UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

Commission file number 0-13092

 

SPECTRASCIENCE, INC.

 

(Exact name of registrant

as specified in its charter)

 

Minnesota   41-1448837

(State or other jurisdiction

of incorporation or organization)

  (I.R.S. Employer Identification Number)

 

11568 Sorrento Valley Rd., Suite 11

San Diego, California 92121

(Address of principal executive offices, including zip code)

(858) 847-0200

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   YES x     NO ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registration was required to submit and post such files). YES  x    NO ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer        ¨ Accelerated filer                  ¨
   
Non-accelerated filer           ¨ Smaller reporting company        x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES ¨ NO x

 

The number of shares of the registrant’s common stock, par value $0.01 per share, outstanding on April 18, 2014 was 168,043,254.

  

 
 

 

SPECTRASCIENCE, INC.

 

FORM 10-Q

For the Three and Nine Months Ended September 30, 2013

 

TABLE OF CONTENTS

 

PART I FINANCIAL INFORMATION:  
     
Item 1. Financial Statements (Unaudited) 3
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 26
     
Item 4. Controls and Procedures 26
     
PART II OTHER INFORMATION  
     
Item 1. Legal Proceedings 27
     
Item 1A. Risk Factors 27
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
     
Item 3. Defaults Upon Senior Securities 27
     
Item 4. Mine Safety Disclosures 28
     
Item 5. Other Information 28
     
Item 6. Exhibits 28
     
SIGNATURES 29

 

2
 

 

PART I     FINANCIAL INFORMATION:

 

Item 1. Financial Statements

 

SpectraScience, Inc. and Subsidiary

Condensed Consolidated Balance Sheets

 

    September 30,     December 31,  
    2013     2012  
    (Unaudited)     (Audited)  
             
ASSETS                
Current assets:                
Cash   $ 238,485     $ 90,192  
Accounts receivable, net     30,000       -  
Inventories     120,642       202,077  
Deferred debt issuance costs     45,076       165,649  
Prepaid expenses and other current assets     223,331       191,030  
Total current assets     657,534       648,948  
                 
Fixed assets, net     31,970       85,592  
Patents, net     1,554,701       1,678,787  
    $ 2,244,205     $ 2,413,327  
                 
LIABILITIES AND STOCKHOLDERS' DEFICIT                
Current liabilities:                
Accounts payable   $ 1,014,469     $ 861,698  
Note payable to an affiliate     45,000       -  
Convertible debt, net of discounts of $259,715 as of September 30, 2013 and $520,851 as of December 31, 2012     2,076,070       608,622  
Derivative liability     2,199,794       2,335,560  
Accrued Expenses     466,242       183,855  
Total current liabilities     5,801,575       3,989,735  
                 
COMMITMENTS                
                 
Stockholders' deficit                
                 
Series A Convertible Preferred Stock, $.01 par value;
0 shares authorized, issued and outstanding as of September 30, 2013 and December 31, 2012 		    -       -  
Series B Convertible Preferred Stock, $.01 par value;
2,585,000 shares authorized, issued and outstanding as of September 30, 2013 and December 31, 2012; liquidation value of $517,000 plus accumulated and and unpaid dividends of $106,931 as of September 30, 2013 and December 31, 2012 		    25,850       25,850  
Series C Convertible Preferred Stock, $.01 par value;
1,000,000 shares authorized; 500,000 and 1,000,000 shares issued and outstanding as of September 30, 2013 and December 31, 2012; liquidation value of $100,000 and $200,000 as of September 30, 2013 and December 31, 2012 		    5,000       10,000  
Common stock, $.01 par value; 321,415,000 shares authorized;
162,295,047 and 152,229,665 shares issued and outstanding as of September 30, 2013 and December 31, 2012 		    1,622,950       1,522,297  
Additional paid in capital     36,524,648       35,491,603  
Accumulated deficit     (41,735,818 )     (38,626,158 )
Total stockholders' deficit     (3,557,370 )     (1,576,408 )
    $ 2,244,205     $ 2,413,327  

 

See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.

 

3
 

 

SpectraScience, Inc. and Subsidiary

Condensed Consolidated Statements of Operation

(Unaudited)

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2013     2012     2013     2012  
                         
Revenue   $ 60,000     $ 150,750     $ 180,000     $ 460,874  
Cost of revenue     36,756       77,949       110,269       278,243  
Gross profit     23,244       72,801       69,731       182,631  
                                 
Operating expenses:                                
Research and development     59,176       235,988       440,086       905,686  
General and administrative     375,200       536,656       1,527,780       1,737,056  
Sales and marketing     33,285       107,174       200,355       347,925  
      467,661       879,818       2,168,221       2,990,667  
                                 
Loss from operations     (444,417 )     (807,017 )     (2,098,490 )     (2,808,036 )
                                 
Other expense (income)                                
Interest expense     79,260       105,596       202,352       259,463  
Change in fair value of derivative and warrant liabilities     (1,156,215 )     (1,206,699 )     (1,073,017 )     3,265,264  
Amortization of derivative and warrant liabilities discount     308,484       806,687       1,328,849       2,252,549  
Amortization of deferred debt issuance costs and original issue discount     141,840       352,544       532,912       957,405  
Loss on extinguishment of debt     -       -       16,989       -  
Other expense (income), net     4,848       335       3,085       2,672  
      (621,783 )     58,463       1,011,170       6,737,353  
                                 
Net income (loss)   $ 177,366     $ (865,480 )   $ (3,109,660 )   $ (9,545,389 )
                                 
Basic and diluted income (loss) per share   $ 0.00     $ (0.01 )   $ (0.02 )   $ (0.09 )
                                 
Weighted average common shares outstanding:                                
Basic and diluted     161,854,734       117,152,589       158,736,987       111,078,252  

 

See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements.

 

4
 

 

SpectraScience, Inc. and Subsidiary

Condensed Consolidated Statement of Shareholders' Deficit

For the nine months ended September 30, 2013

(unaudited)

 

                                        Additional         Total  
    Series B Preferred Stock     Series C Preferred Stock     Common Stock     Paid-In     Accumulated     Shareholders'  
    Shares     Amount     Shares     Amount     Shares     Amount     Capital     Deficit     Deficit  
                                                       
Balance December 31, 2012     2,585,000     $ 25,850       1,000,000     $ 10,000       152,229,665     $ 1,522,297     $ 35,491,603     $ (38,626,158 )   $ (1,576,408 )
                                                                         
Non cash issuance of stock options     -       -       -       -       -       -       287,338       -       287,338  
Common stock issued for cash     -       -       -       -       187,500       1,875       7,500       -       9,375  
Common stock issued for services     -       -       -       -       4,000,000       40,000       204,500       -       244,500  
Common stock issued for debt offering costs     -       -       -       -       312,500       3,125       12,500       -       15,625  
Conversion of convertible debt     -       -       -       -       5,065,382       50,653       246,492       -       297,145  
Conversion of Series C Convertible Preferred     -       -       (500,000 )     (5,000 )     500,000       5,000       -       -       -  
Warrant valuation on issuance of convertible debt     -       -       -       -       -       -       257,726       -       257,726  
Loss on debt extinguishment     -       -       -       -       -       -       16,989       -       16,989  
Net loss     -       -       -       -       -       -       -       (3,109,660 )     (3,109,660 )
                                                                         
Balance September 30, 2013     2,585,000     $ 25,850       500,000     $ 5,000       162,295,047     $ 1,622,950     $ 36,524,648     $ (41,735,818 )   $ (3,557,370 )

 

5
 

 

SpectraScience, Inc. and Subsidiary

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

    Nine Months Ended September 30,  
    2013     2012  
Operating activities:            
Net loss   $ (3,109,660 )   $ (9,545,389 )
Adjustments to reconcile net loss to cash used in operating activities:                
Provision for uncollectable accounts receivable     4,281       -  
Amortization and depreciation     179,308       290,132  
Non-cash issuance of stock options     287,338       279,992  
Amortization of derivative and warrant liabilities discount     1,328,849       2,252,549  
Amortization of deferred debt issuance costs and original issue discount     532,912       957,405  
Change in fair value of derivative and warrant liabilities     (1,073,017 )     3,265,264  
Loss on extinguishment of debt     16,989       -  
Fair market value of common stock issued for services     244,500       8,500  
Changes in assets and liabilities:                
Accounts receivable     (34,281 )     (125,496 )
Inventory     81,435       91,544  
Prepaid expense and other assets     (32,301 )     (95,536 )
Accounts payable     144,156       32,306  
Accrued expenses     350,248       199,696  
Net cash used in operating activities     (1,079,243 )     (2,389,033 )
                 
Investing activities:                
Purchases of fixed assets     (1,600 )     (4,170 )
Net cash used in investing activities     (1,600 )     (4,170 )
                 
Financing activities:                
Proceeds from issuance of convertible notes payable     1,372,000       2,688,000  
Proceeds from issuance of note payable to affiliate     45,000       -  
Proceeds from issuance of common stock for cash     9,375       -  
Debt issuance costs     (197,239 )     (480,002 )
Net cash provided by financing activities     1,229,136       2,207,998  
                 
Net increase (decrease) in cash     148,293       (185,205 )
                 
Cash, beginning of year     90,192       250,723  
                 
Cash, end of period   $ 238,485     $ 65,518  
                 
Supplemental Disclosure of Cash Flow Information:                
Cash paid during the period for:                
Interest   $ 5,539     $ -  
Income taxes   $ -     $ -  
Non Cash Investing and Financing Activities:                
Conversion of convertible notes to common stock   $ 263,158     $ 1,466,316  
Conversion of interest due on convertible notes to common stock   $ 33,988     $ 146,632  
Exchange of interest due on convertible notes to new notes   $ 25,259     $ -  
Conversion of preferred stock to common stock   $ 5,000     $ -  

 

See accompanying summary of accounting polices and notes to unaudited condensed consolidated financial statements .

 

6
 

 

S pectraScience, Inc.

Notes to Unaudited Condensed Financial Statements

 

1.     Nature of Business and Basis of Presentation

 

Description of Business

 

SpectraScience, Inc. was incorporated in the State of Minnesota on May 4, 1983 as GV Medical, Inc. In October 1992, GV Medical discontinued its prior business, refocused its development efforts and changed its name to SpectraScience, Inc. The “Company,” hereinafter, refers to SpectraScience, Inc. and its wholly owned subsidiaries Luma Imaging Corporation (“LUMA”) and Spectra Science International, Inc. (“International”). Since 1996, the Company has focused primarily on developing the WavSTAT Optical Biopsy System (the “WavSTAT System”).

 

The Company has developed and received the European CE mark approval to market a proprietary, minimally invasive technology that optically illuminates tissue in real-time to distinguish between normal, pre-cancerous or cancerous cells without the need to remove the subject cell tissue from the body to make such determinations. The WavSTAT System operates by using cool, safe laser light to optically illuminate and analyze tissue, enabling the physician to make an instant diagnosis during endoscopy when screening for cancer, and if warranted, to begin immediate treatment during the same procedure. Beginning in December 2011, the WavSTAT 4 version of the product began to be sold in the European Union for colon cancer detection. In June 2012, the Company entered into a distribution agreement with PENTAX Europe, GmbH, for the sale of its systems internationally.

 

On November 6, 2007, the Company acquired the assets of LUMA in an equity transaction accounted for as an acquisition of assets and now operates LUMA as a wholly-owned subsidiary of the Company. LUMA had acquired the assets from a predecessor company that had developed, and received FDA approval for, a non-invasive diagnostic imaging system that can detect cervical cancer precursors and which utilizes an underlying technology that is similar to that of the WavSTAT System. The addition of the LUMA technology to the Company’s existing WavSTAT System technology provides the Company with a broad suite of fluorescence-based intellectual property and know-how. During the fiscal year ended December 31, 2010, the Company wrote off the remaining fair value of the LUMA inventory in order to focus on the continued development and marketing of the WavSTAT System. The Company retained the intellectual property of LUMA for use in the development of future generations of the WavSTAT System.

 

The transaction was accounted for as an acquisition of assets that included intellectual property, inventory and equipment. The intellectual property consisted of a total of 34 issued U.S. patents and 28 additional patent applications.

 

Basis of Presentation

 

The accompanying unaudited financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q as they are prescribed for smaller reporting companies. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary to make the financial statements not misleading have been included. Operating results for the nine month period ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. These statements should be read in conjunction with the financial statements and related notes, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

 

7
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

Going Concern

 

Historically, the Company’s sources of cash have come from the issuance and sales of equity securities and convertible debentures. The Company’s historical cash outflows have been primarily used for operating activities including research, development, administrative and sales activities. Fluctuations in the Company’s working capital due to timing differences of its cash receipts and cash disbursements also impact its cash flow. The Company expects to incur significant additional operating losses through at least the end of 2013, as it completes proof-of-concept trials, conducts outcome-based clinical studies and increases sales and marketing efforts to commercialize the WavSTAT4 Systems in Europe. If the Company does not receive sufficient funding, there is substantial doubt that the Company will be able to continue as a going concern. The Company may incur unknown expenses or may not be able to meet its revenue forecast, and one or more of these circumstances would require the Company to seek additional capital. The Company may not be able to obtain equity capital or debt funding on terms that are acceptable. Even if the Company receives additional funding, such proceeds may not be sufficient to allow the Company to sustain operations until it becomes profitable and begins to generate positive cash flows from operations.

 

As of September 30, 2013, the Company had a working capital deficit of $5,144,041 and cash of $238,485, compared to a working capital deficit of $3,340,787 and cash of $90,192 as of December 31, 2012. In December 2011, the Company entered into an Engagement Agreement with Laidlaw & Company (UK) Ltd., which Engagement Agreement was amended in July 2012. Under the Engagement Agreement, Laidlaw agreed to assist the Company in raising up to $20.0 million in capital over a two year period from the date of the Engagement Agreement. During the nine months ended September 30, 2013, the Company raised $1,159,136, net of transaction costs, under this agreement. Subsequent to June 30, 2013, the Company has engaged another agent to assist the Company with raising capital and has commenced raising capital on its own. However, if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined in the Engagement Agreement occur as expected, or if the Company is otherwise able to raise a similar level of funds, such proceeds will be sufficient to allow the Company to sustain operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be able to meet its revenue expectations requiring it to seek additional capital. In such event, the Company may not be able to find capital or raise capital or debt on terms that are acceptable.

 

The holders of Convertible Debentures control the conversion of the Convertible Debentures and certain of the Convertible Debentures were not converted at their maturity constituting a potential default on the matured, but unconverted, Convertible Debentures. In the event of such default, principal, accrued interest and other related costs are immediately due and payable in cash. As of September 30, 2013, Convertible Debentures with a face value of $1,588,733 held by 32 individual investors are in default. None of these investors have served notice of default on the Convertible Debentures held by them.

 

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

 

8
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

2.     Summary of Significant Accounting Policies

 

Revenue recognition

 

The Company recognizes revenues when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Revenue from the sale of the Company’s products is generally recognized when title and risk of loss transfers to the customer, the terms of which are generally free on board shipping point. The Company uses customer purchase orders to determine the existence of an arrangement. The Company uses shipping documents and third-party proof of delivery to verify that title has transferred. The Company assesses whether the price is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, the Company assesses a number of factors, including past transaction history with the customer and the creditworthiness of the customer.

 

Consolidation

 

The accompanying consolidated financial statements include the accounts of SpectraScience, Inc. and its wholly-owned subsidiaries LUMA, and International. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Risks and Uncertainties

 

The Company operates in an industry that is subject to intense competition, government regulation and rapid technological change. The Company's operations are subject to significant risk and uncertainties, including financial, operational, technological, regulatory and other risks associated with a short history of product sales, including the potential risk of business failure.

 

Use of Estimates

 

The Company prepares its consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, which requires management to make estimates and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to the financial statements. Significant estimates made by management include, among others, realization of long-lived assets including intangible assets, assumptions used to value stock options, assumptions used to value the common stock issued and assumptions related to the determination of the fair value of the derivative components associated with the Company’s Convertible Debentures. Actual results could differ from those estimates.

 

Inventory Valuation

 

The Company states its inventories at the lower of cost or market value, determined on a specific cost basis. The Company provides inventory allowances when conditions indicate that the selling price could be less than cost due to obsolescence and reductions in estimated future demand. The Company balances the need to maintain strategic inventory levels with the risk of obsolescence due to changing technology and customer demand levels. Unfavorable changes in market conditions may result in a need for additional inventory reserves that could adversely impact the Company’s gross margins. Conversely, favorable changes in demand could result in higher gross margins when the Company sells products.

 

Valuation of Long-lived Assets

 

The Company’s long-lived assets consist of property and equipment and intangible assets. Equipment is carried at cost and is depreciated over the estimated useful lives of the assets, which are generally two to three years, and leasehold improvements are amortized over the lesser of the lease term or the estimated useful lives of the improvements. The straight-line method is used for depreciation and amortization. Intangible assets consist of patents, which are amortized using the straight-line method over the estimated useful lives of the patents. The Company does not capitalize external legal costs and filing fees associated with obtaining patents on its new discoveries. Acquired intellectual property is recorded at cost and is amortized over its estimated useful life. The Company believes the useful lives assigned to these assets are reasonable. The Company assesses the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent in management’s estimate of future cash flows to determine recoverability of these assets. If management’s assumptions about these assets were to change as a result of events or circumstances, the Company may be required to record an impairment loss.

 

9
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation   (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. The Company adopted ASC 718 on January 1, 2006. The Company estimates the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton option-pricing model (the “Black-Scholes Model”). The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. The Company estimates forfeitures at the time of grant and revises its estimate in subsequent periods if actual forfeitures differ from those estimates.

 

The Company accounts for stock-based compensation awards to non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees  (“ASC 505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable.

 

All issuances of stock options or other equity instruments to employees and non-employees as the consideration for goods or services received by the Company are accounted for based on the fair value of the equity instruments issued. Any stock options issued to non-employees are recorded in expense and additional paid-in capital in shareholders’ equity over the applicable service periods using variable accounting through the vesting dates based on the fair value of the options at the end of each reporting period.

 

As of September 30, 2013, the Company had one stock-based employee compensation plan under which it makes grants, the 2011 Equity Incentive Plan (the “EIP”). The EIP provides for the grant of incentive stock options (“ISOs”), nonqualified stock options (“NQSOs”) and restricted stock awards to full-time employees (who may also be directors) and NQSOs and restricted stock awards to non-employee directors, consultants, customers, vendors or providers of services. The exercise price of any ISO may not be less than the fair market value of the common stock on the date of grant and the term shall not exceed ten years. The amount reserved under the 2011 EIP is 15,000,000 shares of common stock.  At September 30, 2013, the Company had outstanding 19,491,667 options under the EIP and the Company’s prior Amended 2001 Stock Plan representing approximately 12% of the Company’s outstanding shares (12,821,771 of which were exercisable), with 6,453,333 available for future issuance under the 2011 EIP. Awards under the Company’s EIP generally vest over four years.

 

The fair value of options granted were estimated at the date of grant using a Black-Scholes Model which includes several variables including expected life, risk free interest rate, expected stock price volatility, stock option exercise patterns and expected dividend yield. The Company also must estimate forfeitures for employee stock options. These models and assumptions are complex and may change future expenses by increasing or decreasing stock-based compensation expense. There were no stock options granted during the three and nine month periods ended September 30, 2013. Management used the following weighted average assumptions to value stock options granted during the three and nine month periods ended September 30, 2013 and 2012.

 

10
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

    Three months ended September 30,   Nine months ended September 30,
    2013   2012   2013   2012
                 
Expected term of options   None   5 years   None   5 years
Exercise price                
Expected volatility   None   101%   None   101%-114%
Expected dividends   None   None   None   None
Risk-free interest rate   None   0.70%   None   0.70%-0.85%
Forfeitures   None   None   None   None

 

Management believes estimated forfeitures for employee stock options granted under the EIP would have a negligible effect on expenses because such forfeitures would be a very small percentage. Stock option grants have been to a group of individuals that have a high desire to see the Company succeed and have aligned themselves to that end.

 

The expected lives used in the calculations were selected by management based on past experience, forward looking profit forecasts and estimates of what the trading price of the Company’s stock might be at different future dates.

 

The risk-free interest rates used in the calculations are the five-year U.S. Treasury rates as published on the date of the applicable stock option grant.

 

Volatility is a calculation based on fluctuations in the Company’s stock price over a historical time period consistent with the estimated life of the option.

 

Options outstanding as of September 30, 2013 are as follows:

 

          Outstanding Options  
                               
    Options           Weighted Average     Weighted Average     Aggregate  
    Available for     Plan Options     Exercise Price     Remaining Contractual     Intrinsic  
    Grant     Outstanding     Per Share     Term (years)     Value (1)  
Outstanding at January 1, 2013     6,453,333       19,491,667     $ 0.18       8.20     $ -  
Granted     -       -     $ -       -     $ -  
Cancelled     -       -     $ -       -     $ -  
Exercised     -       -     $ -       -     $ -  
Outstanding at September 30, 2013     6,453,333       19,491,667     $ 0.18       7.07     $ -  
                                         
Exercisable at September 30, 2013             12,821,771     $ 0.21       6.46     $ -  
                                         
Weighted average fair value of options granted during the period             -     $ -       -     $ -  

 

(1) These amounts represent the excess, if any, between the exercise price and $0.04, the closing market price of the Company’s common stock on September 30, 2013 as quoted on the Over-the-Counter Bulletin Board under the symbol “SCIE”.

 

11
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

There were no options exercised during the three and nine month periods ended September 30, 2013 and 2012. At September 30, 2013, total unrecognized estimated employee compensation cost related to non-vested stock options granted prior to that date is $556,464, which we expect to be recognized over the next four years.

 

Earnings (Loss) Per Share

 

Basic loss per share is computed by dividing loss available to common shareholders by the weighted-average number of common shares outstanding. Diluted loss per share is computed similar to basic loss per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. Common equivalent shares are excluded from the computation if their effect is anti-dilutive.

 

For the periods ended September 30, 2013 and 2012, the following common equivalent shares were excluded from the computation of loss per share since their effects are anti-dilutive.

 

    September 30,     September 30,  
    2013     2012  
                 
Preferred Stock     3,085,000       3,585,000  
Convertible debentures     39,111,869       20,269,100  
Options     19,491,667       21,041,667  
Warrants     77,127,289       55,815,367  
Total     135,730,825       97,126,134  

 

12
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

The following table sets forth the computation of basic and diluted loss per share and incorporates income and expense related to convertible debentures and warrants and a change in shares that could be outstanding on the conversion of the convertible debentures for the three and nine month periods ended September 30, 2013 and 2012:

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2013     2012     2013     2012  
                         
Numerator:                                
Net income (loss) for basic earnings per share   $ 177,366     $ (865,480 )   $ (3,109,660 )   $ (9,545,389 )
Additions:                                
Interest expense related to convertible debentures     78,054       -       2,425          
Amortization of deferred debt costs and original issue discount     141,840       -       -          
Discounts on warrants and derivative debt     308,484       -                  
Subtractions:                                
Gain (loss) on debt extinguishment     -       -       30,796          
Change in fair value of derivative securities     (1,156,215 )     -       (351,813 )        
Net loss for diluted earnings per share   $ (450,471 )   $ (865,480 )   $ (3,428,252 )   $ (9,545,389 )
                                 
Denominator:                                
Weighted average basic shares outstanding     161,854,734       117,152,589       158,736,987       111,078,252  
Additions:                                
Assumed conversion of convertible debentures at beginning of period     27,231,569       -       2,204,467       -  
Assumed conversion of exchanged convertible debentures during the period     3,204,858       -       -       -  
Subtractions:                                
Convertible debentures converted during the period     -       -       (2,025,203 )     -  
Potentially dilutive common shares     30,436,427       -       179,264       -  
                                 
Denominator for diluted earnings per share- Adjusted weighted average shares     192,291,161       117,152,589       158,916,251       111,078,252  
                                 
Income (loss) per share                                
Basic   $ 0.00     $ (0.01 )   $ (0.02 )   $ (0.09 )
Diluted   $ (0.00 )   $ (0.01 )   $ (0.02 )   $ (0.09 )

 

 

13
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

Inventories

 

Inventories consisted of the following at September 30, 2013 and December 31, 2012: 

 

    September 30,     December 31,  
    2013     2012  
             
Raw materials   $ 132,315     $ 124,905  
Finished goods     35,921       124,766  
      168,236       249,671  
Reserve for obsolescence     (47,594 )     (47,594 )
    $ 120,642     $ 202,077  

 

3. Liabilities

 

Note Payable to an Affiliate

 

In September 2013, the Company issued a nine month unsecured note with a face value of $45,000 and 500,000 restricted shares of common stock to an affiliate of the Company in exchange for $54,325 in cash. The imputed annual rate of interest was calculated to be 18.4% and is to be repaid in nine equal monthly installments. Of the 500,000 shares issued, 312,500 shares were issued for debt issuance costs in an amount of $15,625 which is being amortized as interest expense over the life of the note and 187,500 shares were issued for cash in an amount of $9,375.

 

Convertible Debentures

 

As of September 30, 2013, the Company has issued and outstanding Convertible Debentures (“Debentures”) with original terms of six months to one year, an interest rate ranging from 10-20% per year and an original issue discount of 5% which, at the option of the holder, may convert into common stock at an initial conversion price ranging from $0.045 to$0.099 per share. The Debentures were issued with detachable five year cashless Holders Warrants that allow the holders to purchase one share of stock for each two shares available under the converted Debentures at an exercise price ranging from $0.0745 to $0.1287 per share. In addition, the Company issued five year cashless Agent Warrants equal to 10% of the total number of shares issuable under the Debentures and Holders Warrants at an exercise price ranging from $0.0745 to $0.1287 per share. For debentures issued through March 31, 2013, at the option of the Debenture holder, the terms of the Debentures and Holders Warrants are subject to an exchange feature in the event that the Company issues securities with terms more favorable than those of the then outstanding Debentures and Holders Warrants. Debentures issued subsequent to March 31, 2013 do not contain such an exchange clause.

 

14
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

As of September 30, 2013 and December 31, 2012, the balances of the Debentures are as follows:

 

    September 30,     December 31,  
    2013     2012  
             
Balance at beginning of period   $ 1,129,473     $ -  
Issuance of debentures for cash     1,372,000       3,186,000  
Original issue discount     72,211       167,685  
Debentures surrendered in exchange transactions     (300,002 )     -  
Debentures issued in exchange transactions     325,261       -  
Debentures converted to common stock     (263,158 )     (2,224,212 )
Convertible debt     2,335,785       1,129,473  
Less unamortized costs of financing     259,715       520,851  
Convertible debt, net of unamortized costs   $ 2,076,070     $ 608,622  
                 
Convertible debt in default   $ 1,588,733     $ -  

 

Derivative Liability

 

Since the Company issued Convertible Debentures which included Holders Warrants, Agent Warrants and a conversion option that includes a possible exchange feature in the event of a future financing on terms more favorable than those of the existing warrants and debentures, this results in the warrants and conversion feature of the debentures being recorded as a liability and measured at fair value. The Company measures these warrants and conversion feature using a combination of Black-Scholes option valuation models and Binomial Lattice option valuation models using similar assumptions to those

described under “Stock-Based Compensation.” The time period over which the Company will be required to evaluate the fair value of the warrants is approximately five years and the time period over which the Company will be required to evaluate the fair value of the conversion feature is the lesser of six to twelve months or conversion.

 

The assumptions used in determining fair value represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change, including changes in the market value of the Company’s common stock, managements’ assessment of the probability of a more favorably priced future financing or significant fluctuations in the volatility of the trading market for the Company’s common stock the Company’s fair value estimates could be materially different in the future.

 

The Company computes the fair value of the derivative liability at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component in the value of the derivative liability is the Company’s stock price, which is subject to significant fluctuation and is not under its control. The resulting effect on net loss is therefore subject to significant fluctuation and will continue to be so until the Company’s Debentures, which the convertible feature is associated with, are converted into common stock or paid in full with cash. Assuming all other fair value inputs remain constant, the Company will record non-cash expense when its stock price increases and non-cash income when its stock price decreases.

  

15
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

As of September 30, 2013 and December 31, 2012, the balances of the Derivative Liability are as follows:

 

          Conversion        
    Warrants     Feature     Total  
                   
Balance at January 1, 2012   $ -     $ -     $ -  
Liability on issuance of debt and warrants     2,510,919       2,167,341       4,678,260  
Change in fair value at year end     (780,875 )     991,912       211,037  
Elimination of liability on conversion     -       (2,553,737 )     (2,553,737 )
Balance at December 31, 2012     1,730,044       605,516       2,335,560  
                         
Liability on issuance of debt and warrants     762,111       929,156       1,691,267  
Change in fair value at period end     (847,119 )     (914,850 )     (1,761,969 )
Elimination of liability on conversion     -       (65,064 )     (65,064 )
Derivative liability   $ 1,645,036     $ 554,758     $ 2,199,794  

 

Debentures issued subsequent to March 31, 2013 did not contain an exchange provision and were accounted for using the equity method of valuing the note and warrant. For the three and nine months ended September 30, 2013, $413,908 and $447,090 were recorded as additional paid-in capital.

 

4. Shareholders’ Deficit

 

Common Stock

 

In January 2013, the Company issued 3,000,000 shares of restricted common stock to two vendors for services. The fair value of the vested portion of these shares was determined to be $55,149. In June 2013, the Company issued 1,000,000 shares of restricted common stock to one vendor for services. The fair value of the vested portion of these shares was determined to be $42,345.

 

During the nine months ended September 30, 2013, holders of Convertible Debentures with a face value of $297,146 converted their debentures into 4,592,636 shares of restricted common stock. In addition, associated with these debentures, the Company paid $33,988 in accrued interest by issuing 472,746 shares of restricted common stock.

 

In April 2013, a shareholder converted 500,000 shares of Series C Convertible Preferred stock into 500,000 shares of restricted common stock.

 

In September 2013, the Company issued a nine month unsecured note with a face value of $45,000 and 500,000 restricted shares of common stock to an affiliate of the Company in exchange for $54,325 in cash. The imputed annual rate of interest was calculated to be 18.4% and is to be repaid in nine equal monthly installments. Of the 500,000 shares issued, 312,500 shares were issued for debt issuance costs in an amount of $15,625 which is being amortized as interest expense over the life of the note and 187,500 shares were issued for cash in an amount of $9,375.

 

Warrants

 

During the nine months ended September 30, 2013, in conjunction with the sale of Convertible Debentures, the Company issued five year common stock purchase warrants to acquire 12,653,479 shares to holders of the Debentures and as compensation to Agents. These warrants have exercise prices ranging from $0.0745 to $0.1287 per share.

 

16
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

In addition, during the nine months ended September 30, 2013, the holders of common stock purchase warrants to acquire 1,515,151 shares at an exercise price of $0.1287 exchanged their warrants for new warrants to acquire 2,837,873 shares at an exercise price of $0.0745 under the exchange provisions of their Convertible Debentures.

 

The balance of all warrants outstanding as of September 30, 2013 is as follows:

 

          Weighted  
          Average  
          Exercise  
Warrants   Shares     Price  
Outstanding at January 1, 2013     59,066,992     $ 0.18  
Granted     16,737,575     $ 0.08  
Exchanged cancelled     (1,515,151 )   $ 0.13  
Exchanged issued     2,837,873     $ 0.08  
Cancelled     -     $ -  
Exercised     -     $ -  
Outstanding at September 30, 2013     77,127,289     $ 0.15  
                 
Exercisable at September 30, 2013     77,127,289     $ 0.15  

  

5. Fair Value Measurements

 

Accounting guidance on fair value measurements and disclosures defines fair value, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system, and defines required disclosures. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business.

 

The Company's balance sheet contains derivative and warrant liabilities that are recorded at fair value on a recurring basis. The three-level valuation hierarchy for disclosure of fair value is as follows:

 

Level 1: uses quoted market prices in active markets for identical assets or liabilities.

 

Level 2: uses observable market-based inputs or unobservable inputs that are corroborated by market data.

 

Level 3: uses unobservable inputs that are not corroborated by market data.

 

The fair value of the Company’s recorded derivative and warrant liabilities is determined based on unobservable inputs that are not corroborated by market data, which require a Level 3 classification. A modified Binomial Lattice option valuation model was used to determine the fair value with similar assumptions to those described under “Stock-Based Compensation”. The Company records derivative and warrant liabilities on the consolidated balance sheets at fair value with changes in fair value recorded in the consolidated statements of operations.

 

17
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

The following table presents the balances of liabilities measured at fair value on a recurring basis by level as of September 30, 2013:

 

    Fair Value Measurements Using  
    Quoted Prices in     Significant Other     Significant        
    Active Markets for     Observable     Unobservable        
    Identical Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
                         
As of September 30, 2013                                
Derivative liability   $ -     $ -     $ 554,758     $ 554,758  
Warrant liability     -       -       1,645,036       1,645,036  
Total   $ -     $ -     $ 2,199,794     $ 2,199,794  

 

The following table presents changes in the liabilities with significant unobservable inputs (Level 3) for the nine months ended September 30, 2013:

 

    Warrant     Derivative     Total  
    Liability     Liability     Liability  
Balance December 31, 2012   $ 1,730,044     $ 605,516     $ 2,335,560  
                         
Liability on issuance of debt and warrants     762,111       929,156       1,691,267  
                         
Change in estimated fair value (1)     (847,119 )     (914,850 )     (1,761,969 )
                         
Elimination of liability on conversion     -       (65,064 )     (65,064 )
                         
Balance September 30, 2013   $ 1,645,036     $ 554,758     $ 2,199,794  

 

(1) Included in the Statement of Operations on the line “Change in fair value of derivative liabilities.”

 

Management used the following inputs to value the Derivative and Warrant Liabilities for the nine months ended September 30, 2013:

 

    Derivative Liability   Warrant Liability
Expected term   6 months - 1 year   5 years
Exercise price   $0.045 - $0.099   $0.075 - $0.1287
Expected volatility   52% - 201%   106% - 176%
Expected dividends   None   None
Risk-free interest rate   .04% - .14%   .77% - 1.71%
Forfeitures   None   None

 

In computing the fair value of the derivative and warrant liability at September 30, 2013 for instruments under the Binomial Lattice option-pricing model, management estimated a 50% probability of a down round financing event at a price of $0.036 and a 20% to 80% probability that existing note holders with exchange priviledges would exchange their existing debentures and warrants for new debentures and warrants.

 

6. Contingencies

    

None

 

18
 

 

SpectraScience, Inc.

Notes to Unaudited Condensed Financial Statements (continued)

 

7. Subsequent Events

 

Convertible Debentures and Warrants

 

From October 2013 through April 2014, the Company sold $1,344,271 of Unsecured Convertible Debentures (the “Debentures”) to accredited investors for aggregate consideration of $1,286,376. The Debentures mature in twelve months, carry a fixed conversion price of $.045, an annual interest rate of 10% and are convertible into 29,872,683 shares of common stock at maturity. The Company received net cash proceeds of approximately $1,198,376 after payment of fees and expenses of $88,000. In addition, the Company issued the holders of the Debentures detachable five-year warrants to purchase 14,936,342 additional shares of common stock and issued to a placement agent of a portion of the offering warrants to purchase 200,000 shares of common stock all at an exercise price of $0.090 per share and issued to the same agent 400,000 shares of common stock in lieu of a cash payment.

 

In November 2013, the holders of Convertible Debentures with an aggregate face value of $264,211, interest rate of 16% and conversion prices ranging from $0.0573 to $0.099 per share exchanged their debentures for new debentures with a conversion price of $0.045 per share and an interest rate of 10%. In addition, associated with these new Convertible Debentures, the Company increased the face value by $36,895, which was the accrued interest at the time of exchange, to $301,106. The maturity date for the new debentures is November 30, 2014. In addition, the Company issued new five-year warrants to purchase 3,145,662 shares of common stock with an exercise price of $0.09 per share in exchange for warrants to purchase 1,660,948 shares of common stock with exercise prices ranging from $0.0745 to $0.1287 per share.

 

Common Stock

 

In November 2013, a holder of a Convertible Debenture with a face value of $210,526 converted his Convertible Debenture into 3,674,101 shares of restricted common stock. In addition, associated with this Convertible Debenture, the Company paid $25,378 in accrued interest by issuing 442,905 shares of common stock.

 

In November 2013, 300,000 shares of common stock valued at $12,000 were issued to two individuals in exchange for services provided.

 

In February 2014, an affiliate of the Company exercised a portion of his stock options into 931,200 shares of restricted common stock at an exercise price of $0.02 for proceeds to the Company of $18,624.

 

Subsequent events have been evaluated through the date financial statements are filed with the Securities and Exchange Commission.

 

19
 

 

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

 

Forward-Looking Statements

 

This quarterly report on Form 10-Q (the “Report”) contains forward-looking statements that are not related to historical results, including, without limitation, statements regarding our business strategy and objectives, our anticipated duration of periods of net loss, our near term operating goals, our expectations regarding the market for our products, the introduction of our products in new international markets and our beliefs with respect to opportunities and industry conditions in those markets, our beliefs about our products, product development, acquisition or licensing of complementary technologies and expectations with respect to our products’ performance and acceptance, the results of and our intentions with respect to our distribution agreement with PENTAX Europe GmbH, our beliefs about the strengths of our intellectual property portfolio, our regulatory goals and developments, anticipated clinical trials and research, our agreement with Laidlaw and its effect on our future capital resources and future financial position, our expectations with respect to stock option expense recognition, our future cash needs, the sufficiency of our working capital and our operating losses for the remainder of the current fiscal year. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, there can be no assurance that such assumptions will prove to be accurate and actual results could differ materially from those discussed in the forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause or contribute to such differences, including, but not limited to, changes in law or regulatory policies, unanticipated competition from other similar businesses, adverse outcomes from litigation, unexpected employee departures or disruptions, adverse market and general economic factors and other factors described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Such forward-looking statements are qualified in their entirety by the cautions and risk factors set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

Business

 

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

 

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

 

Plan of Operation

 

During the three and nine month periods ended September 30, 2013, SpectraScience carried forward on the improvements made to the WavSTAT4 in fiscal 2011 and continued working with PENTAX Europe, GmbH (“PENTAX”), for distribution of its products in Europe the Middle East and Africa.

 

20
 

 

Over the next 12 months, SpectraScience intends to:

 

  · Market and sell the WavSTAT4 Optical Biopsy System colon cancer diagnostic application through PENTAX in the European Union;

 

  · Conduct country-specific evaluation trials to demonstrate the effectiveness and cost benefit of the WavSTAT4 Optical Biopsy System in each relevant European jurisdiction;

 

  · Coordinate the creation and publication of scientific papers and presentations related to the country-specific evaluation trials to support widespread education and adoption of the WavSTAT4 ;
     

 

 

· Pursue the introduction of the WavSTAT4 colon cancer application in other international markets, in particular Russia and India;
  · Begin meeting with the FDA towards the preparation and submission of a Supplemental PMA filing with the FDA for the WavSTAT4 and plan for additional clinical trials to support eventual approval for sale in the United States;
 
  · Begin the design and planning for the next generation of multi-modal fluorescence and broadband spectroscopy systems at our facility in San Diego, California; and
     
  · Continue to expand and refine our intellectual property portfolio.

 

Results of Operations

 

Comparison of the Three Months Ended September 30, 2013 and 2012

 

    Three Months Ended September 30,     Favorable        
    2013     2012     (Unfavorable)     %  
                         
Revenue   $ 60,000     $ 150,750     $ (90,750 )     -60.2 %
Cost of revenue     36,756       77,949       41,193       52.8 %
Gross profit     23,244       72,801       (49,557 )     -68.1 %
                                 
Operating expenses:                                
Research and development     59,176       235,988       176,812       74.9 %
General and administrative     375,200       536,656       161,456       30.1 %
Sales and marketing     33,285       107,174       73,889       68.9 %
      467,661       879,818       412,157       46.8 %
                                 
Loss from operations     (444,417 )     (807,017 )     362,600       -44.9 %
                                 
Other expense (income)     (621,783 )     58,463       680,246       NM  
                                 
Net income (loss)   $ 177,366     $ (865,480 )   $ 1,042,846       -120.5 %

 

21
 

 

Revenues

 

Revenues for the quarter ended September 30, 2013 decreased $90,750, 60.2%, to $60,000 compared to $150,750 for the quarter ended September 30, 2012. The primary reason for the revenue decrease was a decrease in the number of WaveSTAT4 Systems shipped- 2 in 2013 vs. 5 in 2012. We anticipate that revenue will increase as a result of our distribution agreement with PENTAX.

 

Cost of Revenue

 

Cost of revenue for the quarter ended September 30, 2013 decreased $41,193, 52.8%, to $36,756 compared to $77,949 for the quarter ended September 30, 2012. The primary reason for the cost of revenue decrease was the reduction in revenue discussed above.

 

Research and Development Expenses

 

Research and development expenses decreased by $176,812, 74.9%, to $59,176 for the quarter ended September 30, 2013 from $235,988 for the quarter ended September 30, 2012. This decrease was primarily due to a reduction in engineering development costs of approximately $36,000 and a reduction of payroll costs of approximately $133,000. We anticipate that development costs will remain low but that clinical costs will increase as we proceed with our introduction of the WaveSTAT4 in Europe.

 

General and Administrative Expenses

 

General and administrative expenses decreased by $161,456, 30.1%, to $375,200 for the quarter ended September 30, 2013 from $536,656 for the quarter ended September 30, 2012. The primary reason for the decrease was a decrease in investor relations costs of approximately $67,000, a decrease in payroll costs of approximately $38,000, and a decrease in depreciation and amortization costs of approximately $50,000. We anticipate that general and administrative expenses will increase as we increase our activity in Europe.

 

Sales and Marketing Expenses

 

Sales and marketing expenses decreased by $73,889, 68.9%, to $33,285 for the quarter ended September 30, 2013 from $107,174 for the quarter ended September 30, 2012. The primary reason for the decrease was a decrease in payroll costs of approximately $35,000 and a decrease in consulting costs of approximately $35,000. We anticipate that sales and marketing expenses will increase as we increase our activity in Europe.

 

Other Expense (Income)

 

Other expense (income) for the quarter ended September 30, 2013 was income of $621,783 compared to expense of $58,463 for the quarter ended September 30, 2012. This change was due primarily to the change in valuation of our derivative liabilities. We anticipate continued large fluctuations in other expense (income) as a result of quarterly re-evaluating these obligations.

 

22
 

 

Comparison of the Nine Months Ended September 30, 2013 and 2012

 

    Nine Months Ended September 30,     Favorable        
    2013     2012     (Unfavorable)     %  
                         
Revenue   $ 180,000     $ 460,874     $ (280,874 )     -60.9 %
Cost of revenue     110,269       278,243       167,974       60.4 %
Gross profit     69,731       182,631       (112,900 )     -61.8 %
                                 
Operating expenses:                                
Research and development     440,086       905,686       465,600       51.4 %
General and administrative     1,527,780       1,737,056       209,276       12.0 %
Sales and marketing     200,355       347,925       147,570       42.4 %
      2,168,221       2,990,667       822,446       27.5 %
                                 
Loss from operations     (2,098,490 )     (2,808,036 )     709,546       -25.3 %
                                 
Other expense     1,011,170       6,737,353       5,726,183       NM  
                                 
Net loss   $ (3,109,660 )   $ (9,545,389 )   $ 6,435,729       -67.4 %

 

Revenues

 

Revenues for the nine months ended September 30, 2013 decreased $280,874, 60.9%, to $180,000 compared to $460,874 for the nine months ended September 30, 2012. The primary reason for the revenue decrease was a decrease in the number of WaveSTAT4 Systems shipped- 6 in 2013 vs. 9 in 2012 coupled with accessories shipped in 2012 of approximately $70,000 vs. no shipments of accessories in 2013. We anticipate that revenue will increase as a result of our distribution agreement with PENTAX.

 

Cost of Revenue

 

Cost of revenue for the nine months ended September 30, 2013 decreased $167,974, 60.4%, to $110,269 compared to $278,243 for the nine months ended September 30, 2012. The primary reason for the cost of revenue decrease was the reduction in revenue discussed above.

 

Research and Development Expenses

 

Research and development expenses decreased by $465,600, 51.4%, to $440,086 for the nine months ended September 30, 2013 from $905,686 for the nine months ended September 30, 2012. This decrease was primarily due to a reduction in engineering development costs of approximately $253,000, a decrease in payroll expense of approximately $151,000 and a reduction in clinical studies of approximately $58,000. We anticipate that development costs will remain low but that clinical costs will increase as we proceed with our introduction of the WaveSTAT4 in Europe.

 

General and Administrative Expenses

 

General and administrative expenses decreased by $209.276, 12.0%, to $1,527,780 for the nine months ended September 30, 2013 from $1,737,056 for the nine months ended September 30, 2012. The primary reason for the decrease was a decrease in investor relations costs of approximately $100,000 and a decrease in depreciation and amortization expenses of approximately $110,000. We anticipate that general and administrative expenses will increase as we increase our activity in Europe.

 

23
 

 

Sales and Marketing Expenses

 

Sales and marketing expenses decreased by $147,570, 42.4%, to $200,355 for the nine months ended September 30, 2013 from $347,925 for the nine months ended September 30, 2012. The primary reason for the decrease was a decrease in payroll costs of approximately $59,000, a decrease in consulting costs of approximately $25,000 and a reduction in trade show and related costs of approximately $49,000. We anticipate that sales and marketing expenses will increase as we increase our activity in Europe.

 

Other Expense

 

Other expense for the nine months ended September 30, 2013 was expense of $1,011,170 compared to expense of $6,737,353 for the nine months ended September 30, 2012. This change was due primarily to the change in valuation of our derivative liabilities. We anticipate continued large fluctuations in other expense (income) as a result of quarterly re-evaluating these obligations.

 

24
 

 

Liquidity and Capital Resources

 

    As of     Increase  
    September 30, 2013     December 31, 2012     (Decrease)  
Working Capital                        
                         
Current assets   $ 657,534     $ 648,948     $ 8,586  
Current liabilities     5,801,575       3,989,735       1,811,840  
Working capital deficit   $ (5,144,041 )   $ (3,340,787 )   $ 1,803,254  
                         
Long-term debt   $ -     $ -     $ -  
                         
Stockholders' deficit   $ (3,557,370 )   $ (1,576,408 )   $ 1,980,962  

 

    Nine Months Ended September 30,     Increase  
    2013     2012     (Decrease)  
Statements of Cash Flows Select Information                  
                   
Net cash provided (used) by:                        
Operating activities   $ (1,079,243 )   $ (2,389,033 )   $ (1,309,790 )
Investing activities   $ (1,600 )   $ (4,170 )   $ (2,570 )
Financing activities   $ 1,229,136     $ 2,207,998     $ (978,862 )

 

    As of     Increase  
    September 30, 2013     December 31, 2012     (Decrease)  
Balance Sheet Select Information                        
                         
Cash   $ 238,485     $ 90,192     $ 148,293  
                         
Accounts receivable   $ 30,000     $ -     $ 30,000  
                         
Inventories   $ 120,642     $ 202,077     $ (81,435 )
                         
Accounts payable and accrued expenses   $ 1,480,711     $ 1,045,553     $ 435,158  

 

Historically, the Company’s sources of cash have come from the issuance and sales of equity securities and convertible debentures. The Company’s historical cash outflows have been primarily used for operating activities including research, development, administrative and sales activities. Fluctuations in the Company’s working capital due to timing differences of its cash receipts and cash disbursements also impact its cash flow. The Company expects to incur significant additional operating losses through at least the end of 2013, as it completes proof-of-concept trials, conducts outcome-based clinical studies and increases sales and marketing efforts to commercialize the WavSTAT4 Systems in Europe. If the Company does not receive sufficient funding, there is substantial doubt that the Company will be able to continue as a going concern. The Company may incur unknown expenses or may not be able to meet its revenue forecast, and one or more of these circumstances would require the Company to seek additional capital. The Company may not be able to obtain equity capital or debt funding on terms that are acceptable. Even if the Company receives additional funding, such proceeds may not be sufficient to allow the Company to sustain operations until it becomes profitable and begins to generate positive cash flows from operations.

 

25
 

 

As of September 30, 2013, the Company had a working capital deficit of $5,144,041 and cash and cash equivalents of $238,485, compared to a working capital deficit of $3,340,787 and cash and cash equivalents of $90,192 as of December 31, 2012. In December 2011, the Company entered into an Engagement Agreement with Laidlaw & Company (UK) Ltd., which Engagement Agreement was amended in July 2012. Under the Engagement Agreement, Laidlaw agreed to assist the Company in raising up to $20.0 million in capital over a two year period from the date of the Engagement Agreement. During the nine months ended September 30, 2013, the Company raised $692,560, net of transaction costs, under this agreement. Subsequent to June 30, 2013, the Company has engaged another agent to assist it with raising capital and has commenced raising capital on its own. During the quarter ended September 30, 2013, The Company raised $466,576, net of transaction costs, under this agreement. However, if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined in the Engagement Agreement occur as expected, such proceeds will be sufficient to allow the Company to sustain operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be able to meet its revenue expectations requiring it to seek additional capital. In such event, the Company may not be able to find capital or raise capital or debt on terms that are acceptable.

 

Off-Balance Sheet Arrangements

 

We have no off-balance sheet arrangements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Not required

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Report (the “Evaluation Date”).  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective as of the Evaluation Date.

 

Changes in Internal Financial Controls

 

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s most recently completed quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

26
 

 

PART II OTHER INFORMATION

 

Item 1. Legal Proceedings

 

None

 

Item 1A. Risk Factors

 

There have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

During the quarter ended September 30, 2013 we issued the following equity securities:

 

          Number of              
    Date of     Common Shares       Source of        
Common Stock   Issuance     Issued       Payment     Amount  
       9/29/2013       500,000       Cash     $ 9,375  

 

Common Stock Purchase Warrants   Date of                  
Issued With Convertible Debentures   Issuance     Number of Shares     Exercise Price     Expiration Date
      7/15/2013       91,853     $ 0.0745     7/15/2018
      9/3/2013       2,923,977     $ 0.0900     9/3/2018
      9/9/2013       2,923,977     $ 0.0900     9/9/2018
      9/15/2013       504,716     $ 0.0900     9/15/2018

 

With respect to the above equity securities issuances, the Company relied on exemptions provided by Sections 4(a)(2) and 3(a)9 of the Securities Act of 1933, as amended (the “Securities Act”). No advertising or general solicitation was employed in offering the securities. The securities were issued to a limited number of persons all of whom were accredited investors as that term is defined in Rule 501 of Regulation D under the Securities Act. All were capable of analyzing the merits and risks of their investment, acknowledged in writing that they were acquiring the securities for investment and not with a view toward distribution or resale, and understood the speculative nature of their investment. All securities issued contained a restrictive legend prohibiting transfer of the shares except in accordance with federal securities laws.

 

Item 3. Defaults Upon Senior Securities

 

As of April 18, 2014 there are 5% Original Issue Discount Unsecured Convertible Debentures with a face value of $1,588,733 held by 32 individual Holders in default. As a result, the outstanding principal amount of these Debentures, plus accrued but unpaid interest, liquidated damages and other amounts owing (estimated to be approximately $75,000) shall become immediately due and payable in cash at the election of the Holders. As of April 18, 2014, none of the Holders of these Debentures have elected to provide notice of default.

 

27
 

 

Item 4. Mine Safety Disclosures

 

None

 

Item 5. Other Information

 

None

 

Item 6. Exhibits

 

31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

 

32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

101* Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended September 30, 2013, formatted in XBRL; (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statement of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements.

  

* Furnished herewith

 

28
 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

SpectraScience, Inc.

(Registrant)

   
Date: April 18, 2014 /s/ Michael P. Oliver
  Michael P. Oliver
  President and Chief Executive Officer
  (Principal executive officer)
   
Date: April 18, 2014 /s/ Lowell W. Giffhorn
  Lowell W. Giffhorn
  Chief Financial Officer
  (Principal financial officer and
principal accounting officer)

 

29

 

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