shares outstanding. Of those shares voted, 4,984,129 were eligible to vote on the transactions. These eligible shares were voted as follows: Voting for 4,974,837 Voting against 9,292 Abstained 0 --------- 4,984,129
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
EXHIBIT NO. DESCRIPTION - ----------- ----------- 10.3* Amendment dated September 4, 2001 to the Research & Development License Agreement between Abbott Laboratories and SpectRx (dated October 10, 1996)
- ---------------- * Confidential treatment requested for portions of this agreement. (b) Reports on Form 8-K The registrant filed a Form 8-K on September 7, 2001 announcing under Item 5 the amendment of the collaborative agreement between SpectRx and Abbott Laboratories, as well as the results of a special stockholders meeting. The registrant also filed a Form 8-K on September 20, 2001 announcing under Item 5 that its Board of Directors had approved a stock repurchase program for up to $1.0 million of our common stock. 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: November 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) EXHIBIT INDEX The exhibits listed below are filed herewith.
EXHIBIT NO. DESCRIPTION - -------- ----------- 10.3* Amendment dated September 4, 2001 to the Research & Development License Agreement between Abbott Laboratories and SpectRx (dated October 10, 1996) - -------- * Confidential treatment requested for portions of this agreement.
EX-10.3 3 g72781ex10-3.txt AMENDMENT TO RESEARCH & DEVELOPMENT LICENSE AGMT. EXHIBIT 10.3 [ABBOTT LETTERHEAD] September 4, 2001 VIA FACSIMILE Mr. Mark Samuels Chairman & CEO SpectRx, Inc. 6025 A Unity Drive Norcross, Georgia 30071 Re: Amendment to the Research & Development License Agreement (October 10, 1996) as previously amended by the parties ("RDL Agreement") Dear Mark: In accordance with our recent discussions, Abbott hereby delivers the Development Program Notification to SpectRx pursuant to the RDL Agreement, and Abbott and SpectRx (the "Parties") hereby amend the terms of the RDL Agreement as follows: 1. Abbott and SpectRx hereby acknowledge the termination of Abbott's rights to and all obligations for the Non-Continuous Product (as defined in the Third Amendment to the RDL Agreement, dated November 30, 1999, ("Third Amendment")) and SpectRx affirms Abbott's right of first negotiation pursuant to the terms of section 4.5 of the Third Amendment for distribution of any Non-Continuous Product developed by SpectRx. 2. The following additional amendments are made to the RDL Agreement: a) Abbott shall be required to pay the first $1 million of the $2 million Milestone due under section 5.1(A)(3) of the Third Amendment by purchasing SpectRx common stock under Section 1 of the Common Stock Purchase * Confidential portions omitted and filed separately with the Commission pursuant to an application for confidential treatment pursuant to Rule 24b-2 under the Securities and Exchange Act of 1934, as amended. Agreement (Appendix 5.1 of the Third Amendment, as further amended by the December 27, 2000 letter agreement between SpectRx and Abbott). b) The second $1 million of the $2 million Milestone due under Section 5.1(A)(3) of the Third Amendment shall not be due unless and until ten (10) business days following delivery of written notice by SpectRx to Abbott of a final decision or settlement of all viable claims alleged by Altea Technologies, Inc. ("Altea") and Non-Invasive-Monitoring Company, Inc. ("NIMCO") against SpectRx in the Demand for Arbitration in the arbitration proceeding ("Arbitration") currently underway with Altea and NIMCO, and provided that SpectRx's rights to sublicense the Technology (as defined in the RDL Agreement, as amended) are not terminated [ * ]. c) In the event that there is a final decision or settlement of the Arbitration pursuant to which SpectRx's rights to sublicense the Technology are terminated [ * ] then SpectRx shall, within ten (10) business days after such decision or settlement, send Abbott a written notice of such decision or settlement and pay to Abbott a sum equal to the difference between $1 million and the fair market value of the shares of SpectRx common stock purchased by Abbott under Section 2(a) above, such fair market value to be calculated based on the average closing sale price of SpectRx common stock as reported on the Nasdaq National Market over the forty five (45) trading days subsequent to the Public Disclosure of the decision or settlement. For this purpose, Public Disclosure shall mean an appropriate filing with the SEC or/and distribution of a press release through a widely disseminated news or wire service that is reasonably designed to provide broad public access. d) Each time period specified in Section 3.7(A) of the Third Amendment shall be extended until the earlier of (i) March 31, 2002, or (ii) the date on which the product specifications (as defined in Appendix 2.7 of the Third Amendment) have been successfully achieved. e) Abbott will assume full funding responsibility for the portion of the Development Program regarding the Continuous Product as of September 1, 2001. As set forth in the Third Amendment, Abbott will not be responsible for any funding regarding the Non-Continuous Product from the date hereof. 2 * Confidential portions omitted and filed separately with the Commission pursuant to an application for confidential treatment pursuant to Rule 24b-2 under the Securities and Exchange Act of 1934, as amended. 3. In consideration of the various agreements made in this amendment, Abbott unconditionally and irrevocably waives, for itself and its successors and assigns, its right to cause a redemption, at its election pursuant to Section (d)(1) of the Designations, Preferences and Rights of Redeemable Convertible Preferred stock of SpectRx, Inc. (the "Designations"), of, and as to, 100,000 shares of Redeemable Convertible Preferred Stock, par value $0.001 per share (i.e., 100,000 shares of the total 525,000 shares of Redeemable Convertible Preferred stock held by Abbott), and agrees not to make such election in respect of such 100,000 shares. Abbott agrees, should it at any time transfer its shares of Redeemable Convertible Preferred Stock, to inform the transferee of the foregoing waiver, and to agree that SpectRx may place a legend on the share certificate(s) for 100,000 of its 525,000 shares of Redeemable Convertible Preferred Stock referencing the applicability of the waiver provided for hereinabove and referring to this amendment. The Parties agree that the exclusion of such 100,000 shares from Abbott's redemption election by virtue of Abbott's waiver in respect thereof will reduce the number of shares redeemable at Abbott's election under Section (d)(1) of the Designations on December 31, 2002 from one-half of the shares (i.e., 262,500 shares) to 162,500 shares of Redeemable Convertible Preferred Stock; the shares that would be required to be redeemed in 2004 under such election would remain unchanged, being one-half of the total (i.e., 262,500 shares). In partial consideration for the foregoing waiver, SpectRx unconditionally and irrevocably waives, as to the 100,000 shares of Redeemable convertible Preferred Stock referenced above, its right to cause, at its election pursuant to Section (d)(2) of the Designations, a redemption of such shares. Nothing contained in the foregoing waivers and agreements shall effect or otherwise amend or limit the redemption election rights of Abbott, or its successors or assigns, or SpectRx, with respect to all of the shares of Redeemable Convertible Preferred Stock now held by Abbott other than the 100,000 shares that are the subject of this paragraph 3. Abbott further agrees to execute and deliver a shareholder consent which SpectRx may later require to obtain the consent of Abbott as the holder of all of the issued shares of the Company's Redeemable Preferred Stock to effect an amendment to the Designations under Delaware law, in form reasonably acceptable to Abbott, to revise the redemption provisions of such Designations to give effect (as such an amendment to the Designations) to the waivers and agreement set forth above, although the waivers and agreements provided for above are effective as of the date hereof and are not in any way conditioned upon any such amendment of the Designations. 3 * Confidential portions omitted and filed separately with the Commission pursuant to an application for confidential treatment pursuant to Rule 24b-2 under the Securities and Exchange Act of 1934, as amended. 4. Except as set forth above, all provisions of the RDL Agreement shall remaining full force and effect. Sincerely, /s/ James J. Koziarz James J. Koziarz, Ph.D. Corporate Vice President Diagnostic Products R & D Abbott Laboratories ACCEPTED THIS 4th DAY OF SEPTEMBER, 2001 SpectRx, Inc. /s/ Mark A. Samuels ----------------------------------- By: Mark A. Samuels ------------------------------ Chief Executive Officer ------------------------------ 4 * Confidential portions omitted and filed separately with the Commission pursuant to an application for confidential treatment pursuant to Rule 24b-2 under the Securities and Exchange Act of 1934, as amended. -----END PRIVACY-ENHANCED MESSAGE-----