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SCIE > SEC Filings for SCIE > Form 10-Q on 15-Nov-2012All Recent SEC Filings

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Form 10-Q for SPECTRASCIENCE INC


15-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This quarterly report on Form 10-Q (the "Report") contains forward-looking statements that are not related to historical results, including, without limitation, statements regarding our business strategy and objectives, near term operating goals, expectations regarding the market for our products and beliefs with respect to opportunities and industry conditions in those markets, beliefs about our products, product development, acquisition or licensing of complementary technologies and expectations with respect to our products' performance and acceptance, the results of our distribution agreement with PENTAX Europe GmbH, our expectations regarding conversion of our Convertible Debentures, beliefs about the strengths of our intellectual property portfolio, regulatory goals and developments, our agreement with Laidlaw and its effect on our future capital resources, future financial position, expectations with respect to stock option expense recognition, future cash needs, the sufficiency of our working capital and operating losses for the remainder of the current fiscal year, and involve risks and uncertainties. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, there can be no assurance that such assumptions will prove to be accurate and actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, changes in law or regulatory policies, unanticipated competition from other similar businesses, adverse outcomes from litigation, unexpected employee departures or disruptions, adverse market and general economic factors and other factors described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Such forward-looking statements are qualified in their entirety by the cautions and risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Business

SpectraScience, Inc. (the "Company," "SpectraScience," "we," "our," or "us") develops and manufactures innovative Laser Induced Fluorescence spectrophotometry systems capable of determining whether tissue is normal, pre-cancerous or cancerous without removing tissue from the body. The WavSTAT Optical Biopsy System (the "WavSTAT System") is SpectraScience's first product to incorporate its proprietary fluorescence technology for clinical use. The WavSTAT System carries the CE mark designation which allows for the sale and marketing in the European Union for the diagnosis of cancer. The Company is developing light-based diagnostics for additional cancer indications including inflammatory bowel disease and esophageal cancer. Once these additional applications are developed the Company plans to self-certify for CE mark approval for sale in the European Union and then file an application with the FDA seeking permission to begin marketing for that indication for use in the United States. The Company believes it has a strong intellectual property portfolio that will allow it to continue to expand its WavSTAT cancer diagnosis platform to address the diagnosis of multiple cancers, utilize additional proprietary bio-photonic techniques to improve the WavSTAT's overall diagnostic performance and ultimately allow for the detection of cancer and pre-cancer over a relatively large area of examined tissue.

Our principal executive offices are located at 11568 Sorrento Valley Rd., Suite 11, San Diego, CA 92121. We can be reached by telephone at (858) 847-0200; by fax at (858) 847-0880; or by email at info@spectrascience.com. We have a Web site at http://www.spectrascience.com. The information contained on our Web site shall not be deemed to be a part of this Report.

Plan of Operation

During the past 12 months, SpectraScience spent a majority of its time and significant resources redesigning and manufacturing its improved WavSTAT4 Optical Biopsy System. Improvements included a redesign of the system to make it easier to use and the development of a new diagnostic algorithm that the Company believes is more accurate and reliable. The WavSTAT4 completed production and qualified for sale in the European Union under the CE Mark in December 2011.

Over the next 12 months, SpectraScience intends to:

Continue to market, sell and expand the geographic footprint of the WavSTAT4 Optical Biopsy System colon cancer diagnostic application in the European Union in conjunction with its distribution partnership with PENTAX Europe GmbH;

Acquire or license complementary technologies for the development of future WavSTAT System diagnostic indications;

Improve the diagnostic capability of the WavSTAT4 colon cancer application;

Begin the design and planning for the next generation of multi-modal fluorescence and broadband spectroscopy systems at our facility in San Diego, California; and

Continue to expand and refine our intellectual property portfolio.

Results of Operations

Three Months Ended September 30, 2012 and 2011

The Company recognized approximately $151,000 and $0 in revenue for the three months ended September 30, 2012 and 2011, respectively. The revenue in the fiscal 2012 three-month period resulted from the Company's distribution agreement with PENTAX Europe, GmbH, signed in June 2012. As a result the Company recognized gross profit of approximately $73,000 for the quarter ended September 30, 2012.

Total operating expenses decreased from approximately $1,193,000 to $880,000, a decrease of approximately $313,000 for the three-month period ended September 30, 2012 as compared to the three-month period ended September 30, 2011. This overall decrease was comprised of approximate decreases in research and development expense of $200,000, general and administration expense of $64,000 and sales and marketing expense of $49,000.

Research and development expenses for the three months ended September 30, 2012 and 2011 were approximately $236,000 and $436,000 respectively. The approximate $200,000 decrease for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 was due to approximate decreases in engineering development expense of $169,000, clinical studies expense of $30,000 and other expense of $1,000. The decrease in engineering development expense reflected the increased expense in the prior period as a result of the re-engineering of the WavSTAT4 System. The decrease in clinical studies was a result of no clinical studies in Europe in the three-month period ended September 30, 2012 as compared to several clinical studies in the same period one year ago.

General and administrative expenses for the three months ended September 30, 2012 and 2011 were approximately $537,000 and $601,000 respectively. The approximate $64,000 decrease for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 was due to approximate decreases in consulting expense of $88,000, legal expense of $17,000, travel expense of $9,000 offset by approximate increases in investor relations expense of $10,000, depreciation expense of $32,000 and all other expenses of $8,000. These expense decreases were a result of lower advisory service fees paid to investment bankers in the three-month period ended September 30, 2012 as compared to the same period one-year ago.

Sales and marketing expenses for the three months ended September 30, 2012 and 2011 were approximately $107,000 and $156,000, respectively. The decrease of approximately $49,000 was due to approximate decreases of $33,000 in advertising expense, $11,000 in travel expense and $5,000 in all other expense. The decreases are generally a result of higher trade-show collateral expenses in the prior three-month period ended September 30, 2011 due to the Company's direct participation in European trade shows and lower travel expenses due to the hiring of a European-based business development executive to service international markets for the three-month period ended September 30, 2012.

As a result of the above, the approximate net operating loss for the three months ended September 30, 2012 and 2011 was $807,000 and $1,193,000 respectively. Of the net operating loss for the quarter ended September 30, 2012, approximately $87,000 was comprised of non-cash stock option expense.

Non-operating expense increased approximately $62,000 as a result of non-cash income and expense related to our convertible debt issuance comprised of approximate increases in amortization of derivative and warrant liability discount of approximately $807,000, increased amortization of debt issuance costs and original issue discount of approximately $353,000, increased interest expense of approximately $106,000 and increases in other non-operating expense of approximately $3,000 offset by warrant and derivative liability income of $1,207,000.

As a result of the above, the approximate net loss decreased by $325,000 for the three months ended September 30, 2012 and 2011 from approximately $1,190,000 to $865,000. Of the net loss for the quarter ended September 30, 2012, the Company recognized a non-cash benefit of approximately ($313,000).

Nine Months Ended September 30, 2012 and 2011

The Company recognized approximately $461,000 and $0 revenue for the nine months ended September 30, 2012 and 2011, respectively. The revenue in the current nine-month period is a result of the Company's distribution agreement and sales to PENTAX Europe, GmbH, signed in June of 2012. As a result the Company recognized gross profit of approximately $183,000 for the nine-month period ended September 30, 2012.

Total operating expenses decreased from approximately $3,010,000 to $2,991,000, a decrease of approximately $19,000 for the nine-month period ended September 30, 2012 as compared to the nine-month period ended September 30, 2011. This overall decrease was comprised of approximate decreases in research and development expense of $30,000 and sales and marketing expense of $63,000 offset by an approximate increase of $74,000 in general and administrative expense.

Research and development expenses decreased approximately $30,000 for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. Overall research and development expenses for the comparative periods were approximately $906,000 and $936,000, respectively. The decrease was comprised of approximate decreases in clinical studies expense of $25,000, stock option expense of $22,000, consulting expense $22,000, engineering development of $21,000 and all other expense of $17,000 offset by an approximate increase in payroll expense of $77,000. The decrease in engineering development expense reflected the completion of the refinement of the WavSTAT4 System. Payroll expense increased due to bonus expense and the hiring of an employee who was formerly a consultant in the nine-month period ended September 30, 2011 as compared to the nine-month period ended September 30, 2012.

General and administrative expenses for the nine months ended September 30, 2012 and 2011 were approximately $1,737,000 and $1,663,000, respectively. The approximate $74,000 increase for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 was due to approximate increases in investor relations expense of $86,000, depreciation expense of $79,000, payroll expense of $56,000, bad debt expense of $27,000, and other expense of $1,000 offset by approximate decreases in stock compensation expense of $67,000, consulting expense of $49,000, legal expense of $33,000 and financial amortization expense of $26,000. Investor relations expense increased because the Company retained a new investor relations firm. Depreciation expense increased due to the classification of certain WavSTAT4 machines as demonstration units. Payroll expense increased due to the payment of senior management bonuses and bad debt expense increased due to the Company's shift from small country-specific distributors to PENTAX Europe GmbH. Stock compensation expense decreased due to a comparative reduction in stock option grants between the two comparative periods.

Sales and marketing expenses for the nine months ended September 30, 2012 and 2011 were approximately $348,000 and $411,000, respectively. The decrease of approximately $63,000 was due to approximate decreases of $65,000 in recruiting expense, $33,000 in advertising expense, $18,000 in travel expense and $10,000 in other expense offset by approximate increases of $53,000 in payroll expense and $10,000 in stock compensation expense. The decreases are generally a result of the long recruitment time required to hire a European-based business development executive to service international markets and an offset with the increased payroll cost of this executive.

As a result of the above, the approximate net operating loss for the nine months ended September 30, 2012 and 2011 was $2,808,000 and $3,010,000, respectively. Of the net operating loss for the nine months ended September 30, 2012, approximately $280,000 was comprised of non-cash stock option expense.

Non-operating expense increased approximately $6,732,000 as a result of non-cash expenses related to our convertible debt issuance comprised of approximate increases in warrant and derivative liability expense of $3,265,000, increased amortization of debt discount of approximately $2,253,000, increased amortization of debt issuance costs and original issue discount of approximately $958,000 and increased interest expense of approximately $259,000 offset by a decrease in other expense of $3,000.

As a result of the above, our net loss increased by approximately $6,541,000 for the nine months ended September 30, 2012 and 2011 from approximately $3,004,000 to $9,545,000. Of the net loss for the nine months ended September 30, 2012, approximately $7,015,000 was comprised of non-cash expense.

Liquidity and Capital Resources

As of September 30, 2012, the Company had negative working capital of approximately $2.7 million and cash and cash equivalents of approximately $66,000, compared to positive working capital of approximately $171,000 and cash and cash equivalents of approximately $251,000 as of December 31, 2011. In December 2011, the Company entered into an Engagement Agreement with Laidlaw & Company (UK) Ltd. Under the Engagement Agreement, Laidlaw agreed to assist the Company in raising up to $20.0 million in capital over the next two years. During the nine-month period ended September 30, 2012, the Company raised approximately $2.2 million, net of transaction costs, under this agreement. However, if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined in the Engagement Agreement occur as expected, such proceeds will be sufficient to allow the Company to sustain operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be able to meet its revenue expectations which requiring it to seek additional capital. In such event, the Company may not be able to find capital or raise capital or debt on terms that are acceptable.

Since December 31, 2011, the Company's net working capital deficit has increased from approximately ($171,000) to ($2,700,000). The primary cause of this deficit increase is a result of the accounting treatment required for the Convertible Debentures issued through the nine-months ended September 30, 2012. The Company has paid principal and interest on the Convertible Debentures that have reached maturity and been voluntarily converted by holders and interest on such Convertible Debentures by issuing shares of common stock and plans to continue to do so in the future. At September 30, 2012, adjusting for the non-cash effect of the Convertible Debentures on the Company's net working capital deficit, the adjusted net working capital deficit would have been approximately ($312,000).

The Company paid principal and interest owing on Convertible Debentures that have been voluntarily converted by holders by issuing shares of common stock. In the future, the Company expects to continue to retire Convertible Debentures and to pay principal and interest owing by issuing common stock. The holders of Convertible Debentures control the conversion of the Convertible Debentures and certain of the Convertible Debentures were not converted at their maturity constituting a potential default on these remaining matured, but unconverted, Convertible Debentures. The holders of these unconverted Convertible Debentures have the option to declare their Convertible Debentures in default. In the event of such default, principal, accrued interest at a default rate of 20% per annum and other related costs are immediately due and payable in cash.

During the three-month period ended September 30, 2012, Convertible Debentures with a face value of approximately $2,350,000 held by a total of 44 investors matured. Of these debentures, those with a face value of approximately $1,940,000 (held by 41 investors) were voluntarily converted as of the date of this quarterly report. There remain matured, but outstanding Convertible Debentures with a face value of approximately $411,000 held by three individual investors. None of these three investors have served the Company with notice of default on the Convertible Debentures held by them.

The financial statements included elsewhere in this quarterly report have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

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