Item 1. Business
Cautionary Statement Regarding Forward-Looking Statements
This report contains ''forward-looking statements’’ within the meaning of Section 27A of the Securities Act of 1933, as amended (the ''Securities Act’’), and Section 21E of the Securities Exchange Act of 1934, as amended (the ''Exchange Act’’). All statements other than statements of historical facts included or incorporated by reference in this annual report on Form 10-K, including without limitation, statements regarding our future financial position, business strategy, budgets, projected revenues, projected costs and plans and objective of management for future operations, are forward-looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as ''may,’’ ''will,’’ ''expects,’’ ''intends,’’ ''plans,’’ ''projects,’’ ''estimates,’’ ''anticipates,’’ or ''believes’’ or the negative thereof or any variation there on or similar terminology or expressions. These forward-looking statements are based on beliefs of our management as well as current expectations, projections and information currently available to the Company and are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from historical results or those anticipated or implied by such forward-looking statements. Certain of these risks are described more fully under the caption “Risk Factors” herein and include, but are not limited to, our ability to raise capital; our ability to retain key employees; our ability to engage third party distributors to sell our products; economic conditions; technological advances in the medical field; demand and market acceptance risks for new and existing products, technologies, and healthcare services; the impact of competitive products and pricing; U.S. and international regulatory, trade, and tax policies; product development risks, including technological difficulties; ability to enforce patents; and foreseeable and unforeseeable foreign regulatory and commercialization factors and any statements of assumptions underlying any of the foregoing. Should one or more of such risks or uncertainties materialize or should underlying expectations, projections or assumptions prove incorrect, actual results may differ materially from those described. Those events and uncertainties are difficult to predict accurately and many are beyond our control. All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the foregoing. Except as required by law, we assume no duty to update or revise our forward-looking statements.
Overview
CytoCore, Inc. (“CCI”, “Cytocore”, the “Company”, “we”, or “us”), formerly Molecular Diagnostics, Inc., is developing, and plans to sell an integrated family of cost-effective products for the detection, diagnosis and treatment of cancer under the trade name of CytoCore Solutions®. CytoCore Solutions products are intended to address sample collection, specimen preparation, specimen evaluation (including detection/screening and diagnosis), treatment and patient monitoring within vertical markets related to specific cancers. Current CytoCore Solutions products are focused upon cervical cancer. We plan that this focus will later be expanded to include other gynecological cancers as well as bladder, lung, and breast cancers, among others. Within each of these markets, we anticipate that the CytoCore Solutions products will be sold as individual value-added drop-in replacements for existing products and as integrated systems that improve the efficiency and effectiveness of clinical and laboratory operations.
Currently our only product is the SoftPAP cell collection device that is intended to replace the spatula and brush currently used to collect cervical cytology samples. SoftPAP® constitutes one of the cell collection components of our CytoCore Solutions System. We are also licensed to sell the PadKit®, another sample collection device directed at ensuring female reproductive tract health, and a cell preservative developed for cytological applications by Cell Solutions LLC. CCI intends to market and sell the SoftPAP and PadKit devices along with this preservative worldwide. The other components of the CytoCore Solutions System include certain biochemical assays and slide-based tests, our next generation specialized system for computer-assisted cytology - the Automated Image Proteomic Systems or AIPS™ - and a drug delivery system.
We believe the CytoCore Solutions System will provide better detection and diagnosis of cancer and cancer-related diseases through improved specimen quality and accuracy of test results, both in terms of a lower incidence of false negatives and fewer inadequate collections of samples. We also believe the system will expand the number of women who can be tested, thereby increasing detection and diagnosis rates.
Background
We were incorporated in Delaware in December 1998 as the successor to Bell National Corporation, a company incorporated in California in 1958. In December 1998, Bell National, which was then a shell corporation, acquired InPath, LLC, a development stage company engaged in the design and development of products used in screening for cervical and other types of cancer. For accounting purposes, the acquisition was treated as if InPath had acquired Bell National. However, Bell National continued as the legal entity and the registrant for Securities and Exchange Commission filing purposes. Bell National merged into Ampersand Medical Corporation, its wholly-owned subsidiary, in May 1999 in order to change the state of incorporation of the company to Delaware.
In September 2001, we acquired 100% of the outstanding stock of AccuMed International, Inc. by means of a merger of AccuMed into a wholly-owned subsidiary of the Company. Shortly after the AccuMed merger we changed our corporate name to Molecular Diagnostics, Inc. The name change was effected by the merger of our wholly-owned subsidiary, Molecular Diagnostics, Inc., with and into Ampersand. In 2006, our shareholders approved a proposal to change the Company’s name from Molecular Diagnostics, Inc. to CytoCore, Inc., which change was effected in Delaware in June 2006. Except where the context requires or as otherwise noted, “CCI,” the “Company,” “we” and “our” refers to CytoCore, Inc. and our subsidiaries and predecessors.
Recent Developments
During 2010 and 2011 to date, our operations were severely restricted by our lack of working capital. We have maintained minimal operations. Due to this restriction, we have not been able to hire marketing and sales personnel or accelerate our research and development activities. If we are unable to raise additional capital, we may be forced to cease operations.
Information About Industry Segments
We operate in one industry segment involving medical screening devices, diagnostics, and supplies. All of our operations during the reporting period were conducted and managed within this segment, with a single management team that reports directly to our Chief Executive Officer. For information on revenues, profit or loss and total assets, among other financial data, attributable to our operations, see the consolidated financial statements included herein.
Description of Business
We develop, manufacture and plan to sell an integrated family of cost-effective products for the detection, diagnosis and treatment of cancer under the trade name of CytoCore Solutions®. CytoCore Solutions products are intended to address sample collection, specimen preparation, specimen evaluation (including detection/screening and diagnosis), treatment and patient monitoring within vertical markets related to specific cancers. Current CytoCore Solutions products are focused upon cervical cancer. We plan that this focus will later be expanded to include other gynecological cancers as well as bladder, lung, and breast cancers among others. Within each of these markets, we anticipate that the CytoCore Solutions products will be sold as individual value-added drop-in replacements for existing products and as integrated systems that improve the efficiency and effectiveness of clinical and laboratory operations.
Total revenue for the years ended December 31, 2010 and 2009 were $30,000 and $44,000, respectively. Of this total revenue, license fees accounted for $29,000, or 97%, of our revenue in 2010 and $40,000, or 90%, of our revenue in 2009. Sales of our SoftPap® product accounted for revenue of $1,000, or 3%, of our revenue in 2010 and $4,000, or 10%, of our revenue in 2009.
Products
Cell Collection Devices
The clinical diagnostics laboratory analyzes or otherwise evaluates samples obtained from the human body for the purpose of detecting the presence of disease, characterizing it as to type and extent, and/or monitoring the efficacy of
treatment. The starting point in any clinical diagnostic test is the collection of a sample that contains the analyte of interest. To a very large extent, the characteristics of the sample collected determine the quality of the results of any tests performed on the sample. The sensitivity and/or accuracy of a test is, for example, likely to be reduced if the sample collection device or method does not capture a sufficient amount of the target analyte, alters the analyte of interest, or collects significant quantities of substances that interfere with the analysis. For this reason, sample collection is a major focus of CytoCore.
SoftPAP®
We currently manufacture and sell the SoftPAP® device for the collection of cervical cell samples that are used in the detection of cervical dysplasia, cancer and human papillomavirus (“HPV”) infections. We believe that SoftPAP, which has been cleared by the Food and Drug Administration (‘FDA”) for sale in the United States and which is CE Marked for international distribution, is positioned as a premium value-added alternative to the spatula, broom and brush-style devices that have traditionally been used for these purposes. Unlike these traditional devices, SoftPAP collects only exfoliated cells and does not scrape, cut or abrade the cervix. This unique sample collection method has been shown in clinical trials to reduce the frequency of false negative and false positive results when the sample is evaluated by cytological methods to detect the presence of dysplasia and cancer. A reduction in the false negative rate means that a greater percentage of patients who have cervical dysplasia, cancer or similar abnormalities are detected during cervical cancer screening (Pap testing) and can, therefore, be treated. A reduced false positive rate means that fewer patients are falsely identified as having cervical dysplasia or cancer, thus sparing these patients the unnecessary stress, discomfort and expense of the additional testing needed to verify that dysplasia or cancer is actually present. In addition, women have reported that having a cervical sample taken using SoftPAP is more comfortable than when a traditional device is used. Variants of SoftPAP are also being designed for the collection of exfoliated cell samples from tissues other than the cervix.
PadKit®
PadKit® is a low cost device that captures a sample that can be evaluated to provide an assessment of the health of the entire female genital tract. We have obtained an exclusive license to sell PadKit for the collection of cellular samples that can be screened for a variety of gynecological cancers (including cervical, endometrial, and ovarian), and for the collection of gynecological samples to be tested for the presence of HPV. In the future, we may obtain licenses to sell PadKit for additional indications such as the collection of samples for sexually transmitted disease (“STD”) testing. PadKit addresses a number of market niches and segments that are not addressed effectively by SoftPAP or traditional gynecological sampling devices. CCI believes that PadKit thus complements SoftPAP in the CytoCore Solutions family of products. PadKit is designed to eliminate the need for assistance from a medical professional when collecting gynecological samples for many screening applications. We believe that this feature, in addition to the range of tests that can be performed on a PadKit sample and PadKit’s low cost, makes PadKit particularly attractive for use in large scale public health screening programs. We are also evaluating the use of PadKit in an internet-based fee-for-service testing program outside of the United States. Additional uses, such as providing a simple and rapid means of monitoring patients who have had an abnormal Pap test or who are undergoing treatment for a gynecological cancer, are also being explored.
Specimen Preparation
Cervical cytology specimens are traditionally prepared as “smears” where the cells on the collecting device are literally wiped or smeared onto a microscope slide. In the mid-1990s an alternative method, variously called a “monolayer” or “liquid-based” preparation (“LBP”), was introduced. In this method, cells are washed off of the collection device into a preservative solution to form a cell suspension. A portion of this cell suspension is then transferred to a microscope slide. LBPs presently account for about 80% of the cervical cytology slides prepared in the United States, but despite the technical benefits of LBPs, only about 20% of the cervical cytology slides in the European Union and much lower percentages in the rest of the world are prepared in this manner. The primary limitations to greater adoption of LBPs outside of the United States are the high equipment and ancillary supply costs associated with the two predominant LBP methods.
Cell Preservative
We have reached an agreement with Synermed Select Partners, Inc. (“Synermed”) under which we will package and market their cell preservative with our SoftPAP and PadKit cell collection devices. We selected this preservative for
inclusion in convenience kits due to both its technical performance and because slides can be prepared manually from cells in this preservative, thus avoiding the high equipment and supply costs incurred when using competing methods. We believe that this methodology provides a cost effective means for laboratories to transition from smears to high quality LBPs. We intend to introduce convenience kits containing the SoftPAP and the preservative in the European Union to address the demand for LBPs in that part of the world. We expect that distribution of such manual kits will then be expanded by region. In parallel, We plan to introduce a cytocentrifuge-based slide preparation system for use in low volume laboratories and to collaborate with Cell Solutions, an affiliate of Synermed, on selling the Cell Solutions automated slide preparation system to high volume laboratories in these countries. Unlike the rest of the world, where this preservative is already approved for use, it is approved only as a general cytology preservative in the United States and requires additional FDA approval before it can be sold for use in specific applications such as cervical cytology. CCI and Cell Solutions have agreed to collaborate on obtaining the necessary FDA approval. We are also working with the manufacturer of PadKit to validate the preservative for this application, where CCI believes its superior ability to process bloody samples is of particular relevance. An independent clinical trial of PadKit in combination with the preservative has recently been initiated by the UCLA School of Nursing.
Stains and Reagents
Once a cytology specimen has been deposited onto a microscope slide, it is stained in order to assist the cytologist in detecting and identifying the various features of the deposited cells that are relevant to determining whether the cells are normal, dysplastic or cancerous. We are developing several proprietary stains for use in cervical cytology and other screening applications. These stains are designed for automated evaluation using the AIPS Imager (see below), but some may also be evaluated visually or using a flow cytometer. We are presently designing clinical studies to validate certain of these stains for use in cervical cytology as well as for use in other cytological assays. We believe that an added benefit of the CCI proprietary stains is that after the specimen has been evaluated using these stains, it can be counterstained with Pap stain for conventional confirmation and archiving.
Specimen Evaluation
When “reading” a cytology specimen, a cytologist traditionally examines the specimen by eye through a conventional optical microscope to detect, classify, record, mark, and report abnormal cells. While performing this examination, the cytologist is also referring to the patient’s medical history, assessing specimen adequacy, and capturing a variety of metrics and other information needed for regulatory compliance and operational purposes. Despite the widespread deployment of computers in the laboratory, many of these operations are still largely paper-based. Even in laboratories where medical histories are available to the cytologists in electronic form and reports are prepared on a computer, it is not uncommon for the data, and sometimes even draft reports, to be initially captured on paper and then transcribed.
In 1994 AccuMed, a corporate predecessor to CytoCore, introduced the AcCell™ computer-assisted cytology workstation. AcCell provided a means to assist the cytologist by automatically capturing the information relevant to screening cytology specimens in electronic form, managing the captured information, and automatically generating the necessary specimen, regulatory and operational reports. The benefits of this approach were clearly demonstrated in several cytology laboratories where installation of the AcCell system reduced operating costs, eliminated transcription errors, and reduced the time needed to generate a reportable result.
AIPS™ Workstation
The AIPS™ Workstation is an updated and improved version of the AcCell Workstation. Like the AcCell, the AIPS Workstation is intended to reduce operating costs and improve operating efficiency in the cytology laboratory. Among the improvements and new features incorporated in the AIPS Workstation are a more efficient user interface, improved data management, workflow management and communications capabilities, and new features such as image capture, audio dictation, a “consult” mode, and support for continuing education and proficiency testing. In keeping with the AcCell tradition, patented context-sensitive software allows these capabilities to be provided in an unobtrusive manner that permits the cytologist to concentrate on evaluating specimens rather than on operating the instrument.
We believe that the AIPS Workstation hardware also incorporates several major advances over the AcCell, competing “computerized microscope” systems, and conventional cytology microscopes. “Fly-by-wire” technology, for
example, allows the user to switch seamlessly between manual and computer-controlled specimen positioning and focusing and makes possible many of the improvements in system ergonomics. This is important as it has been documented that the poor ergonomics of conventional cytology microscopes are responsible for causing many cytologists to leave the field due to carpal tunnel syndrome and related medical problems. The AIPS Workstation is expressly designed to address the root causes of many of these ergonomic problems and is, therefore, expected to improve the retention of trained cytologists, who are in increasingly short supply, by the laboratory. Unlike the AcCell and other computerized microscopes, the AIPS Workstation does not require an external PC for operation. Instead, all necessary computing power is embedded within the workstation frame. This provides multiple benefits ranging from eliminating a considerable quantity of equipment from a cytologist’s typically cramped work area to facilitating the periodic equipment validations that laboratories are required to perform.
In addition to use as part of a cytology screening system, the AIPS Workstation can also be used in conjunction with the AIPS Imager for automated cytological analysis, and in many other applications in which a conventional microscope is used such as pathology and hematology in a clinical laboratory, and applications outside of the clinical laboratory that range from drug discovery and quality control to metallurgy.
AIPS™ Imager
The intent of a medical screening program is to differentiate between patients who show no evidence of the target disease state (“normals”) and those who do (“abnormals”). Patients who have abnormal screening results are offered follow-up testing to confirm the presence of the disease, diagnosis to classify the disease state and determine its extent and, where appropriate, treatment for the disease. Patients who have a normal screening result are not offered these services. In order to allow scarce medical resources to be focused upon those patients having the greatest need, screening programs are structured to differentiate between normal and abnormal patients as accurately, rapidly, reliably and cost effectively as possible.
Although the evaluation of cervical cytology specimens by automated image analysis can be traced back to the 1940s and a number of capable systems have been developed, the FDA has not to date approved any automated image analysis system to “diagnose”, or classify as normal or abnormal, cervical cytology specimens without human intervention. The FDA has, however, approved several systems including the AccuMed TracCell™ for use in “mapping” or “location-guided screening”. In these systems, image analysis is used to identify potentially abnormal cells which are then presented to a cytologist for classification. This approach, which has been shown to reduce the time required to differentiate between normal and abnormal specimens, is starting to be adopted by high volume laboratories, but is presently too expensive for most laboratories. We believe that our imager will be marketable at a price that will be affordable for most laboratories.
The AIPS™ Imager is an advanced version of the AccuMed TracCell location-guided cytology screening system that has been optimized for use with the proprietary CCI stains described above. As these stains are designed to be more effective in highlighting the cellular abnormalities associated with cancer and precancerous conditions than the traditional Pap stain used in conjunction with other automated cytology screening instruments, the AIPS Imager is expected to deliver superior performance when used in cytological screening applications. The AIPS Imager is intended to work in conjunction with the AIPS Workstation. When a specimen slide is evaluated by the AIPS Imager, the locations on the slide of any potentially abnormal cells are recorded to a data file. The slide is then transmitted to an AIPS Workstation where the data file guides the workstation to present each of the potentially abnormal cells detected to the cytologist for classification.
CCI plans several additional software modules that will expand the capabilities of the AIPS Imager. These modules may include those for the analysis of specimens stained with new CytoCore stains, bulk image capture and archiving, generation of time-optimized routing plans to maximize the efficiency of specimen review on an AIPS Workstation, and a “preview” module that assists the cytologist in evaluating difficult specimens. CCI hopes that this product family will also be expanded by the addition of application kits consisting of the stains and associated software that are needed for the automated screening of other types of cytology specimens.
Therapeutics
We have placed the development of a derivative of the SoftPAP cell collection device that can be used to apply a patch containing a therapeutic agent to the cervix on hold pending the availability of the necessary resources. We are
planning to develop and market this applicator, as well as patches containing established therapeutic agents, at some future date in collaboration with a pharmaceutical or transdermal patch manufacturer.
Product Development
Our core product development strategy is to develop the CytoCore Solutions System and its component products, enhance such products, and develop new and innovative diagnostic and screening devices for the early detection of various types of cancer. To implement this strategy, we have and will continue to utilize internal resources, sponsored and collaborative agreements with medical institutions, strategic partnerships with commercial entities, and licenses and acquisitions of intellectual property.
In the future, we anticipate expanding our portfolio to include other cytological assays and tests, tests for STDs, including HPV, and other markers of vaginal health, and medicinal products related to the treatment of diseases of the female reproductive system. The CytoCore product pipeline for 2011 calls for the introduction of PadKit, an improved cytology preservative for use with SoftPAP and PadKit, and possibly a novel cytological stain. In 2012, we expect to introduce the AIPS Workstation and to introduce the AIPS Imager with assay reagents for the location-guided screening of cervical cancer specimens in 2013. Reagents for use in the automated screening for additional conditions such as endometrial and bladder cancer are expected to be introduced in late 2014.
Markets and Marketing Objectives
Diagnostic Focus
Our immediate chief objective is to achieve broad market acceptance of the SoftPAP collection device and the CytoCore Solutions System as a new screening and diagnostic tool for cervical cancer screening, offering an alternative to the current Pap test methods. It is estimated that there are approximately 60 million annual Pap tests given in the United States. Worldwide, approximately 180 million tests are given and approximately 1.5 to 1.8 billion women require annual Pap testing. Many studies have shown that between 70 and 80% of a person’s entire healthcare expenditures over their whole life occur in the last four to six months of life. As a result, more and more attention is being given to the early detection of a disease or condition. Bio-molecular screening, diagnostic, and treatment products consequently are being developed to detect disease states early so they can be dealt with before they become life threatening and expensive to treat. We are designing and developing its products to satisfy this paradigm shift and focus more on diagnostic methods and tools for early detection.
Point of Care for All Populations
We also believe we are well positioned to capitalize on trends affecting the world’s population. The female population of the world is approximately 3 billion, of which 2 billion fall in the range where reproductive healthcare monitoring is necessary and effective. This group falls into two sub-groups: (1) females in the United States and other countries where healthcare is available to most, and where healthcare is more or less effective (estimated at between 300 and 400 million women), and (2) the remainder of the female world population, where healthcare is limited or non-existent. We believe our products can address the needs of both of these groups, since the principal requirements for both groups - minimal cost, near point-of-care delivery, ease of use, and reduced reliance on highly-trained and skilled professionals - are the same. We are developing our initial products to serve the needs of females in developed nations and economies, but anticipate subsequent deployment of such products to less well-developed countries.
Within both developed and developing economies, there are macro trend drivers that are not specific to female healthcare needs, including:
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Increasing life spans, driving the demand for healthcare services up and increasing the emphasis on developing screening tests for the early detection of diseases;
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Limited infrastructure and the fact that a significant portion of the world population lives in locations where the infrastructure does not support the classical laboratory-based model of healthcare delivery, putting a premium on point-of-care diagnostic testing;
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An increasingly mobile population, which has increased the pressure to minimize the time between when a patient is tested and when the test result is available and delivered;
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Increasing worldwide shortage of physicians and laboratory professionals who have the skills and training needed to perform and interpret screening and diagnostic tests, increasing the need for tests that can be performed and interpreted by technicians and para-professionals; and
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Constrained funds available for healthcare, driving the need to reduce healthcare costs.
These trends are set against the major advances that are occurring in many areas related to healthcare. These advances range from a better and more nuanced understanding of disease states to the movement of genomics, proteomics and bioinformatics out of the research laboratory and into routine medical practice. These are supported by rapid advances in information, optical and software technology. This combination is making it possible to perform increasing numbers of screening and diagnostic tests at or near the point of care. CytoCore is focused upon utilizing these advances to provide products that address the needs of these worldwide markets.
Sales and Distribution
The SoftPAP has initially been targeted to the premium segment of the cervical cytology sampling market. This premium segment comprises almost the entire cervical sampling market except for public health programs and research hospitals. We expect that the SoftPAP will be primarily delivered to these customers through local and regional distributors who specialize in the value-added OB/GYN market.
In 2010, we engaged the services of Dr. Mauro Scimia as a sales representative. Dr. Scimia will be focusing upon developing markets for Company products in the European Union and surrounding regions and providing support to our distributors.
In 2010, we entered into an agreement with Prosper Channel for the distribution of SoftPAP in China. We are presently working with Prosper Channel to register SoftPAP for sale in China and expect to receive this approval late in the second quarter or early in the third quarter of 2011.
The AIPS Workstation will be marketed to small and medium-sized hospitals and reference laboratories. The compact, low cost design of the workstation is intended to facilitate its deployment at or in proximity to the point of care. Once the AIPS Workstation has been successfully established in the laboratory market, our strategy is to form alliances with these laboratories and other medical products distribution companies and utilize their sales forces to broaden sales of the system to other markets, including hospitals, clinics, managed care organizations and office-based physician groups. Our marketing strategy to these organizations will vary depending upon the applicable cancer screening test.
We plan to sell cell preservatives in combination with the SoftPap product only. The corresponding PadKit marketing strategy is being developed, but it is currently anticipated to be based upon convenience kits containing PadKit and the preservative.
Many countries in which healthcare has been partially or fully nationalized utilize a “tender system” in which contracts to supply a specified quantity of a product for a specified period of time are periodically made available for bidding. CCI is taking the steps necessary to become qualified to bid on tender offers in selected countries.
Government Regulation, Clinical Studies and Regulatory Strategy
The development, manufacture, sale, and distribution of medical devices are subject to extensive governmental regulation worldwide. In the United States our products are regulated under the Medical Device Amendments to the Food, Drug and Cosmetic Act (the “FD&C Act”) and cannot be sold, shipped or promoted in interstate commerce without prior
authorization by the FDA. In the European Union, medical devices are regulated under the Medical Device, In-Vitro Device and other Directives that require that each product be CE Marked to show that it conforms to all of the requirements of the applicable Directive(s) before it can be imported into or sold in the EU. The regulatory systems in other major markets such as China and South America have been undergoing substantial changes and now in many respects resemble the system in the EU. In particular, the CE Mark is now accepted or required in essentially all significant markets other than the US. In addition to having to obtain the appropriate regulatory approvals, the Company is also required to register its products with the National Health Authority in any country in which it expects to do business; may have its quality and manufacturing systems inspected and/or audited by representatives of various National Health Authorities; and may have to conform to additional regulations imposed by individual countries.
Under these regulations, we are subject to certain registration, record-keeping and reporting requirements; our manufacturing facilities, or those of our strategic partners, may be obligated to conform to specified quality standards, this compliance being subject to audits and inspections; and we are subject to national, state and local laws relating to such matters as safe working conditions, manufacturing practices and environmental protection. Failure to comply with these regulations could have a material adverse effect on our future operations and may impose additional costs and risks.
In the US, the FD&C Act generally bars selling, advertising, promoting, or other marketing of medical devices that have not been authorized (approved or cleared) by the FDA. The promotion or sale of medical devices for non-approved or “off-label” uses is prohibited. The FDA also regulates the design and manufacture of medical devices. These regulations have been largely, but not completely harmonized with the ISO quality system standards for medical devices that are used for similar purposes in most other countries. This incomplete harmonization requires us to maintain two separate, but equal quality systems and increases the cost of regulatory compliance. The FDA and the corresponding regulatory agencies in other countries may withdraw product clearances or approvals for failure to comply with these regulatory standards and may impose additional sanctions.
In the US most low to moderate risk medical devices that have legally marketed predicates receive “clearance” to market through a process described in Section 510(k) of the FD&C Act. In order to receive clearance under this so-called 510(k) process, a product must be shown to be “substantially equivalent” to an appropriate legally marketed “predicate device”. High risk devices and devices that do not have a predicate require “approval” via a PMA submission in which de-novo demonstration of the safety and efficacy must be established. Changes to a product, its intended use, and/or its labeling often require the submission of another 510(k) or PMA application. Obtaining approval to market via the PMA process takes substantially longer and is far more expensive than obtaining clearance to market via the 510(k) notification process.
The e2 Collector, which is the predecessor to the SoftPAP collector, was cleared for marketing by the FDA on May 31, 2002 and the SoftPAP collector received FDA clearance on January 31, 2008. Although most future Company products are expected to qualify for premarket clearance via the 510(k) process, some future products may require PMA approval.
In 2010 the FDA began a major review of the 510(k) process, which has resulted in the announcement of a relatively small number of administrative changes. It is expected that substantive changes, if any, will be announced during the last half of 2011 or during 2012. Some of the proposed changes that are currently under consideration have the potential to substantially increase the time and cost involved in obtaining marketing clearance via the 510(k) process.
In the US we are subject to various federal and state laws pertaining to healthcare fraud and abuse, including federal and state anti-kickback laws and the federal Foreign Corrupt Practices Act, make it illegal for an entity to solicit, offer, receive or pay remuneration or anything of value in exchange for, or to induce, the referral of business or the purchasing, leasing or ordering of any item or service paid for by Medicare, Medicaid or certain other federal healthcare programs. These statutes have been broadly defined to prohibit a wide array of practices, and our activities may subject the company and its partners to scrutiny under such laws. Violations may be punishable by criminal and/or civil sanctions, including fines, as well as the exclusion from participation in government-funded healthcare programs. Laws pertaining to these and related matters also exist in other countries.
Each country has historically imposed its own unique regulations on medical products. In recent years, however, there has been a trend toward the harmonization of these regulations resulting in greater consistency between countries. This has resulted in a large and growing number of countries (over 70 as of this writing) adopting the CE Mark as a central
element of their regulatory process for medical devices. The US is the only major country that has not adopted the CE Mark. In order for a product to be CE Marked, the manufacturer must demonstrate to the satisfaction of the regulatory authorities that the product is safe and effective (conforms to the “Essential Requirements” for that class of product) and that it is manufactured in accordance with specified quality standards. In most countries the CE Mark is a pre-condition for medical device registration and in some places such as the EU, is mandatory in order for a product to be imported into or sold within the country or region. Failure to comply with the regulations pertaining to CE Marking can result in product seizures and other sanctions.
The SoftPAP collector and the preservative are CE Marked to the Medical Device Directive and the In-Vitro Device Directive, respectively. As our products are intended to be marketed globally, we expect that all future products will be CE Marked to the applicable Directives and standards. The CE Mark for a product must be renewed every five years and will generally also require renewal if the requirements imposed by these Directives and standards change. This renewal increases the cost of regulatory compliance. In addition, the specific quality system requirements imposed upon a product are determined by the risk category into which the product is assigned by the applicable Directives. All of our current and planned products are presently considered to be low risk devices and are assigned to Class I which imposes the lowest level of quality system requirements. If a new Company product falls within or a current is reclassified into a higher risk category, we will be required to register our quality system to ISO 13485 in order to maintain the CE Mark on the affected product(s). Our quality system presently conforms to the requirements of ISO 13485, but we have not been formally registered to this standard. Registering a quality system to ISO 13485 and maintaining this registration will substantially increase the costs of regulatory compliance.
Several voluntary systems such as GS-1/GTIN, GMDA and EDMA for the identification of medical devices are presently in use in various parts of the world. The Global Harmonization Taskforce (GHTF), which is comprised of representatives from major medical device regulatory agencies such as the FDA, is in the process of developing a single unified medical device identification system that, when it goes into effect, will be mandatory worldwide. Current proposals combine various portions of the existing voluntary codes in order to construct the new unified identifiers which would then be required to be registered with a central repository. We are well positioned to comply with the currently proposed form of this new regulation as we have both company and product specific GS-1/GTIN codes as well as product specific GMDA and EDMA for our current products and has the mechanisms in place to obtain additional such codes in the future. The proposed regulations include user fees that will increase our cost of regulatory compliance.
We are also required to comply with certain environmental regulations with respect to products that are sold in the EU. One of these regulations is the Directive on Packaging and Packaging Wastes that mandates the minimization of packaging; restricts the use of certain packaging materials; and imposes requirements, including possible “take-back” provisions, with respect to the recycling of packaging materials. All current Company products comply with the requirements of this Directive. At present, we comply with the recycling portions of this Directive by ensuring that all packaging materials are compatible with recycling programs that are in place in the EU. However, in the future we may be required to take a more active role in the recycling of certain types of products including possibly “taking back” and recycling of laboratory instruments. Implementing a complaint take-back program will increase our operating and regulatory compliance costs.
In the EU electronic products, including clinical laboratory instruments such as the AIPS Imager and Workstation, are required to comply with two environmental Directives, one of which requires that the manufacturer “take back” and recycle the electronic portions of these instruments and the other (the so-called RoHS Directive) of which restricts the presence of certain materials in electronic products. We comply with the RoHS Directive by requiring our suppliers to use only RoHS complaint materials in the construction of our products. Upon commencement of instrument sales in the EU, if ever, we expect that we will be required to comply with the take-back requirements by contracting with an established electronic waste recycler in the EU. Such contracts will increase our operating costs.
The “REACH” regulation, which requires the registration of all chemical products produced in or imported into the EU is presently in its implementation phase. The long term impact of this extremely complex multi-level regulation on the Company is unknown at present, but is anticipated to be minimal in the near term as our sales of chemical products (stains, preservative, etc.) are and are expected to continue to be at less than the threshold levels for registration and reporting. An
increase in sales of such products above currently forecast levels and/or a reduction in the applicable thresholds could potentially result in significant costs to the Company.
Data from clinical trials and studies is often required in regulatory submissions and is highly desirable for use in product marketing activities. In general, at least one trial or study is necessary for each new product and additional studies or trials are needed to support new or modified indications for use and new marketing claims.
Each medical device is required to have an expiration date beyond which it may no longer be used. This expiration date is generally set very conservatively at the time of product introduction and may then be extended if warranted and supported by “realtime” data. Since SoftPAP was introduced, we have been collecting product life data from the field and has been conducting internal “stability tests”. The field and laboratory data collected to date suggests that the expiration dating for SoftPAP can be extended by at least 50% and potentially more than 100% over its original duration. We are initiating a clinical study, which is expected to be completed by the end of the second quarter of 2011, to validate these observations and to determine whether, and by what amount, SoftPAP expiration dating can be extended..
SoftPAP has FDA clearance and is CE Marked for the collection of samples for use in cervical cancer screening. At the time that these approvals were obtained, the accepted standard of clinical practice was to perform the initial screening by cytology and to use a HPV test to confirm and further classify any abnormal cytological results that were obtained. Recently several countries, most notably certain countries in the EU, have revised, or have begun revising their accepted practice such that the initial screening is now to be performed using a HPV test with reflex to cytological testing for confirmation and diagnosis of a positive HPV result. This change in use does not affect the approvals presently held by SoftPAP, but a new clinical study based upon this revision to clinical practice is needed for marketing purposes. The necessary study protocol has been prepared and discussions with potential clinical sites are in progress. It is presently anticipated that this study will be completed by no later than the first quarter of 2012. This same study will also provide additional validation data for the use of our preservative with SoftPAP and an independent test of one of the proprietary cytology stains that we are developing.
Several additional clinical trials and studies are planned, but will not be initiated until we can obtain sufficient additional financial and operating resources. The largest of these planned studies and trials is a formal clinical trial of PadKit in conjunction with our preservative for the self-collection of samples for cytology and HPV testing in both the primary and reflex modes. Other planned studies and trials include, but are not limited to, validation of certain stains and markers for use with the AIPS Imager, obtaining additional indications for use for SoftPAP and PadKit, and field validation of the AIPS Workstation.
Cost and Reimbursement
In the United States, laboratory customers bill most insurers (including Medicare) for screening and diagnostic tests such as the Pap test. Insurers, such a private healthcare insurance or managed care payers, in addition to Medicare, reimburse for the testing, with a majority of these insurers using the annually-set Medicare reimbursement amounts as a benchmark in setting their reimbursement policies and rates. Other private payers do not follow the Medicare rates and may reimburse for only a portion of the testing or not at all. Outside of the United States, healthcare providers and/or facilities are generally reimbursed through numerous payment systems designed by governmental agencies, such as the National Health Service in the United Kingdom, the Servicio Sanitaris Nazionale in Italy and the Spanish National Health System, as well as private insurance companies and managed care programs. The manner and level of reimbursement will depend on the procedures performed, the final diagnosis, the devices and/or drugs utilized, or any combination of these factors, with coverage and payment levels determined in the payer’s discretion.
Our ability to successfully commercialize the CytoCore Solutions System and future products will depend, in part, on the extent to which coverage and reimbursement for such products will be available from third-party payers in the United States such as Medicare, Medicaid, health maintenance organizations and health insurers, and other public and private payers in foreign jurisdictions. The coverage policies and reimbursement levels of these third-party payers may impact the decisions of healthcare providers and facilities regarding which medical products they purchase and the prices they are willing to pay for those products. In some countries, our ability to commercialize products will also depend upon us becoming a qualified bidder on the tender offers issued by the National Healthcare Authority. If we succeed in bringing products to the market,
we cannot be assured that third-party payers will pay for such products or establish and maintain price levels sufficient for realization of an appropriate return on our investment in product development. Additionally, we expect many payers to continue to explore cost-containment strategies (e.g., competitive bidding for clinical laboratory services within the Medicare program, so-called “pay-for-performance” programs implemented by various public and private payers, etc.) that could potentially impact coverage and/or payment levels for current or future CytoCore products.
Competition
Historically, competition in the healthcare industry has been characterized by the search for technological innovations and efforts to market such innovations, and technological advances have accelerated the pace of change in recent years. The cost of healthcare delivery has always been a significant factor in markets outside of the United States. In recent years, the U.S. market has also become much more cost conscious. We believe technological innovations incorporated into certain of our products offer cost-effective benefits that address this particular market opportunity.
Competitors may introduce new products that compete with ours, or those that we are developing. We believe the portion of our research and development efforts devoted to continued refinement and cost reduction of our products will permit us to remain or become competitive in the markets in which we presently distribute or intend to distribute our products.
The market for our cancer screening and diagnostic product line is significant, but highly competitive. We are currently not aware of any other company that is duplicating our efforts to develop a fully-automated, objective analysis and diagnostic system for female reproductive-tract cancer screening that can be used at the point of care. Nonetheless, we compete with several large and well-established medical device companies, including companies with financial, marketing, and research and development resources substantially greater than ours. There can be no assurance that our technological innovations will provide us with a competitive advantage.
There are several companies that produce automated and quantitative microscopy instruments. In the past, the market for these instruments has been primarily limited to research applications. However, as a result of recent advances in the area of molecular diagnostics, we believe the market for such instruments and applications will increase over the next several years. We believe our instruments are the most versatile and cost-effective platforms available in the current market whether as an outright purchase or a fee-for-use application.
In general, we believe that our products must compete primarily on the basis of clinical performance, accuracy, functionality, quality, product features and effectiveness of the product in standard medical applications. We also believe that cost control and cost effectiveness are additional key factors in achieving or maintaining a competitive advantage. We focus a significant amount of product development effort on producing systems and tests that will not add to overall healthcare cost.
Specifically, there are several companies whose technologies are similar, adjunctive to, or may overlap with ours. Of these companies, our primary competitors are Rovers and Wallach in the area of cell collection devices and Cytyc and TriPath Imaging in specimen preparation and the automated morphological screening of these specimens. None of these companies offer a complete system comparable to CytoCore Solutions. In addition, both the Cytyc and TriPath systems are “closed” and are focused exclusively on the cervical cytology market whereas CytoCore offers an “open” system that is intended to address most of the 100+ types cytology tests that are currently performed. Indirect competitors are largely companies such as Qiagen and Greiner that offer HPV tests for use in cervical cancer screening. Our sample collection devices are suitable for use with these tests and our cytology products are adjunctive or complementary to them. Companies such as Ventana and Dako, which specialize in the preparation and evaluation of pathology, as opposed to cytology, specimens could potentially enter market segments of interest to CytoCore at some point in the future.
Operations
We conduct research and development work for the CytoCore Solutions System using a combination of our full-time and part-time employees, contract researchers and independent consultants in our Chicago, Illinois location. Where
appropriate we also utilize the services of contract product development companies, but we retain the planning, management, QA/QC, validation and regulatory compliance portions of these projects in-house.
We do not intend to invest capital to develop our own distribution and sales organizations, or construct and maintain a medical-products manufacturing facility and all its related quality systems requirements. Our strategy is to utilize the operations, quality systems and facilities of contract manufacturers specializing in medical products manufacturing to meet our current and future needs in the United States and abroad. This strategy covers manufacturing requirements related to the CytoCore Solutions System’s chemical components, plastic and silicone parts for the SoftPAP, and the instruments and other components of the AIPS workstation.
To this end, we have agreements, including for design and development work, with contract manufacturers of medical devices to supply commercial quantities of the SoftPAP sample collection device. These manufacturers began delivering commercial product to us in 2007 and have the capacity to handle high volume production through facilities in both the United States and several foreign countries. All of our machinery and tooling is located at our suppliers.
Intellectual Property
We rely on a combination of patents, licenses, trade names, trademarks, know-how, proprietary technology, trade secrets and policies and procedures to protect our intellectual property. We consider such security and protection a very important aspect of the successful development and marketing of our products in the U.S. and foreign markets.
In the United States, we follow the practice of filing a provisional patent application for an invention as soon as it has been determined that the invention meets the minimum standards for patentability. While a provisional patent application does not provide any formal rights or protections, it does establish an official priority date for the invention that carries over to any utility patent applications that are derived from the provisional application within the next 12 months. A utility patent application begins the process that can culminate in the issuance of a U.S. patent. We convert each outstanding provisional patent application into some number of utility patent applications within this 12-month period. In most cases each provisional application results in one utility filing. However, in some cases a single provisional application has generated two independent utility filings or multiple (up to five) provisional applications have been consolidated into a single utility application. During the examination of a utility application, the U.S. Patent and Trademark Office may require us to divide the application into two or more separate applications or we may file a continuation-in-part patent application that expands upon the technology disclosed in an earlier patent application and which has the potential of superseding the disclosure of the earlier application. For these reasons, estimating the number of patents that are likely to be issued based upon the number of provisional and utility applications filed is difficult.
Prior to filing a utility application in the United States, we review the application to determine whether obtaining patent coverage for the invention outside of the United States is necessary or desirable to support our business model. If so, a patent application is filed under the Patent Cooperation Treaty (“PCT”) at the same time that the U.S. filing is made. Depending upon the nature of the invention and business considerations, we typically nationalize PCT applications in three to six countries.
As of December 2010, we had filed 12 U.S. utility patent applications. Three of the U.S. utility applications have been issued as U.S. patents, two are pending, and seven have been abandoned. One Chinese patent had been issued and one European case has been abandoned. One U.S. and five foreign patent applications are filed and pending; in order to reduce the expenses related to patent prosecution, we are currently taking only those actions needed to keep them in effect. This group of patents and patent applications covers all aspects of the CytoCore Solutions System including, but not limited to, the point of service instrument, the personal and physicians’ collectors, and the slide-based test. As a result of the acquisition of AccuMed, we acquired 33 issued U.S. patents, one U.S. patent application, and nine foreign patents, of which a combined total of 17 were transferred to a third party under a license agreement. Twenty-four additional foreign patent applications primarily covering the AcCell and AcCell Savant technology and related software were also acquired. We have recovered the AcCell-related patents and patent applications from the third party.
We intend to prepare additional patent applications for processes and inventions arising from our research and development process. The protections provided by a patent are determined by the claims that are allowed by the patent
office that is processing the application. During the patent prosecution process it is not unusual for the claims made in the initial application to be modified or deleted or for new claims to be added to the application. For this reason, it is not possible to know the exact extent of protection provided by a patent until it issues.
Patent applications filed prior to November 29, 2000 in the United States are maintained in secrecy until any resulting patent is issued. As there have been examples of U.S. patent applications that have remained “in prosecution” and, therefore, secret for decades, it is not possible to know with certainty that any U.S. patent that we may own, file for or have issued to us will not be pre-empted or impaired by patents filed before ours and that subsequently are issued to others. Utility patent applications filed in the United States after November 29, 2000 are published 18 months after the earliest applicable filing date. As this revised standard takes full effect, the chances that such a “submarine” patent will impair our intellectual property portfolio are significantly reduced. Foreign patent applications are automatically published 18 months after filing. As the time required to prosecute a foreign utility patent application generally exceeds 18 months and the foreign patents use a “first to file” rather than a “first to invent” standard, we do not consider submarine patents to be a significant consideration in our patent protection outside of the United States.
Our products are or may be sold worldwide under trademarks that we consider to be important to our business. We own the trademarks SoftPAP, CytoCore™, CytoCore Solutions and Cocktail-CVX™. We may file additional U.S. and foreign trademark applications in the future.
Our future technology acquisition efforts will be focused toward those technologies that have strong patent or trade secret protection.
We cannot be sure that patents or trademarks issued or which may be issued in the future will provide us with any significant competitive advantages. We cannot be sure any of our patent applications will be granted or that their validity or enforceability will not be successfully challenged. The cost of any patent-related litigation could be substantial even if we were to prevail. In addition, we cannot be sure that someone will not independently develop similar technologies or products, duplicate our technology or design around the patented aspects of our products. The protection provided by patents depends upon a variety of factors, which may severely limit the value of the patent protection, particularly in foreign countries. We intend to protect much of our core technology as trade secrets, either because patent protection is not possible or, in our opinion, would be less effective than maintaining secrecy. However, we cannot be sure that our efforts to maintain secrecy will be successful or that third parties will not be able to develop the technology independently.
Research and Development Expenditures
Our research and development efforts are focused on introducing new products as well as enhancing our existing product line. We utilize both in-house and contracted research and development personnel, including in collaboration with universities, medical centers and other entities. All of our research and development activities are conducted in the United States.
We believe research and development is critical to the success of our business strategy. During the 2010 and 2009 fiscal years, our research and development expenditures were approximately $275,000 and $372,000, respectively, all of which were charged to expense in our consolidated statement of operations. Settlements to vendors related to research and development activities for less than the recorded amounts totaled $64,000 and $457,000 for the fiscal years 2010 and 2009 respectively, and were credited to expenses.
Our research work in the area of chemical and biological components is expected to continue for the foreseeable future as we seek to refine the current process and add additional capabilities to our analysis procedure, including the detection of other forms of cancer and precursors to cancer.
We anticipate the need to invest a substantial amount of capital in the research and development process, including the cost of clinical trials, required to complete the development and use of the CytoCore Solutions System and bring it to market.
Components and Raw Materials
Low-cost products are a key component of our business strategy. We designed the SoftPAP collection device using widely available and inexpensive silicone and plastic materials. These materials are available from numerous sources and can be fabricated into finished devices by a variety of worldwide manufacturers based on our proprietary designs. Currently, we have manufactured through contract manufacturers the SoftPAP collection device in Wisconsin and China, with quality assurance occurring in our Chicago facility. These contract manufacturers have used our machinery and tooling.
The instrument components of the laboratory version of the CytoCore Solutions System are also available from a number of sources. Computers, cameras, automated slide-staining instruments and automated slide-preparation instruments are currently available from several large manufacturers.
Due to certain regulatory requirements regarding the supply and manufacture of certain products, we may not be able to establish additional or replacement sources for certain components or materials. In the event we are unable to obtain sufficient quantities of raw materials or components on commercially reasonable terms or in a timely manner, we would not be able to manufacture our products on a timely and cost-competitive basis, which may have a material adverse effect on our business and financial condition.
Working Capital Practices
We have financed our U.S. operations and research and development efforts by raising funds through borrowing and the sale of equity securities. We will continue to use these methods to fund our operations until such time as we are able to generate adequate revenues and profits from the sale of some or all of our products.
We believe that future sales of the CytoCore Solutions System or other products into foreign markets may result in collection periods that may be longer than those expected for domestic sales of these products. Our strategy will be to use down payments, letters of credit or other secured forms of payment, whenever possible, in sales of products in foreign markets.
Employees
As of April 4, 2011, we employed a total of six full-time employees. We also utilize independent consultants in the United States on an as-needed basis.
Financial Information About Foreign and Domestic Operations and Export Sales
Markets outside of North America are an important factor in our business strategy. Any business that operates on a worldwide basis and conducts its business in one or more local currencies is subject to the risk of fluctuations in the value of those currencies against the dollar, as well as foreign economic conditions. Such businesses are also subject to changing political climates, differences in culture and the local practices of doing business, as well as North American and foreign government actions such as export and import rules, tariffs, duties, embargoes and trade sanctions. We do not regard these risks, however, as a significant deterrent to our strategy to introduce our CytoCore Solutions System to foreign markets in the future. As we begin to market and sell our CytoCore Solutions System, we will closely review our foreign operational practices. We will attempt to adopt strategies to minimize the risks of changing economic and political conditions within foreign countries.
During the fiscal year ended December 31, 2010, we did not have any foreign operations.
You should carefully consider the following risk factors that affect our business. Such risk factors could cause our actual results to differ materially from those that are expressed or implied by forward-looking statements contained herein. Some of the risks described relate principally to our business and the industry in which we operate. Others relate principally to the securities market and ownership of our capital stock. The risks and uncertainties described below are not the only ones we face. Additional risks are described elsewhere in this report under the Item 1 - Business, Item 3
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common stock is quoted on the Over-the-Counter Bulletin Board (the “OTCBB”) under the symbol “CYOE.OB”. The following table lists the high and low bid information for our common stock for the periods indicated, as reported on the OTCBB. These quotations reflect inter-dealer prices, may not include retail mark-ups, mark-downs, or commissions, and may not reflect actual transactions.
Holders
As of April 4, 2011, we had approximately 407 record holders of shares of our common stock.
Dividends
We have not paid a cash dividend on shares of our common stock, and our Board of Directors is not contemplating paying dividends at any time in the foreseeable future. The terms of certain of our securities, including our Series B, C, D and E preferred stock, prohibit us from declaring any dividends on our common stock (or any other stock junior to such security) except for dividends payable in shares of stock of the Company of any class junior to such security, or redeem or purchase or permit any subsidiary to purchase any shares of common stock or such junior stock, or make any distributions of cash or property among the holders of the common stock or any junior stock by the reduction of capital stock or otherwise, if any dividends on the security are then in arrears.
We paid non-cash dividends, in the form of newly issued shares of our common stock, amounting to $7.00 during 2009 to holders of shares of our preferred stock who elected to convert such shares and cumulative dividends due thereon, into shares of our common stock. There were no conversions in 2010. We have a contingent obligation to pay cumulative dividends on various series of our convertible preferred stock in the aggregate amount of approximately $2,471,100 at December 31, 2010, which we intend to pay through the issuance of shares of our common stock, if and when the holders of the preferred shares elect to convert their shares into common stock.
Stock Transfer Agent
Our stock transfer agent is BNY Mellon Investor Services, 480 Washington Boulevard, Jersey City, NJ 07310 and its telephone number is (800) 522-6645.
Recent Sales of Unregistered Securities
During the quarter ended December 31, 2010, we issued 833,333 shares of restricted common stock and three year warrants to purchase 416,667 shares of common stock at an exercise price of $0.06 per share to a limited number of accredited investors in consideration of gross cash proceeds of $50,000.
During the quarter ended December 31, 2010, we issued 350,000 shares of common stock to a non-executive employee in consideration of services rendered.
During the quarter ended December 31, 2010, a holder of a promissory note converted $19,500 of principal into 1,060,626 shares of common stock at a conversion price of approximately $0.018 per share.
During the quarter ended December 31, 2010, we issued three year warrants to a non-executive employee to purchase 2,000 shares of common stock at an exercise price of $0.03 per share in consideration of services rendered.
We issued the foregoing securities in reliance on the safe harbor and exemptions from registration provided by Section 4(2) of the Securities Act of 1933, as amended, for sales to a limited number of accredited investors, employees, service providers, or creditors with whom we had prior relationships, without engaging in any general solicitation, and without payment of underwriter discounts or commissions to any person.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are developing an integrated family of cost-effective products for the detection, diagnosis and treatment of cancer under the trade name of CytoCore Solutions®. CytoCore Solutions products are intended to address sample collection, specimen preparation, specimen evaluation (including detection/screening and diagnosis), treatment and patient monitoring within vertical markets related to specific cancers. Current CytoCore Solutions products are focused upon cervical cancer. We plan that this focus will later be expanded to include other gynecological cancers as well as bladder, lung, and breast cancers, among others. Within each of these markets, we anticipate that the CytoCore Solutions products will be sold as individual value-added drop-in replacements for existing products and as integrated systems that improve the efficiency and effectiveness of clinical and laboratory operations.
The science of medical diagnostics has advanced significantly during the past decade. Much of this advance has come as a result of new knowledge of the human genome and related proteins, which form the foundation of cell biology and the functioning of the human body. Our goal is to utilize this research as a base to develop screening and diagnostic testing products for cancer and cancer-related diseases. We believe that the success of these products will improve patient care through more accurate test performance, wider product availability and more cost-effective service delivery. We have developed an FDA-cleared sample collection device and are developing and testing stains and reagents for use with the AIPS system to screen for various cancers.
Our strategy is to develop products through internal development processes, strategic partnerships, licenses and acquisitions. This strategy has required and will continue to require additional capital. As a result, we will incur substantial operating losses until we are able to successfully market some, or all, of our products.
We launched sales of the SoftPAP® cervical cell collector in the fourth quarter of fiscal 2007. We believe the revenues from this device along with additional capital will allow us to complete the development of the other components of the CytoCore Solutions System, including the AIPS™ Workstation, AIPS Imager™, and genetic biological markers used for the development of the various protein antibodies that allow for the detection of abnormal cervical, uterine, endometrial and bladder cancer cells.
Outlook
We have incurred significant operating losses since its inception. Management expects that significant on-going operating expenditures will be necessary to successfully implement our business plan and to develop, manufacture and market its products. Implementation of our plans will be contingent upon securing substantial additional financing. During the year ended December 31, 2010, we raised approximately $1.2 million through the sale of common stock, proceeds from the issuance of convertible debt, and advances from related parties. In order to successfully implement our business plan, we will have to obtain additional capital. If we are unable to obtain additional capital or generate profitable sales revenues, we may be required to curtail product development and other activities and in the extreme case, cease operations. No assurances can be given about our ability to obtain capital. The consolidated financial statements presented herein do not include any adjustments that might result from the outcome of this uncertainty.
Critical Accounting Policies and Significant Judgments and Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
We believe that the following critical accounting policies affect our more significant estimates and judgments used in the preparation of our consolidated financial statements:
Management believes that it is reasonably possible that the following material estimates affecting the financial statements could significantly change in the coming year: (1) estimates concerning the method of depreciation or the useful life of the equipment used in the production of SoftPAP collection kits, (2) estimates as to the valuation allowance for the amounts recorded and held as inventory of goods and property and equipment and,(3) estimates of possible litigation losses.
Results of Operations
Fiscal Year Ended December 31, 2010 as compared to Fiscal Year Ended December 31, 2009
Revenue
Revenues of $30,000 for the fiscal year ended December 31, 2010 represented a decrease of $14,000, or 32%, from revenues of $44,000 in fiscal 2009. The decrease was a result of decreased sales of our SoftPAP cervical cell collector totaling $3,000, a reduction in service revenue of $1,000, and a reduction in licensing fees of $10,000.
Costs and Expenses
Cost of Revenues
Cost of revenues represents the cost of the product sold, freight, and other costs of selling our products. For the year ended December 31, 2010, cost of revenues totaled $1,000, a decrease of $2,000 or 67% from cost of revenues of $3,000 for the year ended December 31, 2009.
Research and Development
Research and development expenses include industrial design and engineering covering the disposable and instrument components of CytoCore Solutions System, payments to medical and engineering consultants for advice related to the design and development of our products and their potential uses in the medical technology marketplace, and payroll-related costs for in-house engineering, scientific, laboratory, software development, and research management staff.
For the 2010 fiscal year, research and development expenses were $275,000 before a reduction of $64,000 from a settlement with a former employee, resulting in a net expense of $211,000. Expenses for 2009 were $372,000 before a reduction of $457,000 from a non-cash settlement with a vendor, resulting in a net credit balance of $85,000. The expenses for the year ended December 31, 2010 were $275,000 representing a decrease of $97,000 or 26% from expenses of $372,000 in 2009. Of the $97,000 decrease in R&D expenses, $6,000 related to reduced fees paid to medical consultants, $86,000 related to reduced personnel costs after the $64,000 settlement with a former employee, and $5,000 related to costs incurred for the ongoing improvement of the SoftPAP cervical collection device,
Selling, General and Administrative
For the year ended December 31, 2010, selling, general and administrative expenses were $1,669,000 after a reduction totaling $71,000 from a settlement with a vendor, representing a 45% decrease from SG&A expenses of $3,022,000 for the year ended December 31, 2009. Of this $1,353,000 decrease, $208,000 related to a reduction in employee compensation expense, $494,000 in professional fees for legal and accounting services including a $71,000 benefit from a settlement with a vendor, $34,000 relating to reduced investor and public relations expenses, $42,000 relating to a reduction in marketing costs, $47,000 relating to reduced travel expenses, $68,000 relating to insurance expense, $340,000 reduction in director fees, $75,000 relating to a reduction in franchise taxes, $14,000 in computer expense, $17,000 in rent expense, and $20,000 in printing costs. These reductions were partially offset by increases in other costs totaling $6,000.
Other Income (Expense)
Interest expense increased by $147,000 to $181,000 for the year ended December 31, 2010 from $34,000 in 2009. During 2010, CCI recorded a non-cash totaling $109,000 for interest on related party advances.
During the year ended December 31, 2010, we recorded a non-cash benefit of $334,000 resulting from the remeasurement of the derivative liability as described in Note 11 to the financial statements and $55,000 from the amortization of debt discount.
We recorded a provision for valuation of certain fixed assets in the amount of $399,000for the year ended December 31, 2010.
We recorded a non-cash charge of $222,000 for the year ended December 31, 2009 resulting from a preliminary legal settlement that was settled in 2010.
We also recorded a provision for valuation of finished goods inventory totaling $400,000 for the year ended December 31, 2009.
Net Loss
The net loss for the year ended December 31, 2010, totaled $2,097,000, as compared to $3,552,000 for 2009, a decrease of $1,455,000 or 41%. Of this decrease, $1,353,000 related to decreases in SG&A expenses, $2,000 represented a decrease from cost of revenues exceeding revenues, $222,000 resulting from the cost of a legal settlement and $400,000 representing a reduction in the provision for inventory valuation in 2009 and $334,000 resulting from the non-cash benefit derived from the remeasurement of the derivative liability. These decreases were partially offset by an increase of $296,000 related to R&D costs, an impairment charge to fixed assets totaling $399,000, $147,000 relating to an increase in interest expense including a non-cash charge of $109,000 and $14,000 related to a reduction in revenues.
The net loss applicable to common stockholders which reflects the unpaid and undeclared preferred stock dividends from the period decreased to $2,363,000 for the year ended December 31, 2010 from $3,818,000 for the year ended December 31, 2009, a decrease of $1,450,000 or 38%. In addition to the changes reported above, cumulative dividends on the Company’s outstanding Series E convertible preferred stock converted into common stock totaled $7.00 for the year ended December 31, 2009. There was no divided recorded in 2010. The net loss per common share for each of the years ended December 31, 2010 and December 31, 2009 was $0.05 and $0.09, respectively, on 45,354,805 and 41,874,890 weighted average common shares outstanding, respectively.
Liquidity and Capital Resources
Our capital resources and liquidity needs have been met from sales of our debt and equity securities to individual and institutional investors.
Research and development, clinical trials and other studies of the components of our CytoCore Solutions System, conversions from designs and prototypes into product manufacturing, sales and marketing efforts, medical consultants and advisors, and research, administrative, and executive personnel are and will continue to be the principal basis for our cash requirements. We have provided operating funds for the business since our inception through private offerings of debt and
equity securities to limited numbers of U.S. and foreign investors. We will be required to make additional offerings in the future to support the operations of the business until we are able to generate sufficient income from the sale of our products. We used $1,121,000 and $1,637,000 during 2010 and 2009, respectively, to fund our operating activities. We also used $36,000 and $71,000 in 2010 and 2009, respectively, for the purchase of a license and of tooling and equipment.
At December 31, 2010 we had cash on hand of $13,000, as compared to 2009 where we had checks issued in excess of cash on hand totaling $5,000. We were able to raise $1,170,000 of cash through the sale of common stock, the issuance of convertible debt, and proceeds of advances from related parties during the fiscal year ended December 31, 2010. This cash was used to fund operations, including research and development activities, and the purchase of a license. We currently have enough cash on hand to fund operations into April, 2011. We will need approximately $1,200,000 of additional financing to continue to conduct operations at current levels over the next twelve months. We continue to meet with qualified investors and although no assurance can be given, we believe will be able to raise capital to fund operations in the immediate future until we can be self-sufficient through operations, although no assurance can be given about our ability to obtain such capital. We do not have any material commitments for capital expenditures.
Our operations have been, and will continue to be, dependent upon management’s ability to raise operating capital through the issuance and sale of debt and equity securities and advances from certain of our affiliates. We have incurred significant operating losses since inception of the business. We expect that significant on-going operating expenditures will be necessary to successfully implement our business plan and develop, manufacture and market our products. If we are unable to obtain adequate additional financing or generate profitable sales revenue, or negotiate a favorable settlement plan with creditors, we may be unable to continue its product development and other activities and may be forced to cease operations. The consolidated financial statements presented do not include any adjustments that might result from the outcome of this uncertainty.
Off-Balance Sheet Arrangements
As of December 31, 2010, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Item 8.
Item 8. Financial Statements and Supplementary Data
Our consolidated financial statements for the years ended December 31, 2010 and 2009, together with the report of L J Soldinger Associates LLC dated April 5, 2011, and the notes thereto, are filed as part of this Annual Report on Form 10-K commencing on page and are incorporated herein by reference.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) was carried out by us under the supervision and with the participation of our chief executive officer, who serves as our principal executive officer and principal financial officer. Based upon that evaluation, our chief executive officer concluded that as of December 31, 2010, our disclosure controls and procedures were effective to ensure (i) that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) that such information is accumulated and communicated to management, including our chief executive officer, in order to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). Under the supervision and with the participation of our management,
including our chief executive officer who serves as our principal executive officer and principal financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (''COSO’’) in Internal Control - Integrated Framework. Based on management’s assessment based on the criteria of the COSO, we concluded that, as of December 31, 2010, the Company’s internal control over financial reporting is effective at the reasonable assurance level.
Our internal control system was designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in the U.S. Our internal control over financial reporting includes those policies and procedures that:
(i)
pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(ii)
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the U.S., and that receipts and expenditures of the Company are being made only in accordance with authorization of management and directors of the Company; and
(iii)
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on our consolidated financial statements.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which permits us to provide only management’s report in this annual report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the fourth fiscal quarter ended December 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B
Item 9B Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers, and Corporate Governance
Board of Directors and Executive Officers
Name
Age
Positions with the Company
Robert F. McCullough, Jr.
Chief Executive Officer, Chief Financial Officer and Chairman of the Board of Directors
John H. Abeles, M.D.
Director
Alexander M. Milley
Director
Clinton H. Severson
Director
Richard A. Domanik, Ph.D.
Chief Operating Officer
Board of Directors
We believe that our Board should be composed of individuals with sophistication and experience in many substantive areas that impact our business. We believe that experience, qualifications, or skills in the following areas are most important: accounting and finance; design, innovation and engineering; strategic planning; human resources and development practices; and board practices of other corporations. These areas are in addition to the personal qualifications described in this section. We believe that all of our current Board members possess the professional and personal qualifications necessary for board service, and have highlighted particularly noteworthy attributes for each Board member in the individual biographies below. The principal occupation and business experience, for at least the past five years, of each current director is as follows:
Robert F. McCullough, Jr. was elected Chief Financial Officer and director of the Company in September 2005 and Chief Executive Officer of the Company in October 2007. Mr. McCullough was appointed to serve as Chairman of the Board of Directors on April 21, 2009. Since October 2003, Mr. McCullough has also served as President and as a Portfolio Manager of Summitcrest Capital, Inc., a money management firm and registered investment adviser, which is a holder of approximately 4.9% of our issued and outstanding common stock. From April 1999 to July 2003, Mr. McCullough served as a Portfolio Manager at Presidio Management, a money management firm. Prior to this, Mr. McCullough served as a manager with the accounting firm of Ernst & Whinney (now Ernst & Young) and also served as a financial analyst, a portfolio manager and a Chief Financial Officer of several private companies. Mr. McCullough has a Masters of Business Administration in finance and is a Certified Public Accountant. Mr. McCullough possesses particular knowledge and experience in accounting and finance, organizational leadership and strategic planning that strengthen the Board’s collective qualifications, skills, and experience. In a civil action brought by the SEC in January 2011, the SEC alleged that Mr. McCullough failed to report transactions in Company securities, failed to accurately report his beneficial ownership of Company securities in our proxy statement, and aided and abetted us in violating Section 15(a) of the Exchange Act. In February 2011, Mr. McCullough consented to the entry of a final judgment pursuant to which he was permanently restrained and enjoined from violating Section 14(a) of the Exchange Act, Section 16(a) of the Exchange Act, and from aiding and abetting violations of Section 15(a) of the Exchange Act and paid a civil penalty in the amount of $100,000.
John H. Abeles, M.D. has been a director of the Company since May 1999. Dr. Abeles is President of MedVest, Inc., a venture capital and consulting firm he founded in 1980. He is also General Partner of Northlea Partners, Ltd., a family investment partnership. Dr. Abeles previously served as a senior medical executive at Sterling Drug Company, Pfizer, Inc. and Revlon Healthcare, Inc. and subsequently was a medical analyst at Kidder, Peabody & Co. Dr. Abeles is a director of a number of companies operating in the medical device and healthcare fields, including publicly-traded companies DUSA Pharmaceuticals, Inc. and CombiMatrix Corp. Dr. Abeles has also served as a director of I-Flow Corporation (now a subsidiary of Kimberly Clark Corporation) and Oryx Technology Corp. Dr. Abeles possesses particular knowledge and experience in medical education, venture capital and finance, and the pharmaceutical industry that strengthen the Board’s collective qualifications, skills, and experience.
Alexander M. Milley has been a director of the Company since 1989. Mr. Milley is currently President, Chief Executive Officer and Chairman of the Board of ELXSI Corp., a publicly-held holding company with subsidiaries operating in the restaurant and environmental inspection equipment industries. Mr. Milley has served as Chairman and CEO of ELXSI since September 1989, and was elected President of that company in August 1990. He is also President and Chairman of the Board of Azimuth Corporation, a holding company with subsidiaries operating in the trade show exhibit, retail environment design, and electrical components and fastener distribution industries. From 1988 until 2004, Mr. Milley served as a director and Vice President of Contempo Design, Inc., a designer and manufacturer of trade show exhibits. Contempo Design, Inc. filed a petition a petition under Chapter 11 of the federal Bankruptcy Code in 2004. Mr. Milley was Chairman of the Board and Chief Executive Officer of Bell National Corporation, our predecessor, until December 1998 and was President of Bell National from August 1990 until December 1998. Mr. Milley is the founder, President, sole director and majority stockholder of Milley Management, Inc., a private investment and management-consulting firm. Mr. Milley is also a director and executive officer of Cadmus Corporation, a private investment and management consulting firm, and Winchester National, Inc., an investmet holding company. Mr. Milley possesses particular knowledge and experience in finance, management, marketing and public company governance that strengthen the Board’s collective qualifications, skills, and experience.
Clinton H. Severson was elected to the Board of Directors in November 2006. Mr. Severson has served as President, Chief Executive Officer and a director of the Board of Directors of Abaxis, Inc., a northern California-based provider of portable technology, tools and services used for medical diagnostics sold to customers and distributors worldwide, since 1996. Prior to his assuming the CEO position of Abaxis, where he was appointed Chairman of the Board in 1998, Mr. Severson served as President and CEO for over seven years at MAST Immunosystems, Inc., a privately-held medical diagnostic company. Mr. Severson possesses particular knowledge and experience in international business, management and finance that strengthen the Board’s collective qualifications, skills, and experience.
Executive Officer
Richard A. Domanik, Ph.D. has been our Chief Operating Officer since October 2007. From May 2007 until August 2008, he also served as our President. Since 2001, Dr. Domanik has been the principal at R. Domanik Consulting, Inc., a consulting firm specializing in the development and manufacture of medical and clinical diagnostic devices and instruments and intellectual property management. Between 2002 and 2006, Dr. Domanik served as Director of Technology Development of ZelleRX Corporation, a biotechnology start-up in the field of cellular therapeutics for the treatment of cancer. Dr. Domanik also served as Director of Technology of Xomix, Ltd., a biotechnology consulting company, between 2001 and 2007. From 1999 to 2001, Dr. Domanik served as our Chief Technology Officer and Vice President-Technology. He also served as Chief Technology Officer and Vice President of AccuMed International, which we acquired in 2001, from 1994 to 1999. Prior to his work with CytoCore and its subsidiaries, Dr. Domanik worked for over 15 years at Abbott Laboratories where he held several positions, including Laboratory Manager and Senior Systems Engineer. Dr. Domanik is intimately familiar with both the products offered by us as well as our industry. Dr. Domanik has a long history of working with us and also has provided consulting services to assist other entities with the design, development and manufacture of medical devices. He also has extensive technology and intellectual property experience, all of which contribute to his effective management of the Company as its Chief Operating Officer.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers and directors, and holders of more than 10% of the outstanding shares of our common stock, to file initial reports of ownership and reports of changes in ownership with the Commission. They are also required to furnish us with copies of all Section 16(a) forms that they file with the SEC. Based solely on our review of copies of such forms received by us and/or any written representations from such persons that no other reports were required with respect to 2010, we believe that all Section 16(a) filing requirements were satisfied in a timely fashion during our fiscal year ended December 31, 2010, except that Mr. McCullough failed to file Form 4s in connection with certain sales of Company securities.
Code of Ethics
We have adopted our Code of Ethics and Business Conduct for Officers, Directors and Employees that applies to all of our officers, directors and employees, including our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. We filed the code as an exhibit to our Annual Report on Form 10-KSB for the fiscal year ended December 31, 2003, as filed with the Commission on April 14, 2004. The Code of Ethics is also available on our website at www.cytocoreinc.com.
Board of Directors and Committee Information
Our Board has determined that Dr. Abeles and Messrs. Milley and Severson are “independent” as set forth in the rules and regulations of The Nasdaq Stock Market, including Rule 5605, and Rule 10A-3 of the Exchange Act. The Company does not utilize any other definition or criteria for determining the independence of a director or nominee, and no other transactions, relationships, or other arrangements exist to the Board’s knowledge or were considered by the Board, other than as may be discussed herein, in determining an individual’s independence.
The Board of Directors currently has three standing committees - the Audit Committee, the Compensation Committee and the Nominating and Corporate Governance Committee. The Compensation Committee and Nominating and Corporate Governance Committees were established by the Board in 2008.
Audit Committee
The Audit Committee currently consists of Mr. Milley (Chairman), Dr. Abeles and Mr. Severson, each of whom is independent under applicable independence requirements. The Board of Directors has determined that Mr. Milley qualifies as an “audit committee financial expert” as defined in Item 407(d)(5)(ii) of Regulation S-K promulgated under the Exchange Act.
The Audit Committee acts pursuant to a written charter, which charter authorizes the committee’s overview of the financial operations and management of the Company, including a required review process for all quarterly, annual, and special filings with the Commission, review of the adequacy and efficacy of the accounting and financial controls of the Company as well as the quality of accounting principles and financial disclosure practices, and communications with the Company’s independent registered public accounting firm and members of financial management. A copy of the Audit Committee’s charter was filed as an appendix to the Company’s definitive proxy statement for its 2007 annual stockholders meeting, as filed with the SEC on May 15, 2007, and is available on our website. The Audit Committee met four times in 2010.
Stockholder Nominations
There were no material changes to the procedures by which stockholders may recommend nominees to our board of directors during the 2010 fiscal year.
Item 11.
Item 11. Executive Compensation
Summary Compensation Table
The following table sets forth the compensation earned by the Company’s principal executive officer, and each of the Company’s two most highly compensated executive officers other than the principal executive officer whose compensation exceeded $100,000 (collectively, the “Named Executive Officers”), during the years ended December 31, 2010 and 2009.
Outstanding Equity Awards at Fiscal Year-End
Our named executive officers did not own any outstanding equity awards as of December 31, 2010.
Narrative Disclosure to Summary Compensation Table
During 2009, Mr. McCullough exercised warrants to purchase 485,000 shares of restricted common stock in connection with our offer to all warrant holders to permit exercise of such warrants at the reduced exercise price of $0.25 per share in exchange for the reduction of $121,000 of debt owed by us to such warrant holders. We recorded a charge of $15,000 related to this warrant modification for those warrants which were originally issued as stock based compensation. We made this warrant modification available to all holders of warrants to purchase shares of our common stock.
Mr. McCullough earned an annual salary of $45,000 and $180,000 in 2010 and 2009, respectively, and has elected to defer payment of such salary. We do not have any employment agreement with Mr. McCullough.
We have not entered into an employment agreement with Dr. Domanik, although the basic terms of his compensation have been established. Specifically, we pay Dr. Domanik an annual salary of $150,000, standard benefits as provided to other employees, and reimbursement of reasonable business expenses. Dr. Dominick elected to defer salary totaling $150,000 and $131,250 for the 2010 and 2009 fiscal years, respectively.
Equity Incentive Plan and Employee Stock Purchase Plan
In 1999, we adopted the 1999 Equity Incentive Plan and the 1999 Employee Stock Purchase Plan, both of which expired in 2009. For additional information, see “Equity Compensation Plan Information” in Item 11 below.
Potential Payments Upon Termination or Change-in-Control
We do not offer or have in place any formal severance, change in control or similar compensation programs for our officers or employees. Rather, we individually negotiate with those employees for whom such compensation is deemed necessary. We do not currently have an agreement with any officer with respect to severance, change of control or a similar circumstance. We are obligated to provide warrants to our outside directors upon the occurrence of certain changes in control. For more information, see “Compensation of Directors” below.
Compensation of Directors
The following table sets forth certain information regarding the compensation of directors for our 2010 fiscal year.
(1)
Mr. McCullough has been omitted from this table as he is a management member of our board of directors and is not separately compensated for his service on the board of directors.
Narrative Disclosure to Director Compensation Table
We currently pay our directors a quarterly fee of $5,000 as compensation for their service on our board of directors. Since 2009, our directors have deferred receipt of such fees. We also reimburse all directors for their reasonable expenses incurred in connection with attendance at meetings of the board of directors. In addition, all outside directors are entitled to receive warrants to purchase 25,000 shares of our common stock when our annual revenues reach $20 million and warrants to purchase an additional 25,000 shares of common stock when our annual revenues reach $50 million. The exercise price of such warrants will be at a 33% discount to the average trading price of the common stock during the 45 days prior to the date we achieve each revenue milestone.
Upon our acquisition, all outside directors will receive (1) warrants to purchase 62,500 shares of common stock at $2.50 per share if we are acquired for more than $10.00 per share; (2) warrants to purchase 87,500 shares of common stock at $5.00 per share if we are acquired for more than $20.00 per share; and (3) warrants to purchase 125,000 shares of common stock at $7.50 per share if we are acquired for more than $30.00 per share.
In November 2006, the Board also approved an arrangement whereby we are obligated to reimburse Messrs. McCullough and Milley and Dr. Abeles, for certain tax effects in connection with the exercise of warrants issued in September 2006. We are obligated to pay to each individual 39% of the taxable value of such warrants when exercised, payable within three months of such exercise, such payment to occur only if we are acquired or certain other conditions are met. There have been no reimbursements to date.
During 2009, our Board of Directors voted to issue to each of its members (other than its employee-director member, Robert F. McCullough) a bonus of 100,000 shares of restricted shares of our common stock. As of December 31, 2010, the shares have not been issued.
For information on other consideration received by directors or their affiliates from the Company, see “Transactions with Related Persons, Promoters and Certain Control Persons” in Item 13 below.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Common Stock
The following table sets forth certain information, as of April 4, 2011 with respect to holdings of our common stock by (i) each person known by us to be the beneficial owner of more than 5% of the total number of shares of common stock outstanding as of such date, (ii) each of our directors and executive officers, and (iii) all directors and executive officers as a group. Except as otherwise indicated, the address of each person is c/o CytoCore, Inc., 414 N. Orleans Street, Suite 510, Chicago, Illinois 60610.
Series E Convertible Preferred Stock
The following table sets forth certain information, as of April 4, 2011 with respect to holdings of our Series E Convertible Preferred Stock by (i) each person known by us to be the beneficial owner of more than 5% of the total number of shares of common stock outstanding as of such date, (ii) each of our directors and executive officers, and (iii) all directors and executive officers as a group.
(1)
No executive officers or directors own any shares of Series E Convertible Preferred Stock.
(2)
Converts into 35,157 shares of common stock, including shares issuable upon payment of cumulative dividends.
(3)
Converts into 10,564 shares of common stock, including shares issuable upon payment of cumulative dividends.
Equity Compensation Plan Information
1)
We have included warrants in agreements for providers of investor relations and/or public relations services. Warrants were also issued to financial advisors as remuneration for the procurement of equity, debt and preferred stock convertible into equity.
2)
We have issued warrants in lieu of cash payment for employment services, for achieving certain goals or for other corporate reasons. During fiscal year 2010, a non-executive employee was issued 13,000 warrants.
Equity Incentive Plan and Employee Stock Purchase Plan
In 1999, we adopted the 1999 Equity Incentive Plan (the “Incentive Plan”), which provided for the issuance to consultants, officers, non-employee directors and key employees of shares of common stock pursuant to stock options (incentive and non-qualified), restricted stock, stock appreciation rights (“SARs”) and performance shares and units. Grants under the Incentive Plan are exercisable at fair market value determined as of the date of grant in accordance with the terms of the Incentive Plan. Grants vest to recipients immediately or ratably over periods ranging from two to five years, and expire five to ten years from the date of grant. The Incentive Plan became effective on June 1, 1999 and expired on June 1, 2009. No options have been granted pursuant to our Incentive Plan or otherwise to executive officers or directors in the last two fiscal years. Although the Incentive Plan has expired, as of December 31, 2010, there were options to purchase 10,000 shares of common stock outstanding under the Incentive Plan.
In 1999, we adopted the 1999 Employee Stock Purchase Plan (the “Purchase Plan”). The Purchase Plan offered employees the opportunity to purchase shares of common stock of CytoCore through a payroll deduction plan at 85% of the fair market value of such shares at specified enrollment measurement dates. The Purchase Plan expired in May 2009.
Changes in Control
We are not aware of any arrangements (including any pledge by any person of our securities), the operation of which did or may at a subsequent date result in a change of control.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The following section sets forth information regarding transactions since January 1, 2009, or any currently proposed transactions, between us and certain related persons. For more information on the compensation received by our directors and officers, and the beneficial ownership of equity securities of the Company by such individuals, see Item 11 “Executive Compensation” and Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” above
Board of Directors
During 2009, the Board of Directors, including former directors Daniel J. Burns, Philip Bradley Hall, M.D. and David J. Weissberg, M.D., voted to issue to each of its members (other than its employee-director member, Robert F. McCullough) a bonus of 100,000 shares of restricted, unregistered common stock. The shares were valued at $0.40 per share and we recorded a charge of $280,000 for the aggregate issuance of 700,000 shares of common stock during 2009. None of the 700,000 shares authorized for issuance have been issued to date.
Robert F. McCullough, Jr., Chairman, Chief Executive Officer and Chief Financial Officer
During 2009, Mr. McCullough exercised warrants to purchase 485,000 shares of restricted, unregistered common stock at a modified price of $0.25 in exchange for the reduction of $121,000 of debt owed us to him. We recorded a charge of $15,000 related to this warrant modification. This warrant modification was made available by us to all holders of warrants to purchase shares of our common stock. These shares were issued in 2010.
During 2009, in lieu of salary, we issued to Mr. McCullough 39,459 shares of restricted common stock for services rendered in 2008. We valued the common stock at $0.50 per share for an aggregate value of $20,000 using the fair value method.
Mr. McCullough and a member of his family loaned to us an aggregate $1,013,000 and $866,000 during the 2010 and 2009 fiscal years, respectively. Of the $866,000 loaned during 2009, $121,000 was cancelled in connection with the exercise of the warrants discussed above. The remaining outstanding balance of $1,972,750 is payable upon demand and does not accrue interest.
Related Person Transaction Approval Policy
We recognize that related person transactions can present potential or actual conflicts of interest and create the appearance that our decisions are based on considerations other than the best interests of us and our stockholders. The Board of Directors, therefore, adopted a written policy in May 2008 that requires the review, approval or ratification of all such transactions by the Nominating Committee of the Board of Directors in accordance with the procedures established for such transactions.
For these purposes, a “related person transaction” is any transaction, arrangement or relationship (or series of similar transactions, arrangements or relationships) in which the Company or any subsidiary is, was or will be a participant and in which a related person has, had or will have a direct or indirect interest. A “related person” includes executive officers, directors, nominees for election as a director, five percent holders, and any immediate family members of the foregoing. It also includes entities in which any of the foregoing is employed or is a partner or principal or in a similar position, or in which such person has a five percent or greater beneficial ownership interest.
In advance of each regularly scheduled Nominating Committee meeting, management must propose those transactions to be entered into by us for the coming calendar quarter, including the material terms of such transactions, the parties involved, the interests of the related person(s) in such transactions, and the proposed aggregate value of each such transaction (if calculable). After review, the Nominating Committee must approve or disapprove such transactions and at each subsequently scheduled meeting, management must update the Nominating Committee as to any material change to those proposed transactions. If advance approval of a related person transaction is not feasible, such transactions may be preliminarily entered into by management, subject to ratification by the Nominating Committee at its next meeting. A transaction also may be approved by the Chairman of the Nominating Committee, who possesses delegated authority to act between meetings, in circumstances where it is not practicable or desirable for us to wait until the next committee meeting.
Review and evaluation of a related person transaction include an examination of all material facts and relevant factors, including without limitation:
•
the risks and benefits of such transaction to us;
•
the extent of the related person’s interest in the transaction;
•
the impact on a director’s independence in the event the related person involved in the transaction is a director, an immediate family member or an affiliated entity;
•
if applicable, the availability of other sources of comparable products and services; and
•
whether such transaction is on terms no less favorable than terms generally available to an unaffiliated third party under the same or similar circumstances.
The Nominating Committee shall approve or ratify only those transactions that, in light of known circumstances, are in, or are not inconsistent with, the best interests of the Company and our stockholders, as the Nominating Committee determines in good faith. The committee may also determine to provide standing approval of certain types of transactions. No director shall participate in any discussion or approval of a related person transaction for which he or she is a related person, except that the director is required to provide all material information concerning such transaction as requested by the Nominating Committee or the Board of Directors.
Director Independence
Upon consideration of the criteria and requirements regarding director independence set forth in Rules 5000(a)(19) and 5605(a)(2) of the rules of the NASDAQ Stock Market, we have determined that Dr. Abeles and Messrs. Milley and Severson, who constitute a majority of our board of directors, are independent. With regard to our audit committee, the board of directors has determined that Dr. Abeles and Messrs. Milley and Severson, who constitute all members of the audit committee, are independent with respect to the independence criteria for audit committee members set forth in Rule 5605(a)(2) of the rules of the Nasdaq Stock Market and Rule 10A-3(b)(1) of the Exchange Act.
Item 14.
Item 14. Principal Accountant Fees and Services
L J Soldinger Associates LLC (“LJSA”) served as our independent registered pubic accounting firm each of the fiscal years ending December 31, 2010 and 2009.
Fees
The following table presents fees for the professional services rendered by LJSA for fiscal years 2010 and 2009, respectively:
(1)
Audit fees represent fees billed for professional services rendered for the audit of our annual financial statements and review of the financial statements included in our quarterly reports or services that are normally provided in connection with statutory and regulatory filings or engagements.
(2)
Audit-related fees represent fees billed for assurance and related services reasonably related to the performance of the audit or review of our financial statements not reported in (1) above, including those incurred in connection with securities registration and/or other issues resulting from that process.
(3)
Tax fees represent fees billed for professional services rendered for tax compliance, tax advice and tax planning services.
(4)
All other fees principally would include fees billed for products and services provided by the accountant, other than the services reported under the three captions above.
Pre-Approval Policies
As required by applicable law, the Audit Committee is responsible for the appointment, compensation, retention and oversight of the work of our independent registered public accounting firm. In connection with such responsibilities, the Audit Committee is required, and it is the Audit Committee’s policy, to pre-approve the audit and permissible non-audit services (both the type and amount) performed by our independent registered public accounting firm in order to ensure that the provision of such services does not impair the firm’s independence, in appearance or fact.
The Audit Committee pre-approved all audit services provided to us during fiscal 2010. Non-audit services provided to us during fiscal year 2010 were for tax compliance.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(*) Denotes an exhibit filed herewith.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Report of Independent Registered Public Accounting Firm
To The Board of Directors and
Stockholders of CytoCore, Inc.
We have audited the accompanying consolidated balance sheet of CytoCore, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CytoCore, Inc. and Subsidiaries as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company’s recurring losses from operations and resulting dependence upon access to additional external financing, raise substantial doubt concerning its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ L J Soldinger Associates LLC
April 5, 2011
Deer Park, Illinois
CYTOCORE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
CYTOCORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
CYTOCORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
CYTOCORE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(Dollars in thousands)
The accompanying notes are an integral part of these consolidated financial statements
CYTOCORE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular data in thousands, except per share amounts)
Note 1. The Company and Basis of Presentation
CytoCore, Inc. (“CCI”, “CytoCore” or the “Company”) was incorporated as Ampersand Medical Corporation in Delaware in December 1998.
In September 2001, following the Company’s acquisition of AccuMed International, Inc. (“AccuMed”) via the merger of AccuMed into a wholly-owned subsidiary of CCI, the Company changed its corporate name to Molecular Diagnostics, Inc. in order to better represent its operations and products. On June 16, 2006, the shareholders ratified a proposal to change the Company’s name from Molecular Diagnostics, Inc. to CytoCore, Inc., which change was effected in Delaware on June 22, 2006. Except where the context otherwise requires, “CCI,” “CytoCore”, the “Company,” “we” and “our” refers to CytoCore, Inc. and our subsidiaries and predecessors.
Currently, CCI has one product for sale - its SoftPap collector. CCI is developing, and plans to sell an integrated family of cost-effective products for the detection, diagnosis and treatment of cancer under the trade name of CytoCore Solutions®. CytoCore Solutions products are intended to address sample collection, specimen preparation, specimen evaluation (including detection/screening and diagnosis), treatment and patient monitoring within vertical markets related to specific cancers. Current CytoCore Solutions products are focused upon cervical cancer. CCI plans that this focus will later be expanded to include other gynecological cancers as well as bladder, lung, and breast cancers, among others. Within each of these markets CCI anticipates that the CytoCore Solutions products will be sold as individual value-added drop-in replacements for existing products and as integrated systems that improve the efficiency and effectiveness of clinical and laboratory operations.
Going Concern
The Company has incurred significant operating losses since its inception and has an accumulated deficit at December 31, 2010 of $97,448,000. Management expects that significant on-going operating expenditures will be necessary to successfully implement CCI’s business plan and develop, manufacture and market its products. These circumstances raise substantial doubt about CCI’s ability to continue as a going concern. Implementation of the Company’s plans and its ability to continue as a going concern depend upon its securing substantial additional financing. For the year ended December 31, 2010, the Company sold 1,333,333 shares of restricted, unregistered common stock at an average price of $0.075. CCI received proceeds totaling $100,000.
CCI has only enough cash to operate into April 2011. Management’s plans include efforts to obtain additional capital, although no assurances can be given about the Company’s ability to obtain such capital. If the Company is unable to obtain adequate additional financing or generate profitable sales revenues, or negotiate a favorable settlement plan with creditors, it will be unable to continue its product development and other activities and may be forced to cease operations. The consolidated financial statements presented herein do not include any adjustments that might result from the outcome of this uncertainty.
Note 2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements included herewith include the accounts of the Company and its wholly-owned subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Management believes that it is reasonably possible that the following material estimates affecting the financial statements could significantly change in the coming year: (1) estimates concerning the method of depreciation or the useful life of the equipment used in the production of SoftPAP® collection kits, (2) estimates as to the valuation allowance for the amounts recorded and held as inventory of goods and property and equipment and, (3) estimates of possible litigation losses.
Revenue Recognition
CCI recognizes revenue from product sales in accordance with Staff Accounting Bulletin No. 104, “Revenue Recognition,” when the following criteria are met: shipment of a product or license to customers has occurred and there are no remaining Company obligations or contingencies; persuasive evidence of an arrangement exists; sufficient vendor-specific, objective evidence exists to support allocating the total fee to all elements of the arrangement; the fee is fixed or determinable; and collection is probable.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.
Inventory
As of December 31, 2010 and 2009, inventory consisted of purchased parts totaling $269,000 and $272,000, and finished goods held for sale totaling $624,000 and $627,000, respectively. Inventory is valued at the lower of cost or market, using the first in, first out method. As of December 31, 2009, the Company in testing for lower of cost or market determined a writedown of a portion of the value of the finished goods inventory totaling $400,000 was required in the financial statements.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and are depreciated using the straight-line method over the assets’ estimated useful lives. Principal useful lives are as follows:
Furniture and fixtures
5 years
Laboratory equipment
5 years
Computer and communications equipment
3 years
Design and tooling
5 years
Machinery and equipment
7 years
Leasehold improvements
Useful life or term of lease,whichever is shorter
Normal maintenance and repairs for property and equipment are charged to expense as incurred, while significant improvements are capitalized.
Licenses, Patents, and Technology
Licenses, patents, and purchased technology are recorded at their acquisition cost. Costs to prepare patent filings are expensed when incurred. Costs related to abandoned or denied patents are written off at the time of abandonment or denial. Amortization is begun as of the date of acquisition or upon the grant of the final patent. Costs are amortized over the asset’s
useful life, which ranges from two to 17 years. The Company assesses licenses, patents, and technology periodically for impairment.
Impairment or Disposal of Long-Lived Assets
At each balance sheet date or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, management of the Company evaluates the recoverability of such assets. An impairment loss is recognized if the amount of undiscounted cash flows is less than the carrying amount of the asset, in which case the asset is written down to fair value. The fair value of the asset is measured by either quoted market prices or the present value of estimated expected future cash flows using a discount rate commensurate with the risks involved.
Research and Development Costs
Research and development costs are charged to operations as incurred. CCI conducts a portion of its research activities under contractual arrangements with scientists, researchers, universities, and other independent third parties.
Stock Based Compensation
We follow the guidance of FASB Accounting Standards Codification Section 78-10, which requires that share-based payments be reflected as an expense based upon the grant-date fair value of those awards. The expense is recognized over the remaining vesting periods of the awards, if any.
Foreign Currency Translation
The functional currency of the Company’s foreign operations is the local currency. Accordingly, all assets and liabilities are translated into U.S. dollars using year-end exchange rates, and all revenues and expenses are translated using average exchange rates during the year.
Fair Value of Financial Instruments
The carrying value of accounts receivable, accounts payable, accrued expenses and notes payable approximate their respective fair values due to their short maturities.
Other Comprehensive Income (Loss)
Translation adjustments related to the Company’s foreign dormant subsidiary are included in other comprehensive loss and reported separately in stockholders’ equity (deficit).
Net Loss Per Share
Basic loss per share is calculated based on the weighted-average number of outstanding common shares. Diluted loss per share is calculated based on the weighted-average number of outstanding common shares plus the effect of dilutive potential common shares, using the treasury stock method. CCI’s calculation of diluted net loss per share excludes potential common shares as of December 31, 2010 and 2009 as the effect would be anti-dilutive (i.e. would reduce the loss per share).
In accordance with SEC Accounting Series Release 280 the Company computes its income or loss applicable to common stock holders by subtracting dividends on preferred stock, including undeclared or unpaid dividends if cumulative, from it reported net loss and reports the same on the face of its statement of operations.
Income Taxes
CCI follows the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting carrying amounts and the respective tax bases of assets and liabilities, and are measured using tax rates and laws that are expected to be in effect when the differences are
expected to be recovered or settled. Valuation allowances are provided against deferred tax assets if it is more likely than not that the deferred tax assets will not be realized.
The Company follows the guidance of FASB ASC 740-10 which relates to the Accounting for Uncertainty in Income Taxes , which seeks to reduce the diversity in practice associated with the accounting and reporting for uncertainty in income tax positions. This Interpretation prescribes a comprehensive model for financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.
Risks from Concentrations
Revenues were derived solely from two customers in 2010 and 2009.
Recent Accounting Pronouncements
In April 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-13, “Compensation-Stock Compensation (Topic 718)-Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades.” ASU 2010-13 provides amendments to Topic 718 to clarify that an employee share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity would not classify such an award as a liability if it otherwise qualifies as equity. The amendments in ASU 2010-13 are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The Company expects the adoption of this standard will not have a material effect on its results of operation or its financial position.
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855)-Amendments to Certain Recognition and Disclosure Requirements.” The amendments in the ASU remove the requirement for an SEC filer to disclose a date through which subsequent events have been evaluated in both issued and revised financial statements. Revised financial statements include financial statements revised as a result of either correction of an error or retrospective application of U.S. GAAP. The FASB also clarified that if the financial statements have been revised, then an entity that is not an SEC filer should disclose both the date that the financial statements were issued or available to be issued and the date the revised financial statements were issued or available to be issued. The FASB believes these amendments remove potential conflicts with the SEC’s literature. The Company adopted ASU 2010-09 upon issuance and such adoption had no effect on its results of operation or its financial position.
In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”). ASU 2010-06 includes new disclosure requirements related to fair value measurements, including transfers in and out of Levels 1 and 2 and information about purchases, sales, issuances and settlements for Level 3 fair value measurements. This update also clarifies existing disclosure requirements relating to levels of disaggregation and disclosures of inputs and valuation techniques. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted ASU 2010-06 upon issuance and such adoption did not have a material impact on the Company’s financial statements.
In April 2010, the Financial Accounting Standards Board, or FASB, issued Accounting Standard Update No. 2010-17, Milestone Method of Revenue Recognition (“ASU No. 2010-17”), which provides guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Prior to the issuance of ASU No. 2010-17, authoritative guidance on the use of the milestone method did not exist. ASU No. 2010-17 is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010. Alternatively, ASU No. 2010-17 can be adopted retrospectively for all prior periods. We do not expect the adoption of ASU No. 2010-17 to have a material impact on our financial statements or results of operations.
In December 2010, the FASB issued an accounting standard update 2010-29 that addresses the disclosure of supplementary pro forma information for business combinations. This update clarifies that when public entities are required to disclose pro forma information for business combinations that occurred in the current reporting period, the pro forma information should be presented as if the business combination occurred as of the beginning of the previous fiscal year when comparative financial statements are presented. This update is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company believes this guidance will have no effect on our consolidated financial statements.
In October 2009, the FASB issued a new accounting standard that addresses the accounting for multiple-deliverable revenue arrangements to enable vendors to account for deliverables separately rather than as a combined unit. This new standard addresses how to separate deliverables and how to measure and allocate arrangement consideration to one or more units of accounting. Existing accounting standards require a vendor to use objective and reliable evidence of fair value for the undelivered items or the residual method to separate deliverables in a multiple-deliverable arrangement. Under the new standard, it is expected that multiple-deliverable arrangements will be separated in more circumstances than under current requirements. The new standard establishes a hierarchy for determining the selling price of a deliverable for purposes of allocating revenue to multiple deliverables. The selling price used will be based on vendor-specific objective evidence if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific objective evidence nor third-party evidence is available. The new standard must be prospectively applied to all revenue arrangements entered into in fiscal years beginning on or after June 15, 2010 and became effective for us on January 1, 2011. We believe this guidance will have no effect on our consolidated financial statements.
In June 2009, the FASB issued a new accounting standard that amends the accounting and disclosure requirements for the consolidation of variable interest entities. This new standard removes the previously existing exception from applying consolidation guidance to qualifying special-purpose entities and requires ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity. Before this new standard, generally accepted accounting principles required reconsideration of whether an enterprise is the primary beneficiary of a variable interest entity only when specific events occurred. This new standard is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. This new standard became effective for us on January 1, 2010. The adoption of this standard did not impact our consolidated financial statements.
During June 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-17, Consolidations (ASC 810) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities (“ASU 2009-17”). ASU 2009-17 amended the consolidation guidance applicable to variable interest entities (“VIE”) and changed the approach for determining the primary beneficiary of a VIE. Among other things, the new guidance requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE; requires continuous assessments of whether an enterprise is the primary beneficiary of a VIE; enhances disclosures about an enterprise’s involvement with a VIE; and amends certain guidance for determining whether an entity is a VIE. This accounting guidance was effective for annual periods beginning after November 15, 2009 and was effective for the Company beginning in the first quarter of fiscal 2010. The adoption of this standard had no impact on the Company’s results of operations or financial position.
Note 3. Fixed Assets
Fixed assets consist of the following at December 31:
For the years ended December 31, 2010 and 2009, depreciation expense was $392,000 and $379,000, respectively. The Company did not allocate any of the depreciation expense of the machinery and equipment or the design and tooling into inventory as there was no manufacturing. This depreciation was included as a selling, general and administrative expense as excess idle time.
During 2010 when the Company tested its fixed assets for recoverability, it determined that the value associated with its construction in progress was diminished and recorded an impairment of $399,000 to adjust the value to zero.
During the second quarter of 2009, a supplier filed suit against CCI alleging that the Company owes it approximately $377,000. This supplier had previously placed a lien on all of the Company’s machinery and equipment. See Note 10 -Legal Proceedings for additional information regarding this claim.
Note 4. Licenses, Patents, and Technology
Licenses, patents, and technology include the following at December 31:
During 2008, the Company purchased a license for certain technology for an initial total of $200,000. In addition, CCI is obligated to make future payments totaling $100,000 upon obtaining certain milestones under the agreement. During the year ended December 31, 2010, CCI made payments of $36,000 and is obligated to make eight additional monthly payments of $8,000 on this liability. The Company is amortizing the initial license over its estimated useful life of two years, and will amortize the additional payments over one year. All patent costs and technology have been fully amortized.
Note 5. Accrued Expenses
Accrued expenses include the following at December 31:
Note 6. Notes Payable
Notes payable at December 31 consist of:
On September 2010, the Company made a settlement with White White & Van Etten (“White”), CCI owed White $140,000. As a result of this settlement, CCI issued a non-interest bearing promissory note in the principal amount of $68,750 payable in 11 monthly payments of $6,250 and White forgave the remaining $71,000. The Company recorded the benefit as a reduction of selling, general and administration expense. The CCI also imputed interest totaling $2,000 on this note at the rate of 5% per annum and is amortizing the interest over the term of the note. As of December 31, 2010, CCI has made three payments.
In March 2010, the Company received $75,000 in exchange for a convertible promissory note payable to Asher Enterprises (“Asher”), including unpaid interest, and is convertible into common stock at any time. The note accrues interest at 8% and is unsecured. The conversion price is variable and is determined as 58% of the average of the lowest three trading prices during the ten trading day period prior to the conversion notice. As a result, the Company has recorded a discount of $55,000 and a liability equal to the fixed monetary amount known at inception for the conversion option. The discount will be amortized over the term of the note using the effective interest method. Upon issuance of the shares to settle the liability, equity will be increased by the amount of the liability and no gain or loss will be recognized or any difference between the fixed monetary amount known at inception and the ending market price. During 2010 CCI recorded a charge of $55,000 for amortization of the discount and recorded the charge against the derivative liability. During the fourth quarter of 2010, Asher converted $19,500 of principal due under the note into an aggregate 1,060,626 shares of common stock at an average conversion price of $0.0184 per share.
The Company has failed to make principal and interest payments when due and is in breach of certain warranties and representations under the notes included above, except for White. Such notes require the holder to notify CCI in writing of a declaration of default at which time a cure period, as specified in each individual note, would commence. CCI has not received any written declarations of default from holders of its remaining outstanding notes payable.
During year ended December 31, 2010, the Company was advanced $1,013,000 from related parties. These advances are non-interest bearing and are due on demand. However, using an 8% annual interest rate the Company has recorded a non-cash interest expense totaling $109,000 on the outstanding balances.
Note 7. Stockholders’ Equity
Earnings (loss) per share
A reconciliation of the numerator and the denominator used in the calculation of earnings (loss) per share is as follows:
Stock options and warrants to purchase 4,094,709 and 3,471,197 shares and preferred stock convertible into 550,483 and 522,045 shares for the years ended December 31, 2010, and 2009, respectively, were not included in the computation of diluted loss per share applicable to common stockholders, as they are anti-dilutive as a result of net losses for the years ended December 31, 2010 and 2009, respectively.
Preferred Stock
A summary of the Company’s preferred stock as of December 31 is as follows:
A summary of the Company’s preferred stock as of December 31 is as follows:
Summary of Preferred Stock Terms
Series A Convertible Preferred Stock
Liquidation Value:
$4.50 per share, $212,625
Conversion Price:
$103.034 per share
Conversion Rate:
0.04367-Liquidation Value divided by Conversion Price ($4.50/$103.034)
Voting Rights:
None
Dividends:
None
Conversion Period:
Any time
Series B Convertible Preferred Stock
Series C Convertible Preferred Stock
Liquidation Value:
$3.00 per share, $115,000
Conversion Price:
$6.00 per share
Conversion Rate:
0.50-Liquidation Value divided by Conversion Price ($3.00/$6.00)
Series D Convertible Preferred Stock
Series E Convertible Preferred Stock
Issuance of Securities
Common Stock
During the quarter ended December 31, 2010, CCI received proceeds of $50,000 and issued 833,333 shares of restricted unregistered common stock and warrants to purchase 416,667 shares of restricted unregistered common stock at a price of $0.06 per share. For the year ended December 31, 2010, the Company received proceeds of $100,000 and issued 1,333,333 shares of restricted unregister common stock and warrants to purchase 666,333 shares of restricted unregistered shares of common stock at an average exercise price of $0.07 per share. The warrants have a term of three years.
During the quarter ended March 31, 2010, a settlement agreement was approved by the court and CCI issued 2,658,800 shares of restricted unregistered common stock and a warrant to purchase 217,000 shares of restricted unregistered common stock to NeoMed Innovation III L.P. The Company valued the common stock at $0.19 per share for a total of $505,000 using fair value and the warrant at $33,000 using the Black-Scholes method. The warrant has a term of three years and is exercisable immediately. The aggregate cost totaling $538,000 was recorded as other expense in 2009.
Also in the first quarter of 2010, CCI issued 31,637 shares of restricted, unregistered common stock valued at an average $0.19 per share to a consultant as payment for services rendered. The Company recorded the value of the common stock at $6,000 and recorded the amount as a selling, general and administrative expense. The Company also issued 119,169 vested shares of restricted, unregistered common stock valued at a weighted average $0.19 per share to a consultant as payment for services rendered. The Company recorded the value of the common stock at $30,000 and recorded the amount as a selling, general and administrative expense in 2009 and issued the shares in the second quarter of 2010.
During the quarter ended December 31, 2010, the Company issued 350,000 shares of restricted, unregistered common stock valued at $0.06 per share to a non-executive employee. The Company recorded the value of the common stock at $21,000 and recorded the amount as a selling, general and administrative expense. During the year ended December 31, 2010, CCI issued an aggregate 450,000 vested shares of restricted, unregistered common stock valued at $0.08 per share to a non-executive employee. The Company recorded the value of the common stock at $36,000 and recorded the amount as a selling, general and administrative expense.
Also during the fourth quarter of 2010, a holder of a note converted $19,500 of principal into 1,060,626 shares of common stock at an average fair value of $0.018 per share.
During the quarter ended September 30, 2010, CCI issued 66,667 shares of restricted, unregistered common stock value at $0.15 per share using fair value for the settlement of debt totaling $10,000.
On March 23, 2009, the Company offered to all holders of warrants to purchase shares of the Company’s common stock the option to exercise their warrants at a reduced exercise price of $0.25 per share. The original offer expired on April 23, 2009 and was subsequently extended until May 23, 2009. During the year ended December 31, 2009, the Company received gross proceeds of $214,000 from the exercise of warrants for an aggregate 854,371 shares of unregistered, restricted common stock in connection with its offer. In addition, our former Chairman of the Board of Directors and our Chief Executive Officer exercised warrants to purchase an aggregate 670,000 share of unregistered restricted common stock through the reduction of $168,000 of debt. CCI recorded a charge of $21,000 related to this warrant modification and recorded the amount as interest expense. In addition, holders of warrants to purchase 28,292 exercised their warrants at the original exercise price. CCI received approximately $56,000 from these exercises.
During the year ended December 31, 2009, Board of Directors voted to accept, in lieu of payment for $311,000 due to them, 778,194 shares of restricted, unregistered common stock. The common stock was valued at a fair value of $0.40 per share. The shares have not been issued by the transfer agent.
For the year ended December 31, 2009, CCI received proceeds totaling $270,000 and reduced its debt by $168,000 from the exercise of warrants to purchase an aggregate 1,552,663 shares of unregistered, restricted common stock. CCI issued 485,000 shares of restricted unregistered common stock during the year ended December 31, 2010. As of December 31, 2010, 193,333 shares were not yet issued by the transfer agent.
In the first quarter of the 2009 fiscal year, as described in Note 8 below, the Company issued to two of its executive officers an aggregate 61,144 shares of restricted, unregistered common stock valued at $0.50 per share as compensation for services rendered in 2008. The shares were valued at $31,000, and such amount was recorded as compensation in 2008.
Also, in 2009 the Board of Directors granted each director a bonus of 100,000 shares of restricted, unregistered common stock for services rendered. The shares granted totaled 700,000 and were valued at $0.40 per share. The Company recorded a charge of $280,000 as a selling, general and administrative expense.
In 2009 CCI also issued 16,129 shares of unregistered, restricted common stock to a consultant and were valued at $0.31 per share. The Company recorded a charge of $5,000 as a selling, general and administrative expense.
Warrants
During the quarter ended December 31, 2010, CCI issued warrants to a non-executive employee to purchase 2,000 shares of restricted, unregistered common stock at an exercise price of $0.03 per share. The warrants were valued at $57 using the Black-Scholes valuation model and recorded the amount as a selling, general and administrative expense. For the year ended December 31, 2010, the Company issued warrants to a non-executive employee to purchase an aggregate 13,000 shares of restricted, unregistered common stock at an average exercise price of $0.10 per share. The warrants were valued at $1,000 using the Black-Scholes valuation model and recorded the amount as a selling, general and administrative expense.
During the three months ended December 31, 2009, the Company issued warrants to purchase 2,000 shares of common stock at an exercise price of $0.04 per share to an employee. During the year ended December 31, 2009, the Company issued warrants to purchase 13,000 shares of common stock with a weighted average exercise price of $0.16 per share to an employee. CCI valued the warrants at $2,000 using the Black-Scholes valuation model and recorded the amount as non-cash compensation expense. These warrants have a term of three years and are immediately exercisable.
Conversions of Preferred Stock
During the year ended December 31, 2009, a holder of four shares of Series E Convertible Preferred Stock of CCI elected to convert such preferred shares and accrued and unpaid dividends thereon into 20 unregistered shares of the Company’s common stock. Dividends on these preferred shares were $7.00.
Application of Black-Scholes Valuation Model
In applying the Black-Scholes valuation model, the Company used the following assumptions for the years ended December 31:
Expected volatility is based solely on historical volatility of our common stock over the period commensurate with the expected term of the warrants or stock options. The expected term calculation is based upon the expected term the warrant or option is to be held, which in most cases is one-half of the term of the warrant or option. The risk-free interest rate is based upon the U.S. Treasury yield in effect at the time of grant for an instrument with a maturity that is commensurate with the expected term of the stock options. The dividend yield of zero is based on the fact that we have never paid cash dividends on our common stock and we have no present intention to pay cash dividends.
Warrants
At December 31, 2010, the Company had the following outstanding warrants to purchase shares of Common Stock:
Note 8. Equity Incentive Plan and Employee Stock Purchase Plan
On May 25, 1999, CCI stockholders approved the establishment of the 1999 Equity Incentive Plan effective as of June 1, 1999 (the “Plan”). The Plan provided that the Board may grant various forms of equity incentives to directors and employees, including but not limited to Incentive Stock Options, Non-Qualified Stock Options, Stock Appreciation Rights, and Restricted Stock Awards. Grants under the Plan are exercisable at fair market value determined as of the date of grant in accordance with the terms of the Plan. Grants vest to recipients immediately or ratably over periods ranging from two to five years, and expire five to ten years from the date of grant.
On May 23, 2000, stockholders approved an amendment to the Plan, which increased the number of shares of common stock allocated for use in the Plan from 200,000 shares to 300,000 shares. On June 21, 2002, stockholders approved a second amendment to the Plan, which increased the number of shares allocated for use in the Plan from 300,000 shares to 550,000 shares. On July 29, 2004, stockholders approved a third amendment to the Plan, which increased the number of shares for use in the Plan from 550,000 to 2,000,000 shares. The Plan terminated in June 2009.
The Board of Directors has also granted warrants to purchase common stock of CCI that are not covered by the terms of the Plan.
For the year ended December 31, 2009. The Company did not grant any options under the Plan or otherwise.
During the year ended December 31, 2010, the Company issued a non-executive employee warrants to purchase an aggregate 13,000 shares of common stock with exercise prices of $0.03 and $0.10 per share. The Company valued these warrants at $1,000 using the Black-Scholes valuation model. The warrants have a term of three years and are immediately exercisable.
During the quarter ended March 31, 2009, CCI’s Chief Executive Officer and Chief Operating Officer elected to receive a portion of their compensation, totaling 39,459 and 21,685 shares respectively, in restricted, unregistered common stock for services rendered in 2008. CCI valued the common stock at $0.50 per share for an aggregate total of $31,000 using the fair value method and recorded such value as compensation expense in 2008.
During the quarter ended June 30, 2009, our former Chairman of the Board of Directors and our Chief Executive Officer exercised warrants to purchase an aggregate 670,000 shares of unregistered, restricted common stock at a modified price of $0.25 through the reduction of $168,000 of debt. CCI recorded a charge of $21,000 related to this warrant modification and recorded the amount as interest expense for the three months ended June 30, 2009.
The fair value of each stock option and warrant award was determined as of the date of grant using the Black-Scholes option-pricing model with the following assumptions in each of the years ended December 31:
Expected volatility is based solely on historical volatility of our common stock over the period commensurate with the expected term of the warrants or stock options. The expected term calculation is based upon the expected term the warrant or option is to be held, which in most cases is one-half of the term of the warrant or option. The risk-free interest rate is based upon the U.S. Treasury yield in effect at the time of grant for an instrument with a maturity that is commensurate with the expected term of the stock options. The dividend yield of zero is based on the fact that we have never paid cash dividends on our common stock and we have no present intention to pay cash dividends.
As of December 31, 2010, there were no unrecognized compensation costs related to unvested share-based compensation arrangements since all costs related to grants in 2010 or previous years were fully recognized as of December 31, 2010.
A summary of the Company’s stock option activity and related information follows:
1999 Stock Option Plan
Warrants and options issued outside of the Plan for employee compensation
At the Annual Meeting of Stockholders on May 25, 1999, CCI stockholders also approved the 1999 Employee Stock Purchase Plan (the “Purchase Plan”). The Purchase Plan offered employees the opportunity to purchase shares of common stock of CCI through a payroll deduction plan at 85% of the fair market value of such shares at specified enrollment measurement dates. The Purchase Plan terminated during the second quarter of 2009. There was no activity in the Purchase Plan in 2009.
Note 9. Leases
The current facilities lease is for a term of five years terminating on October 31, 2013, with one option to terminate the lease with nine months notice on October 31, 2011. The lease provides for initial annual rental payments of approximately $127,000, increasing each year to reach $150,000 in the final year of the lease. Total rental expense related to the Company’s headquarters location during the years ended December 31, 2009 and 2008 was $133,000 and $136,000, respectively.
Future minimum annual lease payments under these leases as of December 31, 2010 are:
Note 10. Income Taxes
The provision for income taxes consists of the following for the years ended December 31, 2010 and 2009:
For the years ended December 31, 2010 and 2009, the provision for income taxes differs from the expected tax provision computed by applying the U.S. federal statutory rate to income before taxes as a result of the following:
The significant components of the Company’s deferred tax assets and liabilities are as follows:
At December 31, 2010 and 2009, CytoCore had net operating loss carry forwards for U.S. federal income tax of approximately $69.9 million and $68.6 million and state income tax of approximately $82.3 million and $81.1 million respectively, which will begin to expire in 2018 and 2017, respectively. In September 2001, the Company acquired 100% of the outstanding stock of AccMed International, Inc. by means of merger of AccuMed into a wholly-owned subsidiary of the Company. AccuMed had a net operating loss carry forward for U.S. federal income tax purposes. For federal tax purposes, the acquired NOL is subject to limitation as prescribed under IRC Section 382 to approximately $6.2 million. The net operating loss carry forward began expiring at approximately $415,000 per year, starting December 31, 2006. At December 31, 2010 total net operating loss carry forward from AccuMed is approximately $3.0 million.
For financial reporting purposes, the entire amount of deferred tax assets related principally to the net operating loss carry forwards has been offset by a valuation allowance due to uncertainty regarding the realization of the assets. The valuation allowance increased by approximately $0.6 million and $0.7 million for the years ended December 31, 2010 and 2009, respectively.
Tax Uncertainties
Effective January 1, 2007, the Company adopted the provisions of FASB Interpretation No. 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. The interpretation prescribes recognition and measurement parameters for the financial statement recognition and measurement of tax positions taken or expected to be taken in the Company’s tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement.
Pursuant to FIN 48, the Company has analyzed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as open tax years in these jurisdictions. The periods subject to examination for the Company’s tax returns are for the years 2008 and 2009. The Company believes that its income tax filing positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its financial position. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48. In addition, the Company did not record a cumulative effect adjustment related to the adoption of FIN 48.
The following table summarizes the activity related to the Company’s gross unrecognized tax benefits (in millions):
The Company is subject to U.S. federal income tax including state and local jurisdictions. Currently, no federal or state income tax returns are under examination by the respective taxing jurisdictions.
The Company’s accounting policy is to recognize interest and penalties related to uncertain tax positions in income tax expense. The Company has not accrued interest for any periods.
Note 11. Derivative Liability
In March 2010, as discussed in Note 7, the Company issued a note with a variable conversion feature. This resulted in the Company having an aggregate number of shares of common stock issued as well as instruments convertible or exercisable into common shares that potentially may exceed the number of the Company’s total authorized common shares. Consequently, the Company is required to record a liability for the potential excess of shares over the authorized amount. The Company is required to revalue this liability no less than every quarter. The Company determined that the excess shares were related to warrants issued and outstanding as of March 31, 2010. Based upon the Financial Accounting Standards Board (FASB) guidance, the Company determined the fair value of these excess shares using the Black-Scholes valuation model. As a result, the Company recorded an initial liability of $313,000. The Company increased the liability and reduced additional paid in capital by $173,000 as a result of an additional derivative liability for new warrants and convertible preferred stock. As of December 31, 2010, the Company remeasured this liability, and the Company reduced this liability to $44,000 and correspondingly recorded an unrealized benefit of $96,000. Also included in the derivative liability balance at December 31, 2010 is $55,000 from a note discounted as described in Note 7. As a result, the derivative liability has a balance of $99,000 as December 31, 2010.
Note 12. Commitments and contingencies
Legal Proceedings
Settled in 2010
NeoMed Innovation III L.P. In October 2007, NeoMed Innovation III L.P. (“NeoMed”) filed suit against the Company in the United State District Court, Eastern District of Illinois (Case No. 07C 5721). NeoMed alleged that the Company breached a contract with NeoMed. The alleged contract provided among other things that the Company would exchange two existing notes for a new note in the principal amount of $1,110,000 with an interest rate of 12%, payable on July 31, 2003 at the option of the holder in the form of common stock valued at $1.50 (adjusted for stock splits and equity raised at lower valuations). In 2006, the Company paid to NeoMed $1,060,000 and accrued interest calculated at 7% totaling $318,913. Despite accepting this payment, NeoMed demanded that the Company honor the alleged contract.
In April 2009, the Company entered into a tentative settlement agreement with NeoMed. The terms of the agreement provided that the Company would issue to NeoMed 2,658,800 shares of restricted, unregistered common stock and a warrant to purchase 217,000 shares of restricted unregistered common stock at an exercise price of $0.50 per share. As a result of the tentative settlement, the Company made an additional provision totaling $948,000, which was charged to other expense in the first quarter of 2009. In February 2010, the settlement agreement was approved by the court and CCI issued 2,658,800 shares of restricted unregistered common stock and a warrant to purchase 217,000 shares of restricted unregistered common stock to NeoMed. The warrant has a term of three years and is exercisable immediately. As a result of the settlement becoming final, CCI reduced the $948,000 provision to $222,000 in the fourth quarter. The $726,000 credit was applied to other expense.
Wildman, Harrold, Allen & Dixon LLP. In November 2009, Wildman, Harrold, Allen & Dixon (“Wildman”) filed suit against the Company in the Circuit Court of Cook County Illinois (Case No. 2009-L-013902). Wildman alleged that the Company failed to pay for legal services in the amount of $41,407. In January 2010, the Company entered into a Confession of Judgment and a payment plan with Wildman. The Company has made all of the required payments and believes that it has no further obligation.
Pending as of December 31, 2010
MedPlast Elkhorn, Inc. In May 2009, MedPlast Elkhorn, Inc. (“MedPlast”) filed suit against the Company in the Circuit Court, Walworth County, Wisconsin (Case No. 09 CV00721). MedPlast alleges that the Company has failed to pay
for certain tools and materials used in the manufacturing of the Company’s products. MedPlast is asking for payment of $377,000. The Company believes that it has made adequate provision for any obligation to MedPlast.
Securities and Exchange Commission
SEC Civil Action. In January 2011, the Securities and Exchange Commission (“SEC”) filed a civil injunction action against the Company, Daniel J. Burns, the former Chairman of the Board of Directors of the Company, and Robert F. McCullough, Jr., Chairman of the Board, Chief Executive Officer and Chief Financial Officer of the Company, in the United States District Court sitting in the Northern District of Illinois. The SEC alleged that between 2003 and 2008, the Company paid compensation to unregistered broker/dealers and failed to accurately report the beneficial ownership of certain of our officers and directors in our SEC filings. In February, 2011, the Company consented to the entry of a final judgment which permanently restrains and enjoins the Company from violating Section 14(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Section 15(a) of the Exchange Act, and from aiding and abetting others in such violations. In connection with the foregoing settlement, the Company agreed that for a period of at least two years it will establish and comply with internal policies and procedures designed to prevent it from future violations of certain federal securities laws.
As a result of the SEC complaint, the company learned that false billing for expense had been submitted to it by a former board member noted in the complaint.
Other claims
Other Creditors. CCI was a party to a number of other proceedings, informal demands, or debt for services brought by former unsecured creditors to collect past due amounts for services. CCI is attempting to settle these demands and unfilled claims. CCI does not consider any of these claims to be material.
During the year ended December 31, 2010, CCI entered into a settlement with a vendor to pay $69,000. As a result, the vendor forgave $71,000 of debt. The settlement was recorded as a reduction in Selling, General and administration expense. Also in fourth quarter of 2010, a former employee entered into a settlement with CCI. The Company paid the former employee $15,000 and recorded a reduction of $64,000 in Research and Development.
In 2009, a vendor entered into a non-cash settlement releasing the Company from an obligation totaling $457,000. The settlement was recorded as a reduction in Research and Development expense.
Commitments
The Company has entered into long term commitments with a distributer in China
As a result of cash constraints experienced by the Company, the Illinois Franchise Taxes due for the year 2010 and 2009 have not been paid. CCI believes that it has made adequate provision for the liability including penalties and interest.
Note 13. Related Party Transactions
During the year ended December 31, 2010, the Company was advanced $1,013,000 from related parties. These advance are payable upon demand and are non-interest bearing.
During the year ended December 31, 2009, the Company was advanced $884,000 from related parties. Of these advances, $121,000 was used to exercise warrants held by the lender in lieu of the Company receiving cash payments. This resulted in a remaining balance of $763,000 as of December 31, 2009. These advance are payable upon demand and are non-interest bearing.
Our Chief Executive Officer exercised warrants to purchase an aggregate 485,000 shares of unregistered restricted common stock at a modified price of $0.25 through the reduction of $121,500 of debt. CCI recorded a charge of $15,000 related to this warrant modification for those warrants which were originally issued as stock based compensation. These shares were issued in 2010
In 2009, our former Chairman of the Board Daniel J. Burns exercised warrants to purchase an aggregate 185,000 shares of unregistered, restricted common stock at a modified price of $0.25 through the reduction of $46,000 of debt owed
by CCI to him. This warrant modification was made available by the Company to all holders of warrants to purchase shares of the common stock of the Company.
Note 13. Subsequent Events
Through April 8, 2011, the Company received additional advances of $245,000 from a related party to fund operations. These advances are non-interest bearing and are due on demand.
Also during the first quarter of 2011, Asher Enterprises, Inc. converted $30,000 of principal due under their note into 3,025,812 shares of common stock at an average conversion price of $0.01 per share.