UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K 

 

S	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended: DECEMBER 31, 2014
£	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______________ to ______________

 

Commission File Number: 0-13092

 

SPECTRASCIENCE, INC.

(Exact name of registrant as specified in its charter)

 

 

MINNESOTA	41-1448837
(State of incorporation)	(I.R.S Employer Identification No.)

 

 

11568-11 Sorrento Valley Road, San Diego, CA	92121
(Address of principal executive offices)	(Zip code)

 

 

 

Registrant’s telephone number: (858) 847-0200

 

Securities registered under Section 12(b) of the Exchange Act: NONE

 

Securities registered under Section 12(g) of the Exchange Act:

COMMON STOCK, $0.01 PAR VALUE

(Title of Class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes             £             No              S  

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.

 

Yes             £             No              S

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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            S             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 registrant was required to submit and post such files).

 

Yes            S             No              £

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

 

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  S

 

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

 

Yes             £             No              S  

 

The aggregate market value of the voting Common Stock held by non-affiliates, computed by reference to the price at which the voting Common Stock was sold as of the last business day of the Company’s most recently completed second fiscal quarter is $9,466,000.

 

As of March 20, 2015 the number of outstanding shares of the registrant’s Common Stock, par value $0.01 per share, was 194,355,277.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None. 

 

 

 

SPECTRASCIENCE, INC.

 

FORM 10-K

For the Fiscal Year Ended December 31, 2014

 

TABLE OF CONTENTS

 

	Page
PART I
Item 1. Business	5
Item 1A. Risk Factors	16
Item 1B. Unresolved Staff Comments	22
Item 2. Properties	22
Item 3. Legal Proceedings	22
Item 4. Mine Safety Disclosures	22
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	22
Item 6. Selected Financial Data	23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations	23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk	30
Item 8. Financial Statements and Supplementary Data	30
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	57
Item 9A. Controls and Procedures	57
Item 9B. Other Information	57
PART III
Item 10. Directors, Executive Officers and Corporate Governance	58
Item 11. Executive Compensation	61
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters	63
Item 13. Certain Relationships and Related Transactions, and Director Independence	65
Item 14. Principal Accounting Fees and Services	66

 

  

PART IV
Item 15. Exhibits and Financial Statement Schedules	67
SIGNATURES	68

 

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Annual Report on Form 10-K constitute "forward-looking statements". These statements, identified by words such as “plan”, "anticipate", "believe", "estimate", "should," "expect" and similar expressions include our expectations and objectives regarding our future financial position, operating results and business strategy. These statements reflect the current views of management with respect to future events and are subject to risks, uncertainties and other factors that may cause our actual results, performance or achievements, or industry results, to be materially different from those described in the forward-looking statements. Such risks and uncertainties include those set forth under the caption "Risk Factors" and elsewhere in this Form 10-K. We advise you to carefully review the reports and documents we file from time to time with the Securities and Exchange Commission (“SEC”), particularly our quarterly reports on Form 10-Q and our current reports on Form 8-K.

As used in this annual report, the terms "we", "us", "our", and “SpectraScience” mean SpectraScience, Inc., unless otherwise indicated.

PART I

 

ITEM 1. BUSINESS.

 

Introduction

 

SpectraScience was incorporated in the State of Minnesota on May 4, 1983 as GV Medical, Inc. In October 1992, GV Medical changed its name to SpectraScience, Inc. The Company focuses on developing its WavSTAT ^® Optical Biopsy System (“WavSTAT”). The WavSTAT employs a non-significant risk technology that optically illuminates tissue in real-time to distinguish between normal and pre-cancerous or cancerous tissue.

 

Our principal executive offices are located at 11568 Sorrento Valley Rd., Suite 11, San Diego, CA 92121. You can reach us by telephone at (858) 847-0200; by fax at (858) 847-0880; or by email at info@spectrascience.com. Our website address is www.spectrascience.com. The information contained on our web site is not deemed to be a part of this document.

 

Acquisition of Luma Imaging Corporation Assets

 

On November 6, 2007, the Company acquired 100% of the shares of LUMA Imaging Corporation (“LUMA”) from LUMA’s shareholders in consideration for 11.2 million restricted shares of SpectraScience common stock.

 

LUMA had developed and received approval from the U.S. Food and Drug Administration (the “FDA”) for an optical, non-invasive diagnostic imaging system that was proven to more effectively detect cervical cancer precursors than using conventional means alone (i.e. colposcopy). During the fiscal year ended December 31, 2010, the Company wrote off the remaining fair value of LUMA inventory in order to focus on the continued development and marketing of the WavSTAT. The Company retained the intellectual property of LUMA for use in the development of future generations of the WavSTAT System, in particular as it relates to the development of optical detection technology. The intellectual property consisted of a total of approximately 30 issued U.S. patents, certain foreign patents and 28 additional patent applications.

 

 

  

Products and Markets

 

SpectraScience has developed a technology platform to instantly determine if tissue is normal, pre-cancerous or cancerous, without the need for a physical biopsy. The Company received FDA approval to market its

 

The WavSTAT4 Optical Biopsy System operates by using cool, safe UV 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. The WavSTAT4 uses laser-induced auto-fluorescence to obtain spectral information from tissue at the suspected site. The system is classified as a non-significant risk device which transmits low-level UV laser light energy through an optical fiber to the tissue via the working channel of an endoscope. The tissue in contact with the optical fiber absorbs the light and the resulting tissue auto-fluorescence spectra is collected by the same optical fiber and returned to a detector within the WavSTAT4 console for processing. The system analyzes the spectral data and displays the results graphically for the user as normal tissue (green light), suspected pre-cancerous tissue, or cancerous tissue (red light). Data are recorded and saved redundantly in both flash memory and on a hard drive within the system. The WavSTAT4 has been tested at leading medical centers with results demonstrating statistically significant improvement in physician accuracy in the ability to detect pre-cancerous and cancerous tissue during endoscopy.

 

The WavSTAT Optical Biopsy System was specifically designed to serve as a technology platform to facilitate multiple medical applications for cancer diagnosis. We see additional opportunities for this core technology in esophageal cancer and in several other large as-yet-unexplored markets which include lung, skin, stomach, prostate and bladder cancer diagnosis. The Company is currently exploring these additional applications of its platform for these markets, and is analyzing feasibility of the use of its technology and the revenue opportunity for each market.

 

Colorectal Cancer

 

The American Cancer Society reports colorectal cancer as the third most common cancer diagnosed in the U.S. with approximately 140,000 new cases annually. With an estimated 50,000 deaths annually, colorectal cancer is second only to lung cancer as the leading cause of cancer death in the United States. Candidates for colorectal cancer screening include all persons, with or without symptoms, over the age of 50 (or an estimated 80-90 million people in the U.S.) with the screening market expected to increase 20% over the next ten years. Demographic trends in Europe are very similar.

 

Colorectal cancer is primarily diagnosed through the discovery and histo-pathologic analysis of polyps. Colon polyps are small masses of tissue found in the lining of the colon that may be either benign or malignant. The most commonly performed and generally accepted colorectal cancer screening procedure to detect polyps is an endoscopy of the colon, known as a colonoscopy. According to the American Society for Gastrointestinal Endoscopy guidelines for colorectal cancer screening, large polyps (greater than 1 centimeter) are generally removed as a matter of course and sent to pathology for evaluation. On the other hand, the guidelines further state that small polyps (less than 1 centimeter which account for approximately 85% of all polyps) require, “individualized treatment on a case by case basis”. The clinical utility of the WavSTAT4 occurs when the physician must decide the best course of treatment for small polyps. When small polyps are found, it is left to the physician's discretion based primarily on visual assessment, whether to remove the polyp, place the patient under surveillance, or to perform a physical biopsy. If a biopsy is performed and cancer or pre-cancer is documented by pathology, the polyp must then be removed. Historically in this context, approximately 70% of the physical biopsies taken are determined to be benign. The WavSTAT4 can significantly reduce the procedure cost and attendant complication rates by immediately classifying these polyps as benign without the need for removal and subsequent pathology. The WavSTAT4 was specifically designed to be used during colonoscopy to aid and improve the physician's ability to identify small polyps as normal, pre-cancerous or cancerous tissue in real time.

 

Relative to colorectal cancer, five-year survival rates as reported by the American Cancer Society are as follows:

 

 

			Approximately 90% of patients live five years or longer if the cancer is detected and treated at an early stage;
			Only 70% of patients live five years or longer if the cancer spreads outside the polyp and colon to nearby organs or lymph nodes; and
			The five-year survival rate for those patients in whom the cancer has spread further to the liver or other organs is only 12%.

   

Early detection of colorectal cancer is essential to long-term survival. Unfortunately, the American Cancer Society reports that only 39% of colorectal cancers are detected at an early stage. Clinical studies indicate that colorectal cancer screening procedures result in earlier detection and can prevent as many as 20 to 40% of potential colorectal cancers and subsequently reduce colorectal cancer deaths by 30 to 50%. Colorectal screening procedures not only save lives, they also save money. If a patient is not diagnosed until symptoms develop and the disease has spread, or if misdiagnosed at an early stage, the chance of patient survival plummets and more advanced treatment regimens such as surgery, chemotherapy and/or radiation become necessary.

  

Based on the results demonstrated by our own clinical studies, we believe that using the WavSTAT will:

 

			Significantly improve the physician's diagnostic accuracy in determining whether small polyps in the colon are pre-cancerous or cancerous;
			Improve patient survival rates by earlier detection and treatment of cancers, and more importantly pre-cancers, by more accurately identifying cancers or pre-cancers the physician may misdiagnose;
			Improve the patient's quality of life by providing an immediate analysis of the tissue, thereby eliminating the anxiety of waiting several days to hear the pathology results;
			Enable the physician to diagnose and treat the patient during the same endoscopy procedure with the same biopsy instrument, thereby potentially reducing the need for scheduling a second expensive endoscopy for treatment purposes;
			Significantly reduce the number of physical biopsies performed and reduce the number of unnecessary follow-on endoscopies performed; and
			Reduce the number of misdiagnosed patients, thereby eliminating the need for more costly advanced treatments such as surgery, chemotherapy and/or radiation.

  

Esophageal Cancer

 

Barrett’s esophagus is a condition of the lining of the lower esophagus thought to be caused primarily by Gastro Esophageal Reflux Disease (“GERD”), more commonly known as chronic heartburn. Barrett’s esophagus is considered to be a pre-malignant stage and a precursor to esophageal cancer. Physicians typically recommend that persons with chronic heartburn should have an endoscopy to look for Barrett’s esophagus. Some Barrett’s esophagus patients will advance further to a stage where additional abnormal tissue called dysplasia is present. Dysplasia is known to be the next progressive step toward esophageal cancer and is categorized as either low-grade or high-grade.

  

Barrett’s esophagus, dysplasia and esophageal cancer patients are presently diagnosed via endoscopy of the esophagus with the physician taking multiple random physical biopsies of the esophageal lining; this is a significantly invasive procedure. It is critical that high-grade dysplasia is correctly diagnosed because physicians frequently recommend surgical resection, radio frequency ablation or removal of the esophagus in such an event.

 

 

 Unfortunately, dysplasia is difficult to find and/or diagnose because it is not reliably visible to the physician during standard endoscopy. The result is that physical biopsies (as many as 20 at once) are performed either randomly or in a geometric pattern in the esophagus in the hope of finding any diseased tissue. Current medical practice typically follows the guidelines described below:

 

			Patients with chronic GERD (severe heartburn) receive a screening endoscopy of the esophagus with multiple biopsies to check for Barrett's esophagus;
			Patients with Barrett's esophagus receive an endoscopy with multiple biopsies every year to check for dysplasia;
			Patients with Barrett's esophagus that has progressed to include low-grade dysplasia receive an endoscopy with multiple biopsies every six months to check for high-grade dysplasia; and
			Patients with Barrett's esophagus that has progressed to include high-grade dysplasia receive an endoscopy with multiple biopsies every three months to check for cancer and/or may be referred for esophageal surgical resection, photodynamic therapy or electrical (“RF”) ablation.

 

The relatively high death rate associated with esophageal cancer typically results from a lack of early diagnosis with the outcome being that the cancer has grown to an advanced stage. As described above, the frequency of endoscopic surveillance for these patients increases as the pre-cancerous stages advance in hopes of providing the earliest possible diagnosis.

 

Government Regulation

 

United States

 

Extensive government regulation, both in the United States and internationally, controls the design, manufacture, labeling, distribution and marketing of our products, particularly regarding product safety and effectiveness. In the United States, medical devices are subject to review and clearance or approval by the FDA. The FDA regulates the clinical testing, manufacture, labeling, distribution and promotion of medical devices. If we fail to comply with applicable requirements prior to marketing the WavSTAT4 in the United States, we could face:

 

			fines, injunctions or civil penalties;
			recall or seizure of our products;
			criminal prosecution;
			a recommendation that we not be allowed to contract with the government;
			total or partial suspension of production;
			inability to obtain pre-market clearance/approval for our devices; and
			withdrawal of marketing approvals.

  

The Food, Drug, and Cosmetic Act, the Public Health Service Act, and Safe Medical Devices Act of 1990 and other federal statutes and regulations also govern or influence the testing, manufacture, safety, labeling, storage, recordkeeping, clearance, advertising and promotion of such products.

 

In the United States, medical devices are assigned to one of three classes depending on the controls the FDA deems necessary to ensure the safety and effectiveness of the device. The WavSTAT4 is a Class III device; this is FDA’s most highly regulated category in the Center for Devices and Radiological Health (“CDRH”) guidelines. In addition to adhering to general controls to which all medical devices are subject, and special controls such as performance standards, post-market surveillance and patient registries, a Class III device must receive pre-marketing approval to ensure its safety and effectiveness prior to commercialization. The Company is in the process of obtaining this approval for the WavSTAT4 in the United States.

 

  

FDA approval to distribute regulated devices can be obtained in one of two ways. If a new or significantly modified device is “substantially equivalent” to an existing legally marketed device, the new device can be commercially introduced after filing a 510(k) pre-market notification with the FDA and the subsequent issuance by the FDA of an order permitting commercial distribution. Changes to existing devices that do not significantly affect safety or effectiveness may be made without an additional 510(k) notification. We received 510(k) clearance from the FDA for our disposable and reusable Optical Biopsy Forceps in December 1996.

 

A second, more comprehensive approval process applies to a Class III device that is not substantially equivalent to an existing product. First, the applicant must conduct clinical trials in compliance with testing protocols and patient “informed consent” forms approved by an Institutional Review Board (“IRB” or the “Safety Committee”) at each participating research institution. These boards oversee and approve all clinical studies at their institutions (in some cases a central IRB may approve studies at multiple locations). Second, a Pre-Market Approval (“PMA”) application must be submitted to the FDA describing (i) the clinical trial results, (ii) the device and its components, (iii) the methods, facilities and controls used for manufacture of the device, (iv) proposed labeling and advertising literature, and (v) the demonstration that the product is safe and effective.

 

If the FDA determines, upon receipt of the PMA application, that the application is sufficiently complete to permit a substantive review, they will accept the application for filing. Review of a PMA typically takes from six months to two years from the date the application is accepted for filing, but can take longer. Often, during the review period, a panel primarily composed of clinicians and acting as an advisory committee will be convened to review, evaluate, and provide non-binding recommendations to the FDA as to whether the device should be approved. Toward the end of the application review process, the FDA generally will conduct an inspection of the manufacturer’s facilities to ensure that the facilities are compliant with the applicable Quality System Regulations requirements.

 

If FDA evaluations of both the PMA application and the manufacturing facilities are favorable, the FDA will issue either an approval letter or a conditional approval letter that contains a number of conditions that must be satisfied in order to secure final approval of the PMA application. When and if those conditions are fulfilled to the satisfaction of the FDA, they will issue an approval letter, authorizing commercial marketing of the device for certain indications for use. If the FDA’s evaluation of the PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the application or issue a “not approvable letter.” The FDA may also determine that additional clinical trials are necessary, in which case pre-market approval could be delayed for several years while additional clinical trials are conducted and submitted in an amendment to the PMA application. The pre-market approval process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought have never been approved for marketing.

 

Any products manufactured or distributed pursuant to FDA clearances or approvals, are subject to pervasive and continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences when using the product.

 

Device manufacturers are required to register their establishments and list their devices with the FDA and certain state agencies, and are subject to periodic inspections. The Food, Drug, and Cosmetic Act requires devices to be manufactured in accordance with Quality System Requirements regulations, which impose procedural and documentation requirements upon a manufacturer and any of its contract manufacturers with respect to manufacturing and quality assurance activities. The frequency and depth of inspections of PMA products are generally more detailed and frequent than products cleared in the 510(k) process. The past two inspections by the FDA did not result in any adverse findings. Quality System Requirements regulations also require design controls and maintenance of service records. Changes in existing requirements or adoption or new requirements or policies could adversely affect our ability to comply with regulatory requirements. Failure to comply with regulatory requirements could have a material adverse effect on our business, financial condition or results of operations.

 

  

The Company submitted a PMA for market clearance of the WavSTAT Optical Biopsy System for use during endoscopic screening of the colon in September 1998, and was approved by the FDA in November 2000. Based upon beta site outcome clinical studies, features were added to the WavSTAT, and submitted as a supplement to the original filing in September 2001. The supplement for the WavSTAT2 was approved by the FDA in November 2001. The Company submitted a supplement for approval of WavSTAT3 in February 2002 and approval was received in August 2002. We anticipate, but do not know for certain, that product improvements requiring approval, or any new applications, such as for the WavSTAT4 will be submitted as supplements to the original filing rather than as original PMA filings.

 

We are also subject to numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and disposal of hazardous or potentially hazardous substances. We are not aware of any manufacturing methods for the WavSTAT4 Systems that will require extensive or costly compliance with environmental regulations. However, since laws change over time there can be no assurance that (i) we will not be required to incur significant costs to comply with all applicable laws and regulations in the future, or (ii) the impact of changes in those laws or regulations or adoption of new laws and regulations will not have a material adverse effect upon our ability to do business. 

 

European Union and Other Countries

 

The European Union encompasses most of the major countries in Europe. The European Union has adopted numerous directives and standards regulating the design, manufacture, clinical trial, labeling, and adverse event reporting for medical devices. The principal directive prescribing the laws and regulations pertaining to medical devices in the European Union is the Medical Devices Directive, 93/42/EEC.

 

Devices that comply with the requirements of the Medical Devices Directive and applicable International Standards Organization (ISO) standards are entitled to bear the CE mark. SpectraScience compliance has been confirmed by our Notified Body to market and sell our medical device products in the European Union. Generally, companies must go through the ISO certification process in order to obtain the CE mark. SpectraScience has held the appropriate ISO certifications since July 2000, and the CE mark authorization followed in October 2000. In order to maintain this certification SpectraScience undergoes a yearly audit by our Notified Body. Our last audit was in 2014, when we confirmed both the certification for ISO 9001 and EN 13485:2003, which is the medical device adaptation of the ISO 9001 standard. There can be no assurance that we will be able to maintain international certification or CE mark authorization for our products or product components. Furthermore, even though a device bears the CE Mark, practical complications may arise with respect to market introduction because of differences among countries in areas such as labeling requirements and reimbursement practices. We may be required to spend significant amounts of capital in order to comply with the various regulatory requirements of foreign countries and achieve reasonable payment for our products.

 

Product Research and Development

 

The Company invested significant capital in research and development for the fiscal years ended December 31, 2014 and 2013 as continued improvements were made to the WavSTAT4 Optical Biopsy System. Research and development expenses were approximately $843,000 and $644,000 for the fiscal years ended December 31, 2014 and 2013, respectively.

 

Compliance with Environmental Laws

 

Management has reviewed the cost of compliance with environmental laws and deemed the cost of such compliance to be immaterial for the fiscal year ended December 31, 2014.

 

Distribution and Sales

 

Our objective is to become a leader in the development and commercialization of advanced minimally-invasive diagnostic products with the capability to differentiate in real-time between healthy, and pre-cancerous or cancerous tissue. During 2014, our sales and marketing efforts have been, and will continue to be focused on marketing the WavSTAT4 System in the colorectal diagnostic market. The WavSTAT4 represents a significant redesign and improvement over previous WavSTATs and the WavSTAT4 was completed and available to market in December 2011. We envision particular emphasis on selling the WavSTAT System in international markets and in June 2012 the Company entered into a distribution agreement with PENTAX Europe GmbH (“PENTAX”), for the sale of the WavSTAT in international markets.

 

 

 

During the fiscal year ended December 2013, the Company sold to PENTAX $240,000 of mobile consoles and disposable forceps. PENTAX continues to be a distributor on a non-exclusive basis. We are exploring other distribution channels to develop marketing programs and sell the WavSTAT in the EU. A precondition to broad sales adoption in the major markets of Europe is the completion of a series of marketing evaluations in each of these major markets conducted by key opinion leaders. These evaluations are required to obtain widespread adoption of the WavSTAT System in each European country. We are conducting these multi-national, multi-center studies in order to provide current clinical results and validate economic impact. These evaluations combine both the aspects of clinical efficacy as well as economic impact and are critical data points. During 2015 our focus will be on moving these evaluations to completion.

Approximate sales by principal geographic area (as a percentage of sales) for fiscal years ended December 31, 2014 and 2013 were as follows:

			2014			2013
Domestic sales			—	%		—	%
Foreign sales:
Europe			—			100.0
Total foreign sales			—			100.0
Total sales			—	%		100.0	%

 

Major Customer

During the two years ended December 31, 2014 and 2013, we had sales to the following customer which represented greater than 10% of our annual revenue:

			December 31,
			2014			2013
PENTAX		$	—		$	240,000

The loss of this major customer, unless replaced by similar customers, could have a material adverse effect on our operations and our ability to generate income.

Third-Party Reimbursement

 

If and when the Company secures FDA approval, we expect to market and sell the WavSTAT4 System primarily through managed care hospitals and clinics. In the United States, the purchasers of medical devices generally rely on Medicare, Medicaid, private health insurance plans, health maintenance organizations and other sources of third party reimbursement for health care costs, to reimburse all or part of the cost of medical devices and/or the procedure in which the devices are used. Significant sales of our products will, in part, be dependent on the availability of adequate reimbursement from these third party payers for procedures carried out using our products. We believe that less invasive procedures generally provide less costly overall therapies compared to conventional drugs, surgery and other treatments. We anticipate hospital administrators and physicians will justify the use of our products by the cost and time saving recognized and clinical benefits that we believe will be derived from the use of our products.

 

 

  

Third party payers determine whether to provide coverage for a particular procedure and reimburse health care providers for medical treatment at a fixed rate based on the diagnosis-related group established by the Center for Medicare and Medicaid Services. The fixed rate of reimbursement is based on the procedure performed and is unrelated to the specific type or number of devices used in a procedure. If a diagnosis-related group does not cover a procedure, payers may deny reimbursement. If reimbursement for a particular procedure is approved, third party payers will reimburse health care providers for medical treatment based on a variety of methods, including a lump sum prospective payment system based on a diagnosis-related group or per diem, a blend between the health care provider’s reported costs and a fee schedule, a payment for all or a portion of charges deemed reasonable and customary, or a negotiated per capita fixed payment.

 

Upon product introduction, currently existing available codes can be used to provide a level of reimbursement to users. Management believes however, that currently available reimbursement codes do not adequately reimburse for the anticipated value that optical biopsy technology brings to the medical care system. Optical biopsies in the lower gastrointestinal tract are not currently approved for reimbursement by third-party payers, and there can be no assurance that optical biopsy technology will be approved for any third party reimbursement for use in colorectal cancer screening, even if it proves to play a significant role in improving the endoscopist’s ability to accurately differentiate among polyps in the colon. Recently, a reimbursement code for optical biopsy in the upper gastrointestinal tract (esophagus) was approved, evidence that healthcare providers are accepting this minimally-invasive approach.

 

Demonstrating cost-effectiveness and improved patient outcomes is critical to increasing sales since payers evaluate these factors in determining whether to reimburse for new technologies. Payers may also delay reimbursement decisions for a year or more, even when provided with cost-effectiveness data, while they conduct their own technology assessments. The availability of peer-reviewed literature regarding the technology may help payers in reducing this technology assessment timeline. To promote the dissemination of literature regarding the WavSTAT4 optical biopsy technology, we are working to have published clinical utility and cost/benefit data in peer-reviewed journals.

 

We expect that there will be continued pressure on cost-containment throughout the United States health care system. Cost reduction, cost containment, managed care, and capitation pricing (putting a ceiling on price) are ever more familiar themes within health care. Limits on third-party reimbursements that lead to cuts in reimbursements for new or experimental procedures would affect the ability of smaller companies with new technologies to compete with larger established firms or with established technologies. Lobbying activities are often necessary to broadly introduce these new technologies, but lobbying requires extensive amounts of corporate resources that the Company may not be able to afford.

 

Reimbursement systems in international markets vary by country, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government managed health care systems that control reimbursement for new products and procedures. In most markets, there are private insurance systems as well as government-managed systems. Market acceptance of our products will depend on the availability and level of reimbursement in our targeted international markets. We may not be able to obtain reimbursement in any country within a particular time, for a particular time, for a particular amount, or at all.

 

We are unable to predict what additional legislation or regulation relating to the health care industry or third-party coverage and reimbursement may be enacted in the future, if any, or what effect it might have on us. In particular, we are unable to yet predict the impact that health care reform legislation will have on our business. Reforms include (i) mandated basic health care benefits, (ii) controls on health care spending through limitations on the growth of private health insurance premiums and Medicare and Medicaid spending, (iii) greater reliance on prospective payment systems, (iv) the creation of large insurance purchasing groups, and (v) fundamental changes to the health care delivery system. Management anticipates that Congress and state legislatures will continue to review and assess alternative health care delivery systems and payment mechanisms. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, we cannot predict which reform proposals, if any, will be adopted, when they may be adopted or what impact they may have on us. Failure by hospitals and other users of our products to obtain reimbursement from third-party payers, or changes in government and private third-party payers’ policies toward reimbursement for procedures employing our products, could have a material adverse effect on our business, financial condition and results of operations.

 

  

Manufacturing and Sources of Supply

 

SpectraScience manufactures the WavSTAT4 System at its facility in San Diego. The disposable WavSTAT optical biopsy forceps (one required for each patient) are outsourced to United States contract OEM manufacturers. The Company also performs certain final assembly processes of the WavSTAT forceps. All WavSTAT Systems previously used for pre-clinical testing, FDA compliant clinical trials, and cost effectiveness/outcome clinical studies were manufactured under a Quality System with Standard Operating Procedure controls. Management continues to utilize these quality control systems and adds to or modifies them as necessary. The Company is currently evaluating secondary procurement sources for its products. 

 

The WavSTAT4 Systems are, and will be, manufactured in accordance with current FDA Quality System Regulations and ISO 9001 International Standards, both of which are necessary to sell products within the United States and the European Union. These requirements impose certain procedural and documentation requirements upon SpectraScience with respect to manufacturing and quality assurance activities, as well as upon those third parties with whom the Company contracts to perform certain manufacturing processes.

During 2007, SpectraScience was granted ISO 9001 and 13485:2003 certification for its manufacturing facility and Quality System. These international standards are the European equivalent to the FDA’s Quality System Regulations. Meeting these standards permits use of the CE mark to export the WavSTAT4 Optical Biopsy System to the European Union.

 

The FDA has reviewed the manufacturing processes and Standard Operating Procedures required to build a WavSTAT System and we are authorized to manufacture the product in our current facility.   Both the FDA and the European Notified Body will continue to perform periodic audits as long as SpectraScience manufactures and commercializes medical products.

  

Competition

 

The medical device industry is highly competitive. Management believes the Company has few direct competitors in applying spectroscopy for the differentiation of normal, pre-cancerous or cancerous tissues in the gastrointestinal tract; however, the development of products using spectroscopic diagnostics for various medical specialties is expanding. To the best of our knowledge, no other competitors have completed FDA clinical studies or submitted a pre-market approval application to the FDA or received CE Mark authority to distribute a product for the detection of colorectal or esophageal cancer.

 

Many competitors have substantially greater resources than we do, either internally or in combination with strategic partners. These resources may allow them to develop, market and distribute technologies or products that could be more effective than those developed or marketed by us, or that would render our technologies and products obsolete. The resource advantages they may have are:

 

			greater capital resources;
			greater manufacturing resources;
			greater resources and expertise in testing products in clinical trials;
			greater resources and expertise in the areas of research and development;
			greater expertise in obtaining regulatory approvals; and
			greater resources for marketing and sales activities.

 

  

The companies listed below have developed or are in the process of developing products that use light-based spectroscopic technology or similar methods. These companies compete with and could potentially compete with SpectraScience products or technologies. However, none of these companies use a technology or method which is the same as that used by SpectraScience and only one has commercialized a diagnostic application (Mela Sciences, Inc. for skin cancer) that does not require image analysis and physician interpretation.

 

Competitors

 

There are a number of companies with products or developing products that may directly or indirectly compete with our products. Among these companies are Olympus Corporation, Tokyo, Japan; PENTAX, a division of HOYA Corporation, Tokyo, Japan; Fujifilm Corporation, Tokyo, Japan; Mauna Kea Technologies, Paris France; MELA Sciences, Inc. Irvington, NY; Caliber ID, Rochester, NY; Verisante Technology, Inc., Vancouver, British Columbia; Guided Therapeutics, Inc., Norcross, Georgia; OncoScope, Inc., Durham, North Carolina; and NinePoint Medical, Inc., Cambridge, Massachusetts. Many of these companies have significantly greater resources than we do. In addition, there are other smaller potential competitors working on light-based technologies for detection and diagnosis and several academic centers conducting research.

 Patents

 

SpectraScience currently owns exclusive rights to a total of 34 issued U.S. utility patents, seven U.S. design patents and approximately 25 foreign counterpart patents. Our most recent patent grant was in August 2012 and we continue to apply for patents to expand and strengthen our intellectual property portfolio. Our U.S. patents are listed below:

 

			U.S. Patent
Patent Name			Number
Optical Biopsy Forceps			5,762,613
System for Diagnosing Tissue with Guidewire			5,601,087
Method of Diagnosing Tissue with Guidewire			5,439,000
Guidewire Catheter and Apparatus for Diagnostic Imaging			5,383,467
Optical Biopsy Forceps System and Method of Diagnosing Tissue			6,066,102
Optical Biopsy Forceps			6,129,683
Optical Biopsy System and Methods for tissue Diagnosis			6,174,291
Optical Forceps System and Method of Diagnosing and Treating Tissue			6,394,964
Spectral Volume Microprobe Analysis of Materials			5,713,364
Spectral Volume Microprobe Arrays			6,104,945
Spectroscopic System Employing a Plurality of Data Types			6,385,484
Spectral Volume Microprobe Arrays			6,411,835
Systems and Methods for Optical Examination of Samples			6,411,838
Spectral Data Classification of Samples			6,421,553
Optical Methods and Systems for Rapid Screening of the Cervix			6,427,082
Substantially Monostatic, Substantially Confocal Optical Systems for Examination of Samples			6,760,613
Fluorescent Fiberoptic Probe for Tissue Health Discrimination and Method of Use Thereof			6,768,918
Method and Apparatus for Identifying Spectral Artifacts			6,818,903
Spectral Volume for Microprobe Arrays			6,826,422
System for Normalizing Spectra			6,839,661
Optical Probe Accessory Device for Use In-Vivo Diagnostic Procedures			6,847,490
Methods of Monitoring Effects of Chemical Agents on a Sample			6,902,935
Optimal Windows for Obtaining Optical Data for Characterization of Tissue Samples			6,933,154
Methods and Apparatus for Displaying Diagnostic Data			7,136,518
Colonic Polyp Discrimination by Tissue Florescence and Fiberoptic Probe			7,103,401
Optical Methods and Systems for Rapid Screening of the Cervix			7,127,282
Methods and Systems for Correcting Image Misalignment			7,187,810

 

 

Image Processing using Measures of Similarity			7,260,248
Methods and Apparatus for Processing Spectral Data for use in Tissue Characterization			7,282,723
Methods and apparatus for characterization of tissue samples			7,309,867
Fluorescent fiberoptic probe for tissue health discrimination			7,310,547
Methods and Systems for Correcting Image Misalignment			7,406,215
Methods and Apparatus for Calibrating Spectral Data			7,459,696
Unique Methods and Apparatus for Evaluation of Image Focus			7,469,160

 

SpectraScience is also the exclusive licensee through the Massachusetts General Hospital of U.S. Patent 5,843,000 entitled, “Optical Biopsy Forceps and Method of Diagnosing Tissue”. We believe that this patent, in combination with our other optical forceps patents, provides the Company an advantage in marketing biopsy forceps that contain optical fiber. The above patents expire between 2015 and 2022. Each of the international patents designates several countries for patent protection.

 

The Company believes that it holds one of the strongest patent portfolios of its kind in the field of optical methods for the diagnosis and detection of tissue abnormalities, particularly for identifying cancer and its precursors. Management also believes that its intellectual property portfolio will protect the core technology and methods embodied in the WavSTAT4 Optical Biopsy System as well as for many of the Company’s future products and can create a substantial barrier to entry for others pursuing similar approaches.

 

Core Areas of Patent Protection

 

SpectraScience’s portfolio provides protection in the following key technology, design and methods areas:

 

			Localized tissue characterization using optical methods;
			Specific application and combinations of autofluorescence, broadband spectroscopy and video imaging;
			Design and use of disposable components, in combination with systems and methods, including use of unique identifiers;
			Algorithms specific to optical assessment of tissue characteristics, particularly involving identification, classification and calibration methods;
			Clinical applications of these methods and systems for identifying tissue characteristics, including use of display methods, marking methods (including biomarkers) and in combination with treatment; and
			Applications to further future system development, including applications for screening, treatment and other applications beyond colon and esophageal cancer.

 

SpectraScience holds registered trademarks for the WavSTAT System and SpectraScience trade names, and software and graphics are protected by appropriate copyrights. 

 

Our ability to obtain and maintain patent protection for our products, preserve our trade secrets and operate without infringing on the proprietary rights of others will directly affect how successful our operations will be. Our strategy regarding the protection of our proprietary rights and innovations is to seek patents on those portions of our technology that we believe are patentable, and to protect as trade secrets other confidential information and proprietary know-how. SpectraScience is careful to protect its trade secrets and proprietary know-how by obtaining confidentiality and invention assignment agreements in connection with employment, consulting and advisory relationships. There are certain technological aspects of the WavSTAT Systems that are not covered by any patents or patent applications.

 

  

The patent and trade secret positions of medical device companies like SpectraScience are uncertain and involve complex and evolving legal and factual questions. To date, no claims have been brought against the Company alleging that our technology or products infringe intellectual property rights of others. Often, patent and intellectual property disputes in the medical device industry are settled through licensing or similar arrangements. However, necessary licenses from other parties may not be available to us on satisfactory terms, if at all, and the costs associated with such arrangements may be substantial and could include ongoing royalties.

 

United States patent applications are not publicly disclosed until they are issued or corresponding foreign applications are published in other countries. Since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, management cannot be certain that SpectraScience was the first to invent the inventions covered by each of its pending patent applications, or that it was the first to file patent applications for such inventions. In addition, the laws of some foreign countries do not provide the same degree of intellectual property-rights protection as do the laws of the United States. Litigation associated with patent or intellectual property infringement or protection could be lengthy and prohibitively costly. SpectraScience may not have the financial resources to defend its patents from infringement or claims of invalidity, or to successfully defend itself against intellectual property infringement claims by third parties.

 

Product Liability

 

The risk of product liability claims, product recalls and associated adverse publicity is inherent in the manufacturing, marketing and sale of medical products. We have clinical trial liability insurance coverage for our clinical programs however, there can be no assurance that future insurance coverage will be adequate or available. We may not be able to secure product liability insurance coverage on acceptable terms or at reasonable costs when needed. Any liability damages could exceed the amount of our coverage. A successful product liability claim against us could require us to pay a substantial monetary award. Moreover, a product recall could generate substantial negative publicity about our products and business and inhibit or prevent commercialization of other future products.

 

Employees

 

As of March 20, 2015, SpectraScience has five full-time and four part-time employees and consultants, with five involved in manufacturing/engineering, one in sales and marketing and three in finance and administration. The Company’s payroll is administered through an independent third party. SpectraScience is not subject to any collective bargaining agreement and management believes that employee relations are generally satisfactory.

 

SpectraScience also relies on external consultants in the financial, regulatory, software development and design engineering areas. In the future, if management decided to increase our workforce in response to improved economic, market, and/or business conditions, we might not be able to attract or retain employees with the skills we require.

  

ITEM 1A. RISK FACTORS.

 

We describe below a number of uncertainties and risks which, in addition to uncertainties and risks presented elsewhere in this annual report, may adversely affect our business, operating results and financial condition. The uncertainties and risks enumerated below as well as those presented elsewhere in this annual report should be considered carefully in evaluating our company and our business and the value of our securities. 

 

 

RISKS RELATED TO OUR BUSINESS

 

We have a limited operating history with significant losses and expect losses to continue for the foreseeable future.

 

We have yet to establish any history of profitable operations. We have incurred annual operating losses of approximately $2,706,000 and $2,732,000, respectively, during the past two years of operations. As a result, at December 31, 2014 we had an accumulated deficit of approximately $45,864,000. We have incurred net losses from continuing operations of approximately $4,488,000 and $2,750,000 for the years ending December 31, 2014 and 2013, respectively. Our revenues have not been sufficient to sustain our operations and we expect that they will be insufficient to sustain our operations for the foreseeable future. Our failure to generate meaningful revenues and ultimately profits from the WavSTAT System and applications of our technology could and will likely require that we raise additional capital which may not be available or available on acceptable terms. This could ultimately reduce or suspend our operations and ultimately cause us to go out of business. Our profitability will require the successful commercialization of our imaging systems and no assurances can be given when this will occur or if we will ever be profitable.

 

We will require additional financing to sustain our operations and without it, we may not be able to continue operations.

 

At December 31, 2014, we had a working capital deficit of approximately $5,732,000. We had an operating cash flow deficit of approximately $2,442,000 for the year ended December 31, 2014 and an operating cash flow deficit of approximately $1,613,000 in 2013. We may not have sufficient financial resources to fund our operations and will likely require additional funds to continue our operations.

 

We may face intense competition from companies that have greater financial, personnel and research and development resources.

 

Competitive forces may impact our projected growth and ability to generate revenues and profits, which would have a negative impact on our business and the price of our common stock. Our competitors may be developing products that compete with the WavSTAT Systems. Our commercial opportunities would then be reduced or eliminated should our competitors develop and market products for any of the diseases that we target that are more effective or are less expensive than the products or product candidates we are developing.

 

Even if we are successful in developing an effective WavSTAT System, and we obtain FDA and other regulatory approvals necessary for commercialization, our products may not compete effectively with other successful products. Researchers are continually learning more about diseases, which may lead to new technologies and tools for analysis.

 

Our competitors include fully integrated medical device companies, universities and public and private research institutions. Many of the organizations competing with us may have substantially greater capital resources, larger research and development staffs and facilities, greater experience in product development and in obtaining regulatory approvals, and greater marketing capabilities than we do.

 

The market for medical devices is intensely competitive. Many of our potential competitors have longer operating histories, greater name recognition, more employees, and significantly greater financial, technical, marketing, public relations, and distribution resources than we have. This intense competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to develop, maintain and extend our current technology. Price concessions or the emergence of other pricing or distribution strategies of competitors may diminish our revenues, adversely impact our margins or lead to a reduction in our market share, any of which may harm our business.

 

  

Our WavSTAT System technology may become obsolete.

 

Our WavSTAT System products may be made unmarketable by new scientific or technological developments where new treatment modalities are introduced that are more efficacious or more economical. Any one of our competitors could develop a more effective product which would render our technology obsolete.

 

Our inability to attract and retain qualified personnel could impede our ability to generate revenues and profits and to otherwise implement our business plan and growth strategies, which would have a negative impact on our business and could adversely affect the price of our common stock.  

 

We currently have a staff of nine employees and consultants, consisting of, among others, our Chief Executive Officer, Chief Financial Officer, Director of Sales and Marketing and Chief Engineer Director, as well as administrative employees. We will be required over the longer-term to hire highly skilled managerial, scientific and administrative personnel to fully implement our business plan and growth strategies. We cannot assure you that we will be able to engage the services of such qualified personnel at competitive prices or at all, particularly given the risks of employment attributable to our limited financial resources and lack of an established track record.

Our planned growth will place strains on our management team and other company resources to both implement more sophisticated managerial, operational and financial systems, procedures and controls and to train and manage the personnel necessary to perform those functions. Our inability to manage our growth could impede our ability to generate revenues and profits and to otherwise implement our business plan and growth strategies, which would have a negative impact on our business and the market value of the Company.

 

We will need to significantly expand our operations to implement our longer-term business plan and growth strategies. We will also be required to manage multiple relationships with various strategic partners, technology licensors, customers, manufacturers and suppliers, consultants and other third parties. This expansion and these expanded relationships will require us to significantly improve or replace our existing managerial, operational and financial systems, procedures and controls; to improve the coordination between our various corporate functions; and to manage, train, motivate and maintain a growing employee base. The time and costs to effectuate these steps may place a significant strain on our management personnel, systems and resources, particularly given the limited amount of financial resources and skilled employees that may be available at the time. We cannot assure you that we will institute, in a timely manner or at all, the improvements to our managerial, operational and financial systems, procedures and controls necessary to support our anticipated increased levels of operations and to coordinate our various corporate functions, or that we will be able to properly manage, train, motivate and retain the anticipated increased number of employees.

 

We may have difficulty in developing and retaining an effective sales force or in obtaining effective distribution partners and may not be able to achieve sufficient revenues to affect our business plan.

 

The market for skilled sales and marketing personnel is highly competitive and specialized. If we are unable to hire and retain skilled and knowledgeable sales people it may negatively impact our ability to introduce our products or generate revenue sufficient to affect our future business plans. In addition, our inability to develop business relationships with key technical distributors may also negatively impact our ability to successfully market our products.

 

We may have difficulty in attracting and retaining management and outside independent members to our Board of Directors as a result of their concerns relating to their increased personal exposure to lawsuits and shareholder claims by virtue of holding these positions in a publicly held company.

 

The directors and management of publicly traded corporations are increasingly concerned with the extent of their personal exposure to lawsuits and shareholder claims, as well as governmental and creditor claims which may be made against them, particularly in view of recent changes in securities laws imposing additional duties, obligations and liabilities on management and directors. Due to these perceived risks, directors and management are also becoming increasingly concerned with the availability of directors and officers liability insurance to pay on a timely basis the costs incurred in defending such claims. We currently carry directors and officers’ liability insurance, but such insurance is expensive and can be difficult to obtain. If we are unable to obtain directors and officers liability insurance at affordable rates or at all in the future, it may become increasingly more difficult to attract and retain qualified outside directors to serve on our board of directors. The fees of directors are also rising in response to their increased duties, obligations and liabilities as well as increased exposure to such risks. As a company with a limited operating history and limited resources, we will have a more difficult time attracting and retaining management and outside independent directors than a more established company due to these enhanced duties, obligations and liabilities.  

 

 

If we fail to comply with extensive regulations enforced by domestic and foreign regulatory authorities, the commercialization of our products could be prevented or delayed.

 

Our WavSTAT Systems are subject to extensive government regulations related to development, testing, manufacturing and commercialization in the United States and other countries. The determination of when and whether a product is ready for large scale purchase and potential use will be made by the government through consultation with a number of governmental agencies, including the FDA, the National Institutes of Health, and the Centers for Disease Control and Prevention. Some of our product candidates are in the clinical stages of development and have not received required regulatory approval from the FDA for applications we hope to commercially market. The process of obtaining and complying with the FDA and other governmental regulatory approvals and regulations is costly, time consuming, uncertain and subject to unanticipated delays. Despite the time and expense incurred, regulatory approval is never guaranteed. We also are subject to the following risks and obligations, among others:

 

			The FDA may refuse to approve an application if they believe that applicable regulatory criteria are not satisfied;
			The FDA may require additional testing for safety and effectiveness;
			The FDA may interpret data from pre-clinical testing and clinical trials in different ways than us;
			If regulatory approval of a product is granted, the approval may be limited to specific indications or limited with respect to its distribution; and
			The FDA may change their approval policies and/or adopt new regulations.

 

Failure to comply with these or other regulatory requirements of the FDA may subject us to administrative or judicially imposed sanctions, including:

 

			Warning letters;
			Civil penalties;
			Criminal penalties;
			Injunctions;
			Product seizure or detention;
			Product recalls; and
			Total or partial suspension of production.

  

Delays in successfully completing our clinical and European evalustion trials could jeopardize our ability to obtain regulatory approval or market our WavSTAT System candidates on a timely basis.

 

Our business prospects will depend on our ability to complete clinical trials, obtain satisfactory results, obtain required regulatory approvals and successfully commercialize our WavSTAT System product candidates. Completion of our clinical trials, announcement of results of the trials and our ability to obtain regulatory approvals could be delayed for a variety of reasons, including:

 

 

 

			Unsatisfactory results of any clinical trial;
			The failure of principal third-party investigators to perform clinical trials on our anticipated schedules; and
			Different interpretations of pre-clinical and clinical data, which could initially lead to inconclusive results.

 

Our development costs will increase if we have material delays in any clinical trial or if we need to perform more or larger clinical trials than planned.  

 

If clinical or evaluation trial delays are significant, or if any of our WavSTAT System product candidates do not prove to be safe or effective or do not receive required regulatory approvals, our financial results and the commercial prospects for our product candidates will be harmed. Furthermore, our inability to complete our clinical trials in a timely manner could jeopardize our ability to obtain regulatory approval.

 

The independent clinical investigators that we rely upon to conduct our clinical trials may not be diligent, careful or timely, and may make mistakes, in the conduct of our clinical trials.

 

We depend on independent clinical investigators to conduct our clinical trials. The investigators are not our employees, and we cannot control the amount or timing of resources that they devote to our product development programs. If independent investigators fail to devote sufficient time and resources to our product development programs, or if their performance is substandard, it may delay FDA approval of our products. These independent investigators may also have relationships with other commercial entities, some of which may compete with us. If these independent investigators assist our competitors at our expense, it could harm our competitive position.

 

Our product development efforts may not yield marketable products due to results of studies or trials, failure to achieve regulatory approvals or market acceptance, proprietary rights of others or manufacturing issues.

 

Our success depends on our ability to successfully develop and obtain regulatory approval to market new products. We expect that a significant portion of the research that we will conduct will involve new and unproven technologies. Development of a product requires substantial technical, financial and human resources even if the product is not successfully completed.

 

Potential products may appear to be promising at various stages of development yet fail to reach the market for a number of reasons, including the:

 

			Lack of adequate quality or sufficient prevention benefit, or unacceptable safety during pre-clinical studies or clinical trials;
			Failure to receive necessary regulatory approvals;
			Existence of proprietary rights of third parties; and/or
			Inability to develop manufacturing methods that are efficient, cost-effective and capable of meeting stringent regulatory standards.

  

Our inability to protect our intellectual property rights could negatively impact our projected growth and ability to generate revenues and profits, which would have a negative impact on our business.

  

  

We rely on a combination of patent, patent pending, copyright, trademark and trade secret laws, proprietary rights agreements and non-disclosure agreements to protect our intellectual properties. These measures may not prove to be effective in protecting our intellectual properties.

 

In the case of patents, our existing patents may be invalidated, any patents that we currently or prospectively have applied for may not be granted, or any of these patents may not ultimately provide significant commercial benefits. Further, competing companies may circumvent any patents that we may hold by developing products which closely emulate but do not infringe our patents. While we currently have and intend to seek patent protection for our products in selected foreign countries, those patents may not receive the same degree of protection as they would in the United States. We may not be able to successfully defend our patents and proprietary rights in any action we may file for patent infringement. Similarly, we may be required to defend litigation involving the patents or proprietary rights of others, or we may be able to obtain licenses for these rights. Legal and accounting costs relating to prosecuting or defending patent infringement litigation may be substantial.

 

The WavSTAT System is protected by 34 issued patents, in the United States and approximately 25 foreign patents, which we own, and one additional patent for which we own the exclusive license. We also rely on proprietary designs, technologies, processes and know-how not eligible for patent protection. Our competitors may independently develop the same or superior designs, technologies, processes and know-how.  

 

While we have and will continue to enter into proprietary rights agreements with our employees and third parties giving us proprietary rights to certain technology developed by those employees or parties while engaged by the Company, courts of competent jurisdiction may not enforce those agreements.

 

The patents we own comprise a large portion of our assets, which could limit our financial viability.

 

Our patents comprise approximately 60% of our assets at December 31, 2014. If our existing patents are invalidated or if they fail to provide significant commercial benefits, it will severely hurt our financial condition, as a significant percentage of our assets would lose their value. Further, since our patents are amortized over the course of their term until they expire, our assets comprised of patents will continually be written down to zero.

 

Legislative actions and potential new accounting pronouncements are likely to impact our future financial position and results of operations.

 

Compliance with publicly-traded company regulations adversely impacts our resources. As a publicly-traded company, we are subject to rules and regulations that increase our legal and financial compliance costs, make some activities more time-consuming and costly, and divert our management's attention away from the operation of our business. We are obligated to file with the U.S. Securities and Exchange Commission, or the SEC, annual and quarterly information and other reports that are specified in the Securities Exchange Act of 1934, or the Exchange Act, and are also subject to other reporting and corporate governance requirements, including requirements of the Sarbanes-Oxley Act of 2002, and the rules and regulations promulgated thereunder, which impose significant compliance and reporting obligations upon us.  We may not be successful in complying with these obligations, and compliance with these obligations could be time consuming and expensive. Failure to comply with the additional reporting and corporate governance requirements could lead to fines imposed on us, deregistration under the Exchange Act and, in the most egregious cases, criminal sanctions could be imposed.

 

Our products may be subject to recall or product liability claims.

 

Our WavSTAT System products may be used in connection with medical procedures in which it is important that those products function with precision and accuracy. If our products do not function as designed, or are designed improperly, we may be forced by regulatory agencies to withdraw such products from the market. In addition, if medical personnel or their patients suffer injury as a result of any failure of our products to function as designed, or due to an inappropriate design, we may be subject to lawsuits seeking significant compensatory and punitive damages. Any product recall or lawsuit seeking significant monetary damages may have a material effect on our business and financial condition.

 

   

ITEM 1B. UNRESOLVED STAFF COMMENTS.

 

None

 

ITEM 2. PROPERTIES.

 

SpectraScience leases its principal facility from an unrelated third party. The facility is located at 11568-11 Sorrento Valley Road, San Diego, California 92121, and is well maintained and approved by the FDA for manufacturing. The facility consists of approximately 5,080 square feet of office, research and development, manufacturing, quality testing, and warehouse space. The lease provides for monthly rental payments ranging from $4,826 to $5,432 through April 2018, plus a pro rata share of operating expense and real estate taxes (approximately $1,500 per month). We believe that our present facility is adequate for our needs for the foreseeable future. In the event of the termination of this lease, we believe that we could lease other acceptable space on a comparable basis.

 

ITEM 3. LEGAL PROCEEDINGS.

 

We are not currently a party to any legal proceedings.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

None. 

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

Our Common Stock is quoted on the OTCQB under the symbol SCIE.QB. The last reported bid price of the Common Stock on March 16, 2015 was $0.02.

 

The following table sets forth for the calendar period indicated; the quarterly closing prices of our Common Stock as reported by the OTCBB and the OTCQB, the bulletin boards on which our common stock was traded during fiscal years 2014 and 2013.

 

			Closing Price
			High			Low
Year Ended December, 2013
First Quarter		$	0.08		$	0.05
Second Quarter		$	0.08		$	0.04
Third Quarter		$	0.05		$	0.03
Fourth Quarter		$	0.04		$	0.02
Year Ended December, 2014
First Quarter		$	0.05		$	0.02
Second Quarter		$	0.06		$	0.04
Third Quarter		$	0.05		$	0.02
Fourth Quarter		$	0.03		$	0.01

 

  

 On March 20, 2015 we had approximately 800 shareholders of record of our common stock.

 

To date, we have not declared or paid cash dividends on our common stock. The current policy of the board of directors is to retain any earnings to fund the development and growth of our business. Any future determination to pay cash dividends will be at the discretion of our board of directors, and will be dependent upon our financial condition, results of operations, capital requirements and other factors our board may deem relevant at the time.  

 

Recent Sales of Unregistered Securities

 

During the quarter ended December 31, 2014 we issued the following equity securities: 

 

Number of

Date of

Common Shares

Source of

Common Stock

Issuance

Issued

Payment

Amount

12/31/2014

20,654,189

Convertible Debt Conversion

$

907,886

  

Common Stock Purchase Warrants			Date of
Issued With Convertible Debentures			Issuance			Number of Shares			Exercise Price			Expiration Date
			10/1/2014			555,556		$	0.0900			10/1/2019
			10/17/2014			1,111,112		$	0.0900			10/17/2019
			10/23/2014			3,086,442		$	0.0900			10/23/2019
			10/24/2014			555,556		$	0.0900			10/24/2019
			11/18/2014			50,000		$	0.0900			11/18/2019
			11/22/2014			3,086,442		$	0.0900			12/22/2019

 

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 6.	SELECTED FINANCIAL DATA
	Not required.
	ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis provides information that management believes is relevant to assess and understand our results of operations and financial condition. This discussion should be read in conjunction with the consolidated financial statements and footnotes that follow such consolidated financial statements.

 

Certain statements contained in this Annual Report on Form 10-K, including in this Item 7, that are not related to historical results, including, without limitation, statements regarding our business strategy and objectives, near term operating goals, our expectations regarding the market for our products and beliefs with respect to

 

 

opportunities, strategic partnerships and industry conditions in those markets, our beliefs about our products and expectations with respect to their performance and acceptance, regulatory practices and developments, our beliefs about our employees, our beliefs and intentions with respect to intellectual property, our beliefs with respect to reimbursement, our beliefs and expectations regarding competition, future operating losses and our future financial position, our expectations with respect to future cash needs and the sufficiency of our working capital, and estimated cost savings, are forward-looking statements and involve risks and uncertainties. Although we believe that the assumptions on which these forward-looking statements are based are reasonable, such assumptions may not prove to be accurate and actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, changes in law or regulatory policies, unanticipated competition from other similar businesses, adverse outcomes from litigation, unexpected employee departures or disruptions, adverse market and general economic factors and other factors described in Item 1A of this Form 10-K. All forward-looking statements contained in this Form 10-K are qualified in their entirety by this statement.

 

Plan of Operation

 

During the year ended December 31, 2014, SpectraScience continued improvements made to the WavSTAT4 in 2013 under its distribution agreement with PENTAX Europe, GmbH (“PENTAX”), for distribution of its products in Europe, the Middle East and Africa. All of the sales of approximately $240,000 for the year ended December 31, 2013 were to PENTAX.

 

Over the next 12 months, SpectraScience intends to:

 

			Market and sell the WavSTAT4 Optical Biopsy System colon cancer diagnostic application through PENTAX and other distribution channels 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 China, Saudi Arabia and India;
			Begin meeting with the FDA towards the preparation and submission of a Supplemental PMA filing with the FDA 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.
			Continue to expand and refine our intellectual property portfolio.

 

Cash Requirements

 

SpectraScience expects to incur significant additional operating losses through 2015, as we continue with outcome-based clinical studies, research and development activities and ramp up sales and marketing efforts to sell the WavSTAT4 Systems. We may incur unexpected expenses, or we may not be able to meet our revenue forecast, and such events will require us to seek additional capital.

 

SpectraScience has financed its capital requirements principally through the private sale of equity securities. The Company had cash balances of approximately $224,000 at December 31, 2014 and $237,000 at December 31, 2013. The approximate $13,000 decrease in cash for the year was a result of approximately $2,442,000 of cash used in operations and approximately $6,000 related to acquisitions of equipment offset by net proceeds from the sale of convertible debentures and debt of approximately $2,435,000. The Company will have to raise additional cash to provide working capital to execute its present business plans.

 

  

SpectraScience’s future liquidity and capital requirements will depend upon a number of factors, including but not limited to:

 

			The timing and progress of market evaluation clinical trials;
			The timing and extent to which SpectraScience’s products gain market acceptance;
			The timing and expense of developing marketing and strategic distribution channels;
			The progress and expense of developing next generation products and new applications for incorporation into the WavSTAT Optical Biopsy Systems;
			The potential requirements and related costs for product modifications;
			The timing and expense of various U.S. and foreign regulatory filings;
			The maintenance of various U.S. and foreign government approvals, or the timing of receipt of additional approvals;
			The status, maintenance and enhancement of SpectraScience’s patent portfolio; and
			The overall effect of global economic conditions, in particular the uncertainty within the economies of the European Union, on the ability of the Company to generate sales revenue.

 

Results of Operations

 

The following discussion should be read in conjunction with the consolidated Financial Statements and Notes thereto appearing elsewhere in this report.

 

 

 

Comparison of years ended December 31, 2014 and December 31, 2013

 

			Year Ended December 31,						Favorable
			2014			2013			(Unfavorable)			%
Revenue		$	—		$	240,000		$	(240,000	)		NM
Cost of revenue			(8,083	)		125,395			133,478			106.4	%
Gross profit			8,083			114,605			(106,522	)		-92.9	%
Operating expenses:
Research and development			924,367			644,076			(280,291	)		-43.5	%
General and administrative			1,414,615			1,934,482			519,867			26.9	%
Sales and marketing			374,753			267,757			(106,996	)		-40.0	%
			2,713,735			2,846,315			132,580			4.7	%
Loss from operations			(2,705,652	)		(2,731,710	)		26,058			-1.0	%
Other income (expense)			(1,782,629	)		(17,935	)		(1,764,694	)		NM
Net income (loss)		$	(4,488,281	)	$	(2,749,645	)	$	(1,738,636	)		63.2	%

 

Revenues

 

                        There were no revenues for the year ended December 31, 2014 compared to $240,000 for the year ended December 31, 2013 when 8 units of the WaveSTAT4 Systems shipped associated with European clinical trials. We anticipate that revenue will increase on the conclusion of clinical trials and acceptance of our products.                         

                        Cost of Revenue                         

                        Cost of revenue for the year ended December 31, 2014 decreased $133,478 to a negative $8,083 as a result of several systems coming off of warranty. For the year ended December 31, 2013, cost of revenue was $125,395 when 8 units were sold associated with European clinical trials. We anticipate that cost of revenue will increase on the conclusion of clinical trials and acceptance of our products.                         

                        Research and Development Expenses                         

                        Research and development expenses increased by $280,291, 43.5%, to $924,367 for the year ended December 31, 2014 from $644,076 for the year ended December 31, 2013. This increase was primarily due to an increase in payroll expense of approximately $35,000 and an increase in clinical studies of approximately $196,000. 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 $519,867, 26.9%, to $1,414,615 for the year ended December 31, 2014 from $1,934,482 the year ended December 31, 2013. The primary reason for the decrease was a reduction in payroll costs of approximately $104,000, a reduction in legal and auditing expenses of approximately $113,000, a reduction in consulting expenses of approximately $199,000, a reduction in investor relations costs of approximately $70,000 and a reduction in depreciation and amortization expenses of approximately $55,000. We anticipate that general and administrative expenses will increase as we increase our selling activity in Europe.    

                        Sales and Marketing Expenses                        

                        Sales and marketing expenses increased by $106,996, 40.0%, to $374,753 for the year ended December 31, 2014 from $267,757 for the year ended December 31, 2013. The primary reason for the increase was an increase in payroll costs of approximately $61,000 and an increase in travel related expenses of approximately $24,000. We anticipate that sales and marketing expenses will increase as we increase our activity in Europe.                          

                        Other Expense                         

                        Other expense for the year ended December 31, 2014 was expense of $1,782,629 compared to expense of $17,935 for the year ended December 31, 2013. 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. 

  

Liquidity and Capital Resources

 

		As of							Increase
		December 31, 2014			December 31, 2013				(Decrease)
Working Capital
Current assets		$	858,962		$	801,109		$	57,853
Current liabilities			6,591,087			4,881,597			1,709,490
Working capital deficit		$	(5,732,125	)	$	(4,080,488	)	$	1,651,637
Long-term debt		$	—		$	—		$	—
Stockholders' deficit		$	(4,380,566	)	$	(2,551,231	)	$	1,829,335

 

			Year Ended December 31,						Increase
			2014			2013			(Decrease)
Statements of Cash Flows Select Information
Net cash provided (used) by:
Operating activities		$	(2,441,793	)	$	(1,612,677	)	$	829,116
Investing activities		$	(6,275	)	$	(4,178	)	$	2,097
Financing activities		$	2,435,000		$	1,763,260		$	671,740

 

			As of December 31,						Increase
			2014			2013			(Decrease)
Balance Sheet Select Information
Cash		$	223,529		$	236,597		$	(13,068	)
Accounts receivable		$	—		$	60,000		$	(60,000	)
Inventory		$	283,624		$	247,433		$	36,191
Accounts payable and accrued expenses		$	1,509,148		$	1,440,063		$	69,085

 

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 2015, 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. 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. This raises substantial doubt about the Company’s ability to continue as a going concern. 

 

                            

As of December 31, 2014, the Company had a working capital deficit of $5,732,125 and cash of $223,529, compared to a working capital deficit of $4,080,488 and cash of $236,597 as of December 31, 2013. 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 six months ended June 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 six months ended December 31, 2013, the Company raised $1,156,576, net of transaction costs, under this agreement. For the year ended December 31, 2014, the Company raised approximately $2,400,000 under various funding agreements. 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 various funding agreements 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

 

The Company has no off balance sheet arrangements.

 

Critical Accounting Policies and Estimates

 

This discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate these estimates, including those related to intangibles, income taxes, financing operations, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We have identified the policies below as critical to our business operations and the understanding of our results of operations. The impact and any associated risks related to these policies on our business operations is discussed throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. Note that our preparation of this Report on Form 10-K requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amount of revenue, if any, and expenses during the reporting period. Actual results may differ from those estimates.

 

Revenue Recognition

 

We recognize 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 our 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. We use customer purchase orders to determine the existence of an arrangement. We use shipping documents and third-party proof of delivery to verify that title has transferred. We assess whether the fee is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, we assess a number of factors, including past transaction history with the customer and the creditworthiness of the customer.

 

 

Stock Based Compensation

 

We account for stock-based compensation under the provisions of FASB ASC Topic 718, Compensation—Stock Compensation, or 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. We adopted ASC 718 on January 1, 2006 using the modified prospective method. We estimate the fair value of stock-based awards on the date of grant using the Black-Scholes-Merton (Black-Scholes) option-pricing model. These standards require us to expense employee stock options and other share-based payments. The Company recognizes as expense the fair value of employee and non-employee stock option grants. These expenses amounted to approximately $390,000 and $376,000 for the years ended December 31, 2014 and 2013, respectively.

   

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.  

Convertible Debentures and Warrants

For Convertible Debentures issued previous to March 31, 2013 containing exchange features, we account for the Convertible Debentures, associated warrants and conversion features under the provisions of FASB Topic 470, Debt, or ASC 470 which requires the measurement and recognition of the fair values for all components related to the Convertible Debentures at the end of each reporting period. We estimate the fair value of the contingent beneficial conversion option, holders’ warrants and agent warrants at each measurement date using a combination of the Black-Scholes-Merton and modified Binomial Lattice option-pricing models. These standards require us to record the fair value of the Convertible Debentures and warrants at the time of issuance and to remeasure these values and record associated income statement expense or benefit at each reporting period. A more detailed description can be found in Note 8 of the enclosed financial statements.  For Convertible Debentures issued subsequent to March 31, 2013 which did not contain exchange features, we account for the Convertible Debentures, associated warrants and conversion features under the provisions of ASC 815 which requires the valuation of the debt discount to be recognized on the date of issuance and the amount of debt discount to be amortized over the life of the Convertible Debenture.

RECENT ACCOUNTING PRONOUNCEMENTS: None

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not required.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

 

Consolidated audited financial statements for the years ended December 31, 2014 and 2013 are filed as part of this Form 10-K.

 

 

SpectraScience, Inc. and Subsidiaries

Consolidated Financial Statements

Years Ended December 31, 2014 and 2013

 

		Page
Report of Independent Registered Public Accounting Firm			32
Consolidated Balance Sheets as of December 31, 2014 and 2013			33
Consolidated Statements of Operations for the years ended December 31, 2014 and 2013			34
Consolidated Statements of Shareholders’ Deficit for the years ended December 31, 2014 and 2013			35
Consolidated Statements of Cash Flows for the years ended December 31, 2014 and 2013			36
Notes to Consolidated Financial Statements			37

 

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders

SpectraScience, Inc. and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of SpectraScience, Inc., and subsidiaries as of December 31, 2014 and 2013, and the related consolidated statements of operations, shareholders' deficit, and cash flows for the two years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated 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 audits 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 also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide 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 SpectraScience, Inc. and subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for the two years then ended in conformity with U.S. generally accepted accounting principles.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and its ability to continue as a going concern is dependent on the Company’s ability to attract investors and generate cash through issuance of equity instruments and convertible debt. This raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. 

 

/s/ HJ Associates & Consultants, LLP 

 

HJ Associates & Consultants, LLP

Salt Lake City, Utah

March 20, 2015

 

 

   

SpectraScience, Inc. and Subsidiaries
Consolidated Balance Sheets

  

			December 31,			December 31,
			2014			2013
ASSETS
Current assets:
Cash		$	223,529		$	236,597
Accounts receivable, net			—			60,000
Inventory			283,624			247,433
Deferred debt issuance costs			107,636			82,227
Prepaid expenses and other current assets			244,173			174,852
Total current assets			858,962			801,109
Fixed assets, net			3,665			15,917
Patents, net			1,347,894			1,513,340
		$	2,210,521		$	2,330,366
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable		$	836,136		$	1,009,018
Note payable to an affiliate			—			30,000
Note payable			100,000			—
Convertible debt, net of discounts of $576,502 as of December 31, 2014 and $644,518 as of December 31, 2013			3,920,100			2,307,111
Derivative liability			1,061,839			1,104,423
Accrued Expenses			673,012			431,045
Total current liabilities			6,591,087			4,881,597
COMMITMENTS AND CONTINGENCIES
Stockholders' deficit
Series A Convertible Preferred Stock, $.01 par value; 0 shares authorized, issued and outstanding as of December 31, 2014 and December 31, 2013			—			—
Series B Convertible Preferred Stock, $.01 par value; 2,585,000 shares authorized, issued and outstanding as of December 31, 2014 and December 31, 2013; liquidation value of $517,000 plus accumulated and and unpaid dividends of $106,931 as of December 31, 2014 and December 31, 2013			25,850			25,850
Series C Convertible Preferred Stock, $.01 par value; 500,000 shares authorized, issued and outstanding as of December 31, 2014 and December 31, 2013; liquidation value of $100,000 as of December 31, 2014 and December 31, 2013			5,000			5,000
Common stock, $.01 par value; 746,915,000 shares authorized; 194,355,277 and 166,712,054 shares issued and outstanding as of December 31, 2014 and December 31, 2013			1,943,553			1,667,120
Additional paid in capital			39,509,115			37,126,602
Accumulated deficit			(45,864,084	)		(41,375,803	)
Total stockholders' deficit			(4,380,566	)		(2,551,231	)
		$	2,210,521		$	2,330,366

See accompanying report of independent registered public accounting firm, summary of accounting polices and notes to consolidated financial statements.

 

 

SpectraScience, Inc. and Subsidiaries
Consolidated Statements of Operations

 

			Year Ended
			December 31,
			2014			2013
Revenue		$	—		$	240,000
Cost of revenue			(8,083	)		125,395
Gross profit			8,083			114,605
Operating expenses:
Research and development			924,367			644,076
General and administrative			1,414,615			1,934,482
Sales and marketing			374,753			267,757
			2,713,735			2,846,315
Loss from operations			(2,705,652	)		(2,731,710	)
Other income (expense)
Interest expense			(499,797	)		(295,111	)
Change in fair value of derivative and warrant liabilities			(154,898	)		2,060,749
Amortization of derivative and warrant liabilities discount			(1,127,143	)		(1,304,867	)
Amortization of deferred debt issuance costs and original issue discount			(281,118	)		(694,939	)
Gain on extinguishment of debt			302,510			225,830
Other expense, net			(22,183	)		(9,597	)
			(1,782,629	)		(17,935	)
Net loss		$	(4,488,281	)	$	(2,749,645	)
Basic and diluted loss per share		$	(0.03	)	$	(0.02	)
Weighted average common shares outstanding			170,237,633			160,015,532

See accompanying report of independent registered public accounting firm, summary of accounting polices and notes to consolidated financial statements.

 SpectraScience, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Deficit
For Years Ended December 31, 2014 and 2013

																					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 January 1, 2013			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			—			—			—			—			—			—			360,213			—			360,213
Common stock issued for cash and prepaid expenses			—			—			—			—			500,000			5,000			20,000			—			25,000
Common stock issued for services			—			—			—			—			4,300,000			43,000			213,500			—			256,500
Conversion of convertible debt			—			—			—			—			9,182,389			91,823			323,035			—			414,858
Conversion of Series C Convertible Preferred			—			—			(500,000	)		(5,000	)		500,000			5,000			—			—			—
Warrant valuation on issuance of convertible debt			—			—			—			—			—			—			718,251			—			718,251
Net loss			—			—			—			—			—			—			—			(2,749,645	)		(2,749,645	)
Balance December 31, 2013			2,585,000			25,850			500,000			5,000			166,712,054			1,667,120			37,126,602			(41,375,803	)		(2,551,231	)
Non cash issuance of stock options			—			—			—			—			—			—			389,936			—			389,936
Common stock issued for cash on option exercise			—			—			—			—			931,200			9,312			9,312			—			18,624
Common stock issued for debt offering costs			—			—			—			—			1,000,000			10,000			40,000			—			50,000
Conversion of convertible debt			—			—			—			—			25,712,023			257,121			903,657			—			1,160,778
Warrant valuation on issuance of convertible debt			—			—			—			—			—			—			1,027,583			—			1,027,583
Warrant valuation on issuance of short term debt			—			—			—			—			—			—			1,659			—			1,659
Non cash issuance of warrant for consulting services			—			—			—			—			—			—			10,366			—			10,366
Net loss			—			—			—			—			—			—			—			(4,488,281	)		(4,488,281	)
Balance December 31, 2014			2,585,000		$	25,850			500,000		$	5,000			194,355,277		$	1,943,553		$	39,509,115		$	(45,864,084	)	$	(4,380,566	)

See accompanying report of independent registered public accounting firm, summary of accountingpolicies and notes to consolidated financial statements.

SpectraScience, Inc. and Subsidiaries
Consolidated Statements of Cash Flows

			December 31,
			2014			2013
Operating activities:
Net loss		$	(4,488,281	)	$	(2,749,645	)
Adjustments to reconcile net loss to cash used in operating activities:
Write off of uncollectable accounts receivable			—			(78,624	)
Amortization and depreciation			183,973			239,300
Non-cash issuance of stock options			389,936			360,213
Non-cash interest on issuance of warrants			12,025			—
Amortization of derivative and warrant liabilities discount			1,127,143			1,304,867
Amortization of deferred debt issuance costs and original issue discount			281,118			694,939
Change in fair value of derivative and warrant liabilities			154,898			(2,060,749	)
Gain on extinguishment of debt			(302,510	)		(225,830	)
Fair market value of common stock issued for services			—			256,500
Changes in assets and liabilities:
Accounts receivable			60,000			18,624
Inventories			(36,191	)		(45,356	)
Prepaid expense and other assets			(69,321	)		31,803
Accounts payable			(172,882	)		138,705
Accrued expenses			418,299			502,576
Net cash used in operating activities			(2,441,793	)		(1,612,677	)
Investing activities:
Purchases of fixed assets			(6,275	)		(4,178	)
Net cash used in investing activities			(6,275	)		(4,178	)
Financing activities:
Proceeds from issuance of convertible notes payable			2,506,376			2,122,000
Proceeds from issuance of note payable			100,000			—
Proceeds from issuance of note payable to affiliate			—			45,000
Payments against note payable to affiliate			(30,000	)		(15,000	)
Proceeds from issuance of common stock for cash			—			9,375
Proceeds from exercise of stock options			18,624			—
Debt issuance costs			(160,000	)		(398,115	)
Net cash provided by financing activities			2,435,000			1,763,260
Net increase (decrease) in cash			(13,068	)		146,405
Cash, beginning of year			236,597			90,192
Cash, end of year		$	223,529		$	236,597
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest		$	—		$	12,237
Income taxes		$	—		$	—
Non Cash Investing and Financing Activities:
Conversion of convertible notes to common stock		$	1,089,474		$	473,684
Conversion of interest due on convertible notes to common stock		$	176,334		$	59,366
Exchange of interest due on convertible notes to new notes		$	—		$	62,155
Conversion of preferred stock to common stock		$	—		$	5,000

See accompanying report of independent registered public accounting firm, summary of accounting polices and notes to consolidated financial statements.

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements 

 

Note 1: Organization and 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 Corp., SpectraScience International, Inc. and SpectraScience (UK) Ltd. From 1996, the Company primarily focused 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 Imaging Corporation (“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 minimally-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 intellectual property consisted of a total of 34 issued U.S. Patents and 28 additional patent applications.

 

Note 2: 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 2015, 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. 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. This raises substantial doubt about the Company’s ability to continue as a going concern.

 

As of December 31, 2014, the Company had a working capital deficit of $5,732,125 and cash of $223,529, compared to a working capital deficit of $4,080,488 and cash of $236,597 as of December 31, 2013. 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 six months ended June 30, 2013, the Company raised $692,560, net of transaction costs of $169,440, 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 six months ended December 31, 2013, the Company raised $1,156,576, net of transaction costs of $103,424, under this agreement.

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

For the year ended December 31, 2014, the Company raised approximately $2,400,000 under various funding agreements. 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 various funding agreements 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.

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 December 31, 2014, Convertible Debentures with a face value of $1,862,160 held by 35 individual investors are in default. None of these investors have served notice of default on the Convertible Debentures held by them.

 

The accompanying consolidated 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.

 

Note 3: Summary of Significant Accounting Policies

 

Consolidation

 

The accompanying consolidated financial statements include the accounts of SpectraScience, Inc. and its wholly-owned subsidiaries Luma Imaging Corp., SpectraScience International, Inc. and SpectraScience (UK) Ltd. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Reclassifications

 

Certain reclassifications have been made to the 2013 financial statements in order for them to conform to the 2014 presentation. Such reclassifications have no impact on the Company’s financial position or results of operations.

 

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.

 

Accounts Receivable 

Receivables are carried at original invoice amount less payment received and an estimate is made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Receivables are generally considered past due 30 days after payment date as specified on the invoice. We determine allowance for doubtful accounts by regularly evaluating individual receivables and considering a creditor’s financial condition, credit history and current economic conditions. Receivables are written off when deemed uncollectible. Recoveries of previously written off receivables previously written off are recorded when received.

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Inventory

 

We state our inventory at the lower of cost (using the first-in, first-out method) or market value, determined on an average cost basis. We provide inventory allowances when conditions indicate that the selling price could be less than cost due to obsolescence and reductions in estimated future demand. We balance 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 inventory reserves that could adversely impact our gross margins. Conversely, favorable changes in demand could result in higher gross margins when we sell products.

 

During the year ended December 31, 2014, the Company concentrated on clinical trials in Europe to validate the accuracy and cost effectiveness of the WavSTAT system. In anticipation of purchase orders on the completion of the trials, the Company purchased inventory for approximately 30 consoles which will be used to fulfill initial orders expected from the United Kingdom and Germany.

 

Property and Equipment

 

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.  

 

Patents

 

The Company accounts for acquired intangible assets under FASB ASC Topic 350 Goodwill and Other Intangibles –General Intangibles Other than Goodwill. All patents are amortized over the shorter of their remaining legal lives or estimated economic lives. When acquired, the WavSTAT System patents had an average remaining useful life of 14 years, while the LUMA patents had an average remaining life of approximately 16 years.

 

Convertible Debentures/Warrants

For Convertible Debentures issued previous to March 31, 2013 containing exchange features, we account for the Convertible Debentures, associated warrants and conversion features under the provisions of FASB Topic 470, Debt, or ASC 470, which requires the measurement and recognition of the fair values for all components related to the Convertible Debentures at the end of each reporting period. We estimate the fair value of the contingent beneficial conversion option, holders’ warrants and agent warrants at each measurement date using a combination of the Black-Scholes-Merton and modified Binomial Lattice option-pricing models. These standards require us to record the fair value of the Convertible Debentures and warrants at the time of issuance and to remeasure these values and record associated income statement expense or benefit at each reporting period. A more detailed description can be found in Note 8 to the financial statements.  For Convertible Debentures issued subsequent to March 31, 2013 which did not contain exchange features, we account for the Convertible Debentures, associated warrants and conversion features under the provisions of ASC 815 which requires the valuation of the debt discount to be recognized on the date of issuance and the amount of debt discount to be amortized over the life of the Convertible Debenture.

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated 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 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.

 

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 fee 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.

 

 Research and Development

 

 Research and development costs are expensed as incurred. There may be cases in the future where certain research and development costs such as software development costs are capitalized. For the years ended December 31, 2014 and 2013, research and development costs were approximately $924,000 and $644,000, respectively.

 

Fair Value of Financial Instruments

 

The carrying amount of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their estimated fair values due to the short-term maturities of those financial instruments.

 

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

Income Taxes

 

Income taxes are provided for the tax effects of transactions reported in the consolidated financial statements and consist of taxes currently due plus deferred income taxes. Deferred income taxes are recognized for temporary differences between the financial statement and tax basis of assets and liabilities that will result in taxable or deductible amounts in the future. Deferred income taxes are also recognized for net operating loss carryforwards that are available to offset future taxable income and research and development credits. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

 

FASB Accounting Standards Codification Topic 740, Income Taxes (“ASC 740”), clarifies the accounting for uncertainty in income taxes recognized in the financial statements. ASC 740 provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits of the position. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. ASC 740

also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We have determined that the Company does not have uncertain tax positions on its tax returns for the years 2014 and prior. Based on evaluation of the 2014 transactions and events, the Company does not have any material uncertain tax positions that require measurement. Because the Company had a full valuation allowance on its deferred tax assets as of December 31, 2014 and 2013, the Company has not recognized any tax benefits since inception.

 

Our policy is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrual for interest or penalties on our consolidated balance sheets at December 31, 2014 or 2013, and have not recognized interest and/or penalties in the consolidated statement of operations for the years ended December 31, 2014 or 2013.

 

We are subject to taxation in the U.S. and the state of California. All of our tax years are subject to examination by the U.S. and California tax authorities due to the carry-forward of unutilized net operating losses.

 

Earnings (Loss) Per Share

 

Basic earnings (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period of computation. Diluted earnings (loss) per share is computed similarly to basic earnings 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 only if the additional common shares would be dilutive. (See Note 13)

 

Note 4: Accounts Receivables

 

Accounts receivables are carried at the expected realizable value and consisted of the following at December 31, 2014 and 2013:

 

			December 31,
			2014			2013
Accounts receivable - trade		$	—		$	60,000
Allowance for doubtful accounts			—			—
Accounts receivable, net		$	—		$	60,000

 

During the year ended December 31, 2013, we had one significant customer who accounted for 100% of sales.

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

At December 31, 2013, we had one significant customer who accounted for 100% of our accounts receivable. 

 

Note 5: Inventory

 

Inventory is carried at the lower of average cost or market and consisted of the following at December 31, 2014 and 2013:

 

			December 31,
			2014			2013
Raw materials		$	238,441		$	201,098
Finished goods			45,183			46,335
			283,624			247,433
Reserve for obsolescence			—			—
		$	283,624		$	247,433

 

Note 6: Property and Equipment

 

The following is a summary of equipment, at cost, less accumulated depreciation at December 31, 2014 and 2013:

 

			December 31,
			2014			2013
Computers and office fixtures		$	50,342		$	47,817
Machinery and equipment			428,650			424,900
			478,992			472,717
Less accumulated depreciation			475,327			456,800
		$	3,665		$	15,917

 

Depreciation expense for the years ended December 31, 2014 and 2013 was $18,527 and $73,853, respectively. Repairs and maintenance are charged to expense as incurred while improvements are capitalized. Upon the sale, retirement or disposal of fixed assets, the accounts are relieved of the cost and the related accumulated depreciation with any gain or loss recorded to the consolidated statements of operations.

 

Note 7: Patents

 

The following is a summary of patents less accumulated amortization at December 31, 2014 and 2013:

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

			December 31,
			2014			2013
Patents		$	2,980,033		$	2,980,033
Less accumulated amortization			1,632,139			1,466,693
		$	1,347,894		$	1,513,340

 

Amortization expense associated with patents for the years ended December 31, 2014 and 2013 was $165,446 and $165,447, respectively. The estimated future amortization expense related to patents as of December 31, 2014 is as follows:

 

Year Ended December 31.			Amount
2015		$	162,422
2016			160,948
2017			159,347
2018			148,649
2019			135,775
Thereafter			580,753
Total		$	1,347,894

 

Note 8: Liabilities

 

Note Payable

 

In November 2014, the Company issued for cash of $100,000 an unsecured note payable and a five year warrant with an exercise price of $0.09 per share for the purchase of up to 50,000 shares of common stock. The terms of the note are a repayment of $115,000 if paid by February 18, 2015 and, if paid thereafter, the principal balance of the note is to be increased to $115,000 and interest will accrue at 20% from February 18, 2015 until paid. The imputed annual rate of interest was calculated to be 59.5%. The warrant was valued at $1,659 using the Black-Scholes Pricing Model and was recorded as additional paid-in capital and expensed to non-cash interest.

 

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 was repaid in nine equal monthly installments of $5,000. At December 31, 2014, the note had been paid in full. Of the 500,000 shares issued, 312,500 shares were issued for prepaid expenses in an amount of $15,625 which was 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 Debt

 

 SpectraScience, Inc. and Subsidiaries
Notes to Consolidated Financial Statements (continued)

As of December 31, 2014, 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 ranging from 5% to 10% 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. During the year ended December 31, 2013, Debentures with accumulated principal of $564,213 and accrued interest of $62,155 were exchanged for Debentures with accumulated principal of $626,368. Debentures issued subsequent to March 31, 2013 do not contain such an exchange clause.

As of December 31, 2014 and 2013, the balances of the Debentures are as follows:

			December 31,
			2014			2013
Balance at beginning of period		$	2,951,629		$	1,129,473
Issuance of debentures for cash			2,506,376			2,122,000
Original issue discount			128,071			111,685
Debentures surrendered in exchange transactions			—			(564,213	)
Debentures issued in exchange transactions			—			626,368
Debentures converted to common stock			(1,089,474	)		(473,684	)
Convertible debt			4,496,602			2,951,629
Less unamortized costs of financing			576,502			644,518
Convertible debt, net of unamortized costs		$	3,920,100		$	2,307,111
Convertible debt in default		$	1,862,160		$	1,324,212

Derivative Liability

 

Since the Company issued Convertible Debentures which included Holders 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.

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

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 the Company’s control. The resulting effect on net loss is therefore subject to significant fluctuation and will continue to be so until the Company’s Debentures, to which the convertible feature is associated, are converted into common stock or paid in full. 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.

 

As of December 31, 2014 and 2013, the balances of the Derivative Liability are as follows:

						Conversion
			Warrants			Feature			Total
Balance at January 1, 2013		$	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 year end			(1,688,671	)		(1,126,094	)		(2,814,765	)
Elimination of liability on conversion			—			(107,639	)		(107,639	)
Balance at December 31, 2013			803,484			300,939			1,104,423
Change in fair value at period end			(38,526	)		(4,058	)		(42,584	)
Balance at December 31, 2014		$	764,958		$	296,881		$	1,061,839

 

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 years ended December 31, 2014 and 2013, $1,027,583 and $718,251 were recorded as additional paid-in capital related to the initial valuation of debt discounts and warrants associated with new debentures entered into subsequent to March 3l, 2013.

 

Note 9: Income Taxes

 

The significant components of deferred tax assets as of December 31, 2014 and 2013 are shown below. A valuation allowance has been established to offset the deferred tax assets, as realization of such assets is uncertain.

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

  

			December 31,
			2014			2013
Excess of financial accounting over tax depreciation		$	31,000		$	54,000
State income tax benefits			2,093,000			2,166,000
Net operating loss carryforward			12,686,000			12,181,000
Allowance for obsolete inventory			—			—
Allowance for bad debts, returns and discounts			—			—
Warranty expense			5,000			12,000
Derivative liability expense			1,550,000			878,000
Research and development credit carryforwards			607,000			538,000
Patent amortization			(537,000	)		(603,000	)
Vacation accrual			10,000			3,000
Other			—			(356,000	)
Valuation reserve			(16,445,000	)		(14,873,000	)
Net deferred tax asset		$	—		$	—

 

The following reconciles the tax provision with the expected provision obtained by applying statutory rates to pretax income:

 

			December 31,
			2014			2013
Federal income tax benefit computed at the Federal statutory rate		$	(1,788,000	)	$	(1,055,900	)
State income tax expense benefit net of Federal benefit			31,000			(273,700	)
Federal net operating loss carry-forward			(766,000	)		564,000
Tax valuation allowance			1,572,000			308,100
Permanent differences			37,000			56,000
Research and development credit			(69,000	)		(51,400	)
Other			983,000			452,900
Income tax benefit		$	—		$	—

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

The components of federal income tax benefit from continuing operations consisted of the following for the year ended:

 

			December 31,
			2014			2013
Current income tax expense (benefit):
Federal		$	—		$	—
State			—			—
Net current tax expense (benefit)		$	—		$	—
Deferred tax expense (benefit) resulted from:
Difference between financial and tax depreciation		$	14,000		$	6,000
State income tax benefits			31,000			(21,100	)
Net operating (loss) income			(766,000	)		(564,000	)
Research and development credits			(69,000	)		(21,000	)
Allowance for obsolete inventory			—			(13,000	)
Amortization of patents			(66,000	)		66,000
Derivative liability recognition			(623,000	)		191,000
Vacation accrual			(7,000	)		17,000
Warranty expense			7,000			—
Allowance for bad debts, returns and discounts			—			31,000
Other			(93,000	)		—
Valuation reserve			1,572,000			308,100
Net deferred tax benefit		$	—		$	—
		$	—		$	—

 

 At December 31, 2014, the Company had federal net operating loss carry-forwards of approximately $37,300,000 that expire from 2018 through 2034.  In addition, the Company had research and development tax credits of approximately $544,000 that expire from 2018 through 2034. As a result of previous stock transactions, the Company's ability to utilize its net operating loss carry-forwards to offset future taxable income and utilize future research and development tax credits is subject to certain limitations under Section 382 and Section 383 of the Internal Revenue Code due to changes in equity ownership of the Company.

 

The Company has a history of operating losses and, as of yet, has not had any taxable income. The Company has calculated a deferred tax asset for its tax credits but offsets the tax asset with a valuation allowance. As a result, the Company has not realized or recorded any tax benefit related to its tax credits.

 

Note 10: Lease Obligations

 

The Company leases its principal facility from an unrelated third party. The facility consists of approximately 5,080 square feet of office, research and development, manufacturing, quality testing, and warehouse space. The lease provides for monthly rental payments ranging from $4,826 in 2014 to $5,432 in 2018 plus an additional shared estimated facility cost of approximately $1,500 per month. Lease expense for the years ended December 31, 2014 and 2013 amounted to $77,770 and $73,843, respectively. The following is a schedule of minimum annual rental payments for the next five years:

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

 

Years ending December 31,
2015		$	59,649
2016			61,439
2017			63,282
2018			21,727
Thereafter			—
Total minimum lease payments		$	206,097

 

Note 11: Equity Transactions

 

Series B Convertible Preferred Stock

 

 

There are authorized and outstanding 2,585,000 shares of Series B Convertible Preferred Stock (“Series B”). The Series B is convertible at $0.20 per common share and carries a liquidation preference of a like amount. At December 31, 2014 and 2013, the Series B had accumulated and unpaid dividends of $106,931.

 

 

Series C Convertible Preferred Stock

 

 

There were authorized and outstanding at December 31, 2014, 500,000 shares of Series C Convertible Preferred Stock (“Series C”). In April 2013, 500,000 shares of the Series C was converted into 500,000 shares of common stock. The remaining 500,000 shares of Series C outstanding at December 31, 2014 carries a liquidation preference of a like amount.

 

Common Stock

 

In February 2014, an affiliate of the Company exercised a stock option with an exercise price of $0.02 per share for 931,200 shares of common stock.

 

In March 2014, the Company issued 310,000 shares of restricted common stock to one vendor for services. The fair value of these shares was determined to be $15,500. In June 2014, the Company issued 690,000 shares of restricted common stock to one vendor for services. The fair value of these shares was determined to be $34,500.

 

During the year ended December 31, 2014, holders of Convertible Debentures with a face value of $1,089,474 converted their debentures into 22,315,196 shares of restricted common stock. In addition, associated with these debentures, the Company paid $176,332 in accrued interest by issuing 3,396,827 shares of restricted 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 $192,000. 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 $52,500. In November 2013, the Company issued 300,000 shares of restricted common stock to two vendors for services. The fair value of the vested portion of these shares was determined to be $12,000.

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

During the year ended December 31, 2013, holders of Convertible Debentures with a face value of $473,684 converted their debentures into 8,266,737 shares of restricted common stock. In addition, associated with these debentures, the Company paid $59,365 in accrued interest by issuing 915,652 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 prepaid expenses 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

 

During 2014, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $2,634,447 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.045, together with five-year warrants to purchase approximately 29,271,670 common shares at an exercise price equal to $0.09 per share.

 

From February through July 2013, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $917,895 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.0573, together with five-year warrants to purchase approximately 8,010,000 common shares at an exercise price equal to $0.0745 per share.

 

From September through December 2013, the Company entered into subscription agreements with accredited investors to purchase an aggregate principal amount of $1,315,790 of Convertible Debentures initially convertible into shares of common stock at a conversion price of $0.045, together with five-year warrants to purchase approximately 14,620,000 common shares at an exercise price equal to $0.09 per share.

 

Stock Options

 

As of December 31, 2014, the Company had one stock-based employee compensation plan under which it makes grants, the 2011 Equity Incentive Plan (the “EIP”) which has been approved by our shareholders in August 2014. 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. At December 31, 2014, the Company had outstanding options to purchase up to 34,293,800 shares of common stock under the EIP and the Company’s prior Amended 2001 Stock Plan representing approximately 17.6% of the Company’s outstanding shares (14,526,142 of which were exercisable). 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. Management used the following weighted average assumptions to value stock options granted during the years ended December 31, 2014 and 2013:

 

 SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

			Year Ended December 31,
			2014			2013
Expected term of options			5 years			None
Exercise price			$0.02			None
Expected volatility			187%			None
Expected dividends			None			None
Risk-free interest rate			1.64%			None
Forfeitures			None			None

 

 In addition to the above, management estimated the forfeitures on employee options under the Option Plan would have negligible effects because such forfeitures would be a very small percentage. Management believes that options granted 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. Risk-free interest rates used are the five-year U.S. Treasury rate as published for the applicable measurement dates.

 

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.

  

A summary of the status of the options granted under the Company’s 2011 EIP at December 31, 2014 and 2013, and changes during the years then ended is presented below:

 

						Outstanding Options
			Options
			Shares			Weighted Average Exercise Price			Weighted Average Fair Value			Weighted Average Remaining Contractual Terms in Years
Outstanding, December 31, 2012			19,491,667		$	0.18						8.20
Granted			—			—
Cancelled			(4,416,667	)	$	0.33
Exercised			—			—
Outstanding, December 31, 2013			15,075,000		$	0.14						6.94
Granted			35,550,000		$	0.02		$	0.02
Exchanged			(14,225,000	)	$	0.14
Cancelled			(1,175,000	)	$	0.08
Exercised			(931,200	)	$	0.02
Outstanding, December 31, 2014			34,293,800		$	0.02						8.99
Exercisable, December 31, 2013			10,510,313		$	0.15						6.45
Exercisable, December 31, 2014			14,526,142		$	0.02						8.95

 

There was no intrinsic value of the options outstanding under the EIP at December 31, 2014 and 2013.

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

A summary of the status of the options outstanding under the EIP at December 31, 2014, is presented in the table below:

 

					Outstanding									Exercisable
		Range of Exercise Prices			Number Outstanding			Weighted Average Remaining Contractual Life			Weighted Average Exercise Price			Number Exercisable			Weighted Average Exercise Price
	Options
	$	0.02			33,868,800			9.03		$	0.02			14,142,809		$	0.02
	$	0.06			200,000			6.85		$	0.06			158,333		$	0.06
	$	0.15			200,000			5.96		$	0.15			200,000		$	0.15
	$	0.90			25,000			0.28		$	0.90			25,000		$	0.90
					34,293,800			8.99		$	0.02			14,526,142		$	0.02

 

There was one stock option exercised for 931,200 common shares during the year ended December 31, 2014 and none exercised during the year ended December 31, 2013. At December 31, 2014, total unrecognized estimated employee and director compensation cost related to stock options granted is $497,711, which is expected to be recognized over the next three to four years.

  

Warrants

 

During the year ended December 31, 2014, in conjunction with the sale of Convertible Debentures and Notes, the Company issued five-year common stock purchase warrants with an exercise price of $0.09 per share to acquire 29,346,670 shares to holders of the Debentures and 1,111,111 similar warrants as compensation to Agents.

 

During the year ended December 31, 2013, in conjunction with the sale of Convertible Debentures, the Company issued five-year common stock purchase warrants to acquire approximately 22,629,000 shares to holders of the Debentures and 2,880,000 similar warrants as compensation to Agents. Of these warrants, approximately 10,385,000 have an exercise price of $0.0745 per share and approximately 15,124,000 have an exercise price of $0.1287 per share.

 

A summary of the status of the warrants granted under various agreements at December 31, 2014 and 2013, and changes during the years then ended is presented below:

 

  

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

			Warrants
			Shares			Weighted Average Exercise Price			Weighted Average Fair Value
Outstanding, December 31, 2012			59,066,992		$	0.18
Granted			25,509,506		$	0.08		$	0.05
Expired on exchange to new warrant			(4,024,286	)	$	0.11
Issued on exchange to new warrant			7,377,582		$	0.09
Exercised			—
Outstanding, December 31, 2013			87,929,794		$	0.15
Granted			30,457,781		$	0.09		$	0.03
Expired			(14,957,500	)	$	0.31
Exercised			—
			103,430,075		$	0.11
Outstanding, December 31, 2014
Exercisable, December 31, 2013			87,929,794		$	0.15
Exercisable, December 31, 2014			103,430,075		$	0.11

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

A summary of the status of the warrants outstanding at December 31, 2014 are presented in the table below:

 

					Outstanding									Exercisable
		Range of Exercise Prices			Number Outstanding			Weighted Average Remaining Contractual Life			Weighted Average Exercise Price			Number Exercisable			Weighted Average Exercise Price
	Warrants
	$	0.0745			39,333,936			2.52		$	0.07			39,333,936		$	0.07
	$	0.08-0.09			50,413,846			4.18		$	0.09			50,413,846		$	0.09
	$	0.1287			4,222,599			2.95		$	0.13			4,222,599		$	0.13
	$	0.30-0.35			9,459,694			0.44		$	0.31			9,459,694		$	0.31
					103,430,075			3.16		$	0.11			103,430,075		$	0.11

 

Note 12: 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 Black Scholes 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.

 

The following table presents the balances of liabilities measured at fair value on a recurring basis by level as of December 31, 2014:

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

			Fair Value Measurements at December 31, 2014 Using
			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Derivative liability		$	—		$	—		$	296,881		$	296,881
Warrant liability			—			—			764,958			764,958
Total		$	—		$	—		$	1,061,839		$	1,061,839

 

			Fair Value Measurements at December 31, 2013 Using
			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
Derivative liability		$	—		$	—		$	300,939		$	300,939
Warrant liability			—			—			803,484			803,484
Total		$	—		$	—		$	1,104,423		$	1,104,423

 

 

The following table presents changes in the liabilities with significant unobservable inputs (Level 3) for the years ended December 31, 2014 and 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
Elimination of liability on conversion			—			(107,639	)		(107,639	)
Change in estimated fair value (1)			(1,688,671	)		(1,126,094	)		(2,814,765	)
Balance December 31, 2013			803,484			300,939			1,104,423
Change in estimated fair value (1)			(38,526	)		(4,058	)		(42,584	)
Balance December 31, 2014		$	764,958		$	296,881		$	1,061,839

 

(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 year ended December 31, 2014:

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

		12/31/2014				12/31/2013
		Derivative Liability		Warrant Liability		Derivative Liability		Warrant Liability
Expected term		6 months - 1 year		5 years		6 months - 1 year		5 years
Exercise price		$0.045 - $0.099		$0.075 - $0.1287		$0.045 - $0.099		$0.075 - $0.1287
Expected volatility		232% to 242%		189% to 199%		70% - 244%		175% - 186%
Expected dividends		None		None		None		None
Risk-free interest rate		0.10% to 0.25%		1.62% to 1.78%		.04% - .14%		.77% - 1.75%
Forfeitures		None		None		None		None

 

In computing the fair value of the derivative and warrant liability at December 31, 2014 for instruments under the Binomial Lattice option-pricing model, management estimated a 60% probability of a down round financing event at a price of $0.036 and an 11% to 45% probability that existing note holders with exchange privileges would exchange their existing debentures and warrants for new debentures and warrants. At December 31, 2013, in computing the fair value of the derivative and warrant liability for instruments under the Binomial Lattice option-pricing model, management assumed a 40% probability of a down round financing event at various assumed stock prices.

 

Note 13: Loss Per Share

 

Basic and diluted loss per share are the same for the fiscal years ended December 31, 2014 and 2013, since any additional common stock equivalents would be antidilutive. Potentially dilutive shares of common stock that have been excluded from the calculation of the weighted average number of dilutive common shares for the years ended December 31, 2014 and 2013 are as follows: 

			Year Ended December 31,
			2014			2013
Preferred Stock			3,085,000			3,085,000
Convertible debentures			92,264,257			56,036,190
Options			34,293,800			15,075,000
Warrants			103,430,075			87,929,794
Total			233,073,132			162,125,984

 

The following table sets forth the computation of basic and diluted earnings per share

for the years ended December 31, 2014 and 2013:

 

 

SpectraScience, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (continued)

 

			Year Ended
			December 31,
			2014			2013
Numerator:
Net loss for basic earnings per share		$	(4,488,281	)	$	(2,749,645	)
Net loss for diluted earnings per share		$	(4,488,281	)	$	(2,749,645	)
Denominator:
Weighted average basic shares outstanding			170,237,633			160,015,532
Denominator for diluted earnings per share-adjusted weighted average shares			170,237,633			160,015,532
Loss per share
Basic		$	(0.03	)	$	(0.02	)
Diluted		$	(0.03	)	$	(0.02	)

 

Note 14: Subsequent Events

 

Convertible Debentures and Warrants

 

From January 2015 through March 2015, the Company sold $277,778 of an Unsecured Convertible Debenture (the “Debenture”) to an accredited investor for aggregate consideration of $250,000. The Debenture matures in twelve months, carries a fixed conversion price of $.045, an annual interest rate of 10% and is convertible into 6,172,844 shares of common stock at maturity. The Company received net cash proceeds of approximately $230,000 after payment of fees and expenses of $20,000. In addition, the Company issued the holder of the Debenture a detachable five-year warrant to purchase 3,086,420 additional shares of common at an exercise price of $0.090 per share.

 

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

 

  

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

                        None.

                         

ITEM 9A.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 the 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 effective as of the Evaluation Date.

 

Evaluation of Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). The Company’s 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 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 the financial statements.

 

Under supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework within the Internal Control-Integrated Framework, management concluded that our internal control over financial reporting was effective as of December 31, 2014.

 

Management’s assessment of the effectiveness of our internal control over financial reporting as of December 31, 2014 has not been attested to by HJ Associates & Consultants LLP, the Company’s independent registered public accounting firm, as stated in their report which is included herein pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report within this annual report.

 

Changes in Internal Financial Controls

 

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

 

ITEM 9B. OTHER INFORMATION.

 

None.

 

  

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.

 

The following information is provided with respect to the directors and officers of the Company:

 

Name		Age		Director/Officer Since
Michael P. Oliver, President and Chief Executive Officer, Director		66		2011/2010
Lowell W. Giffhorn, Chief Financial Officer and Secretary		68		2013
Mark McWilliams, Chairman of the Board		58		2004
Sheldon L. Miller, Director		78		2010
Stanley Pappelbaum, M.D., Director		77		2006
Chester E. Sievert, Director		63		2004
F. Duwaine Townsen, Director		81		2009
Rand Mulford		71		2014

 

Michael P. Oliver, President and Chief Executive Officer, Director, joined SpectraScience as President and Chief Executive Officer in November 2010, and was elected a director in 2011. Prior to joining the Company and since 2007, Mr. Oliver was Executive Vice President for Worldwide Marketing and Business Development for Silicon Border Development, a privately-owned developer of industrial properties for high technology companies. From 2004 to 2007, Mr. Oliver was a Senior Vice President at Thomas Group, a consultancy that specialized in operational improvement. From 1998 to 2003, Mr. Oliver was engaged as in a business development role with PricewaterhouseCoopers working with medical device and technology companies. From 1990 to 1998 Mr. Oliver was a member of four separate management teams that took struggling medical device companies, increased their revenues and profitability and sold them to strategic buyers. In those companies he served in the capacity of head of sales and marketing and, in two cases, had major operational responsibilities as well. He began his career with American Hospital Supply Corporation serving in a variety of sales, marketing and general management positions. Mr. Oliver received his MSA from George Washington University and his BS from the United States Naval Academy. The Board believes that Mr. Oliver’s experience in the medical device and technology industries, as well as his success in increasing revenues for medical device companies, make Mr. Oliver a valuable resource for the Board.

 

Lowell W. Giffhorn, Chief Financial Officer and Secretary, joined the Company as Chief Financial Officer and Secretary in September 2013.Since 2005, Mr. Giffhorn has served as the Chief Financial Officer and Director of Brendan Technologies, Inc., a developer and marketer of computational analytical software products for the biopharmaceutical industry. Also since 2005, he serves as the Chief Financial Officer of Imagenetix, Inc., a publicly held nutritional supplement company. He was the Chief Financial Officer from 1997 to 2005 and a member of the Board of Directors from 1999 to 2006 of Patriot Scientific Corporation, a publicly held microprocessor and intellectual property firm. From 1992 to 1996 and from 1987 to 1990 he was the CFO of Sym-Tek Systems, Inc. and Vice President of Finance for its successor, Sym-Tek Inc., a supplier of capital equipment to the semiconductor industry. Previous to 1987, he held various financial management positions in industries including defense contracting, hospitality, and public accounting. He obtained a M.B.A. degree from National University in 1975 and a B.S. in Accountancy from the University of Illinois in 1969. He was also a director and chairman of the audit committee of DND Technologies, Inc., a publicly held company, until it was acquired in 2009. Mr. Giffhorn devotes approximately 50% of his time to our affairs.

 

Mark McWilliams, Director. Since June 2007, Mr. McWilliams has served as the CEO of Medipacs, Inc., a development stage infusion pump company. From December 2003 to November 2005, Mr. McWilliams was Director of Cell Imaging and Analysis at Beckman Coulter after the sale of Q3DM to Beckman in December 2003. He was President and Chief Executive Officer and Director of Q3DM, from October 2001 to December 2003, a life-sciences startup that raised several angel and venture capital funding rounds that was acquired by Beckman Coulter. Previously, he was founder and COO of Medication Delivery Devices (“MDD”), an alternate care infusion systems company that was acquired by Baxter Healthcare in 1996. Mr. McWilliams served as a VP of Research and Development at Baxter Healthcare for three years following the sale of MDD. Prior to MDD, he served as Product Development Manager at the founding of Block Medical where he was responsible for bringing the company’s first two FDA approved products rapidly to market. Block was sold to Hillenbrand Industries in 1991. He previously worked for Hughes Aircraft, Vacuum General and Martin Marietta. Mr. McWilliams brings his expertise in managing and growing small technology companies and his strong network of contacts within the medical devices industry, to the Board of Directors. He earned his MSME from the Massachusetts Institute of Technology, his BSME from Northeastern University and holds eight utility patents.

 

 

Sheldon L. Miller, Director . Sheldon L. Miller has been a litigator and expert counsel for more than forty years and in private practice for more than 30 years. Mr. Miller has operated the Law Office of Sheldon Miller, PC for the past 30 years. Mr. Miller was a member of the Board of Governors of the American Trial Lawyers Association from 1977 through 2009 (longest tenure in history). From 1979 through 1992, he was the President of the Mediation Tribunal Association in Wayne County (Detroit), Michigan. In 1971, he pioneered the concept of mediation and was the first mediator on behalf of the Plaintiff’s Bar in the State of Michigan. Mr. Miller was also the first to prosecute and articulate the concept of “comparative negligence” in the State of Michigan. Mr. Miller graduated from Wayne State University Law School in Detroit in 1961. Mr. Miller brings his considerable experience in legal risk analysis and responsibility to the Board of Directors.

 

Stanley J. Pappelbaum M.D., Director. Dr. Pappelbaum has been Managing Partner of Pappelbaum, Turner & Associates, a national healthcare consultancy company that advises hospital, medical group, health insurance, and governmental healthcare clients, since 2000. Dr. Pappelbaum joined Scripps hospital in 1996 as Chief Transformational Officer in charge of creating and implementing Scripps’ strategic vision of the future. In 1997, he was promoted to Executive Vice President and Chief Operating Officer and, in 1999, he was promoted to President and Chief Executive Officer when the hospital reached annual revenues of over $1 billion. From 1985 to 1995, he was the managing partner of Professional Health Consulting Group, a national company of physician executives that analyzed and managed change for complex not-for-profit healthcare systems clients throughout the United States. From 1969 to 1984, Dr. Pappelbaum taught and practiced Pediatric Cardiology at the University of California, San Diego and at San Diego Children’s Hospital, where he was Chief of Pediatric Cardiology from 1972 to 1978. Dr. Pappelbaum completed his undergraduate work at McGill University in Montreal and received his medical degree from the University of British Columbia Faculty of Medicine in Vancouver. He completed his residency in pediatric medicine at Montreal Children’s Hospital of McGill University and did graduate studies in cardiovascular physiology and a fellowship in pediatric cardiology at the University of California, Los Angeles. He also was awarded an Alfred P. Sloan Fellowship at the Massachusetts Institute of Technology, where he earned a Master's degree in management (health option). Dr. Pappelbaum brings his intimate knowledge of the healthcare industry and familiarity with recent changes in the healthcare environment to the Board of Directors.

 

Chester E. Sievert, Jr., Director. Mr. Sievert has been President of Advanced Photodynamic Technologies since January 2003. He previously worked at SpectraScience as a consultant in June 1996, and subsequently held various executive positions. Mr. Sievert served as Chairman of the Board of SpectraScience beginning in June 1999. He served as President from March 1998, and Chief Executive Officer from January 1999 until December 2001. He then became Executive Vice President of Technology and Chairman of the Board until September 2002. Prior to joining SpectraScience, Mr. Sievert was a founder and President of two medical product companies: ReTech, Inc., from 1980 to 1986, and FlexMedics Corporation, from 1986 to 1995. Both companies were sold to American Endoscopy, Inc. and Phillips Plastics Corporation, respectively. As a former Senior Research Health Scientist on staff at the University of Minnesota Medical School and the Veterans Administration Medical Center, Mr. Sievert has published more than 50 medical journal articles in the fields of gastroenterology, endoscopy and fiber optics. He has also been awarded eight United States and international patents. Mr. Sievert has a Bachelor of Science Degree in Comparative Physiology from the University of Minnesota.   Mr. Sievert brings his significant experience in the application of light based and fluorescence technologies in the medical field to the Board of Directors, as well as his significant management experience and legacy understanding of the Company.

 

F. Duwaine Townsen, Director.  Mr. Townsen co-founded and has been the Managing Partner of EndPoint Late-Stage Fund of San Diego since 1999. This fund invests exclusively in late-stage life science companies. Mr. Townsen co-founded the Ventana Growth Funds in 1982 and served as the group’s Managing Partner directing investments in early and middle stage life-science, high-technology and telecommunications companies. Prior to this, Mr. Townsen was the CEO and Chairman of Kay Laboratories, Inc., a medical device company, where he led the company through a successful IPO in 1978 and subsequent sale to American Hospital Supply Corporation in 1981. Following his public accounting experience, Mr. Townsen became a founder and Chief Financial Officer of Oceanographic Engineering Corporation and guided the company to profitability and its sale to Dillingham Corporation in 1967.  Mr. Townsen serves as a director on the board of Sequal Technologies, a privately held high-technology company and has held numerous directorships at private and public companies, some of which included Agouron Pharmaceuticals, Inc., Brooktree Corporation, Cymer, Inc. and Maxim Pharmaceuticals, Inc.  Mr. Townsen began his career with Arthur Young & Co. after graduating from San Diego State University. Mr. Townsen brings his specific public accounting environment and public markets experience to the Board of Directors, as well as his deep expertise related to corporate governance and fiduciary responsibility issues.

 

 

Rand Mulford, Director.  Mr. Mulford has for the past five years successfully completed a variety of projects including managing M&A transactions, developing strategy for companies in therapeutic antibodies, cell-based therapy for eye diseases, prescription drug distribution, and developing a potential cure for AIDS. Previously, Mr. Mulford had joined with two other partners to found a specialty pharmaceutical company. Before that, he was E.V.P for Strategy with Chatham Capital and Forest Health Services, a for-profit chain of hospitals. For two years, Mr. Mulford worked with a venture capital firm working directly with four portfolio companies. His corporate experience includes: Group V.P. of planning and control for a petrochemical company; head of corporate planning at Merck; C.F.O. of a human tissue company; C.O.O. of a drug discovery company and president of its subsidiary, a research chemical company; C.O.O. of a diagnostics company; Chairman of the Board of a medical device company; and head of the corporate development at a bio-pharmaceutical company. Mr. Mulford started his business career with the consulting firm of McKinsey & Co. During an eight-year period, he served about twenty clients working on a variety of issues primarily related to strategy and organization. Rand obtained a bachelor’s degree in engineering with honors from Princeton University in 1965. For the next five years he served as a naval officer in the nuclear submarine program. Subsequently, he earned an M.B.A. with high distinction at Harvard Business School.  Mr. Mulford brings his past financial and operational expertise to the Board of Directors.  

 

Our Board of Directors has the responsibility for establishing broad corporate policies and for overseeing our overall performance. Members of the Board are kept informed of our business activities through discussions with the CEO and other officers, by reviewing analyses and reports sent to them, and by participating in Board and committee meetings. Our bylaws provide that each of the directors serves for a term that extends until resignation or replacement.

 

Code of Ethics. The Company has adopted a code of ethics applicable to its chief executive officer, senior financial officer and other employees. The code is available at no charge by request to the Company in writing, to the attention of the CFO. The Code is also available on the Corporate Governance section of the Company’s website at www.spectrascience.com . The Company intends to satisfy Form 8-K disclosure requirements by including on its website any amendment to, or waiver from, a provision of its Ethics or Code of Conduct policy that applies to the principal executive officer, principal financial officer, principal accounting officer and controller that relates to any element of the code of ethics definition enumerated in Item 406(b) of Regulation S-K under the Securities Act of 1933.

 

 

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

 

Section 16(a) of the Securities Exchange Act of 1934 requires the Company’s executive officers and directors, and persons who own more than ten percent of the Company’s Common Stock, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than ten percent shareholders (“Insiders”) are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms they file.

 

To the Company’s knowledge, based on a review of the copies of such reports furnished to the Company during the fiscal year ended December 31, 2014, all Section 16(a) filing requirements applicable to Insiders were complied with.

 

  

Audit Committee Financial Expert. The Audit Committee of the Board of Directors is comprised of four non-employee directors; F. Duwaine Townsen (Chairman), Mark McWilliams, Rand Mulford and Dr. Stanley Pappelbaum. The Board of Directors has determined that Mr. Townsen is an audit committee financial expert and is independent as defined under NASDAQ Rule 5605(a)(2).

 

ITEM 11. EXECUTIVE COMPENSATION

 

Summary Compensation Table for 2014

 

     The following table summarizes compensation awarded to, earned by or paid to the Company’s Chief Executive Officer and other executive officers who were “Named Executive Officers” during the years ended December 31, 2014 and 2013.

 

Name and Principal Position			Fiscal Year			Salary ($)			Bonus ($)			Option Awards ($)			All Other Compensation ($)			Total ($)
Michael P. Oliver (1)			2014		$	241,667		$	—		$	239,014		$	—		$	480,681
President, CEO and Director			2013		$	197,000		$	—		$	—		$	—		$	197,000
			2012		$	225,000		$	—		$	211,779		$	—		$	436,779
Lowell W. Giffhorn (2)			2014		$	90,000		$	—		$	89,630		$	—		$	179,630
CFO and Secretary

  

(1)		Mr. Oliver was appointed President and CEO on November 29, 2010. In January 2014, we entered into an employment agreement with Mr. Oliver. Per the terms of the agreement, Mr. Oliver’s base salary was $225,000 per year until the company accumulated at least $2,000,000 of equity financing in one transaction or $3,000,000 in the aggregate at which time his base salary was increased to $325,000 per year. He will be entitled to an annual bonus of up to 50% of his base salary based on performance criteria to be determined by the Board of Directors. He shall be entitled to 12 month’s severance pay if terminated for reasons other than cause, as defined in the agreement, and an additional 12 month’s severance if a change in control action, as defined in the agreement, takes place.
(2)		Mr. Giffhorn’s employment with the Company started in September 2013. Mr. Giffhorn devotes approximately 50% of his time to the Company’s affairs.
(3)		The value of each option award is the grant date fair value as determined under FASB ASC Topic 718, Compensation – Stock Compensation, or ASC 718.

 

Pension Benefits. The Company does not have a pension benefit plan.

  

Nonqualified Deferred Compensation. There was no nonqualified deferred compensation in fiscal year 2014 to officers of the Company.

 

Outstanding Equity Awards at Fiscal Year End. The following table describes the outstanding stock option grants to named executive officers at year end. There are no Stock Awards issued or outstanding.

 

 

Name			Number of Securities Underlying Unexercised Options (#) Exercisable			Number of Securities Underlying Unexercised Options (#) Unexercisable			Option Exercise Price ($)			Option Expiration Date
Michael P. Oliver (1)			4,754,167			7,245,833		$	0.02			1/10/2024
President, CEO and
Director
Lowell W. Giffhorn (2)			1,500,000			3,000,000		$	0.02			1/10/2024
CFO and Secretary

 

(1)		Option vests over four years, with 2,600,000 vesting on grant and 195,833 vesting per month for 48 months.
(2)		Option vests over four years, with 1,500,000 vesting on grant and 62,500 vesting per month for 48 months subject to Mr. Giffhorn accepting full-time employment with the Company.

 

Compensation of Directors.

 

The Company does not pay directors for Board of Directors’ meetings or committee meetings attended, but reimburses each such director for reasonable travel and out-of-pocket expenses for attendance at these meetings. Each sitting director is awarded annually a stock option to purchase a number of shares of common stock at an exercise price equal to market price on the date of grant. The number of shares to be granted is determined by the Board of Directors on a recommendation by the Compensation Committee.

 

The options granted to employee and non-employee directors under the EIP expire ten years from the date of grant (subject to earlier termination in the event of death or termination), are not transferable (except by will or the laws of descent and distribution).

 

The following table shows the fair value of the compensation earned by each of our non-employee directors who received stock option grants during the year ended December 31, 2014:

 

  

DIRECTOR COMPENSATION FOR 2014 

			Fees
			Earned
			or
			Paid In			Option
			Cash			Awards			Total
Name			($)			($)			($)
Mark McWilliams		$	—		$	25,893		$	25,893
Sheldon L. Miller		$	—		$	17,926		$	17,926
Stanley Pappelbaum, M.D.		$	—		$	25,893		$	25,893
Chester E. Sievert		$	—		$	25,893		$	25,893
F. Duwaine Townsen		$	—		$	17,926		$	17,926
Rand Mulford		$	—		$	—		$	—

 

The option awards amount represent the value of the current year amortization of stock options issued in prior years. 

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS.

 

Summary of Securities Authorized for Issuance Under Equity Compensation Plans

 

The following table sets forth December 31, 2014 information on our equity compensation plans in effect as of that date:

 

Plan Category			Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)			Weighted average exercise price of outstanding options, warrants and rights (b)			Number of securities remaining available for issuance under equity compensaton plans (excluding securities reflected in column (a)) (c)
Equity compensation
plans approved by
security holders			34,293,800		$	0.02			706,200
Equity compensation
plans not approved
by security holders			—						—
Total			34,293,800		$	0.02			706,200

 

  

EQUITY COMPENSATION PLAN INFORMATION

  

2011 Equity Incentive Plan

 

The Board adopted the 2011 SpectraScience, Inc. Equity Incentive Plan in February 2011 (the “EIP”) it was approved by the shareholders in August 2014. The EIP provides for the grant of ISOs, NSOs, restricted stock awards, restricted unit awards, stock appreciation rights and performance awards to full-time employees (who may also be directors), non-employee directors, consultants, advisors 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. At December 31, 2014, the amount reserved under the EIP is 35,000,000 shares of common stock with stock option grants for 34,293,800 common shares outstanding and 706,200 shares of common stock available for future stock option grants.

 

OWNERSHIP OF COMMON STOCK

 

The following table shows as of March 20, 2015, the stock ownership of (i) all persons known by us to be beneficial owners of more than five percent of our outstanding shares of Common Stock, (ii) each director and each nominee for election as a director, (iii) the Named Executive Officers (as defined above in the section titled “Executive Compensation”), and (iv) all current directors and executive officers as a group.

 

Beneficial ownership of the Common Stock is determined in accordance with the rules of the SEC and includes any shares of Common Stock over which a person exercises shared or sole voting or investment powers, or of which a person has a right to acquire ownership at any time within 60 days of March 20, 2015. Except as otherwise indicated, and subject to applicable community property laws, the persons named in this table have sole voting and investment power with respect to all shares of Common Stock held by them. Applicable percentage ownership in the following table is based on 194,355,277 shares of Common Stock outstanding as of March 20, 2015, plus for each individual, any securities that individual has the right to acquire within 60 days of March 20, 2015.

 

Unless otherwise indicated below, the address of each principal shareholder is c/o SpectraScience, Inc., 11568-11 Sorrento Valley Road, San Diego, California 92121.

 

			Amount of Benefical			Percent of
Name of Beneficial Owner			Ownership (1)			Ownership
Sheldon L. Miller (2)(10)			5,362,363			2.7%
Michael P. Oliver (3)(11)(10)			5,782,332			2.9%
Stanley Pappelbaum M.D. (4)(10)			1,004,733			*
Mark McWilliams (5)(10)			1,490,966			*
Chester E. Sievert (6)(10)			1,156,388			*
F. Duwaine Townsen (7)(10)			654,165			*
Lowell W. Giffhorn (8) (11)			1,500,000			*
Rand Mulford (10)			—			*
All officers and directors as a group (9) (7 persons)			16,950,947			8.2%

  

	**	Less than 1%
	(1)	Beneficial ownership is determined in accordance with Rule 13d-3(a) of the Securities Exchange Act of 1934 and generally includes voting or investment power with respect to securities. Except as indicated by

   

  

   

  

		footnotes and subject to community property laws, where applicable, the person named above has sole voting and investment power with respect to all shares of the Common Stock shown as beneficially owned by him or her.
	(2)	Includes 643,058 shares which may be acquired upon exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015. Also includes warrants to purchase 985,000 shares of Common Stock.
	(3)	Includes 5,733,332 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015.
	(4)	Includes 954,733 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015.
	(5)	Includes 123,736 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015. Also includes warrants to purchase 273,808 shares of Common Stock.
	(6)	Includes 1,051,388 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015.
	(7)	Includes 654,165 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015.
	(8)	Includes 1,500,000 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015.
	(9)	Includes 10,660,412 shares which may be acquired upon the exercise of options which are currently exercisable or which become exercisable within 60 days of March 20, 2015. Also includes warrants to purchase 1,258,808 shares of Common Stock.
	(10)	Director
	(11)	Executive Officer

  

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

Related Party Transactions

 

There have been no transactions during the last two fiscal years to which we have been a party in which the amount involved exceeded 1% of the Company’s average total assets for the last two fiscal years and in which any of our executive officers, directors or beneficial holders of more than 5% of our capital stock had or will have a direct or indirect material interest.

 

Director Independence

 

Although the Company is not listed on a national securities exchange, the Company has chosen to evaluate independence based upon the NASDAQ listed company rules. The Company has determined that Messrs. McWilliams, Miller, Pappelbaum, Sievert, Mulford and Townsen are independent under NASDAQ Rule 5605(a)(2). Mr. Oliver is not independent under NASDAQ Rule 5605(a)(2) because he has an employment relationship with the Company. Other than Mr. Oliver, the remaining directors of the Company are independent in that they have no relationship to the corporation that may interfere with the exercise of their independence from management and the Company. No independent director has a business or family relationship with another director to the best of management’s knowledge.

 

  

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.

 

Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditor

 

Our audit committee of the Board of Directors is responsible for pre-approving all audits and permitted non-audit services to be performed for us by our independent auditor.

 

Our Audit Committee must pre-approve all audit services, engagement fees and terms, and all permitted non-audit engagements, subject to the de minimus exceptions permitted pursuant to the Securities Exchange Act of 1934. All audit-related fees were approved by our Audit Committee in fiscal 2014.

 

Independent Public Accountants’ Fees.   During 2014, we changed our independent public accounting firm to HJ Associates & Consultants, LLP who audited our consolidated financial statements for the year ended December 31, 2014 and 2013. The firm of McGladrey LLP, independent public accountants, reviewed our consolidated financial statements for the quarter ended March 31, 2013. 

 

The following table presents fees for professional services rendered for the two most recent fiscal years.

 

			HJ Associates & Consultants LLP						McGladrey LLP
Fee category			2014			2013			2013
Audit fees		$	64,000			54,000		$	39,000
Audit-related fees		$	—			—		$	—
Tax fees		$	2,250			—		$	—
All other fees		$	—			—		$	—
Total fees		$	66,250			54,000		$	39,000

 

(1)		Audit fees include fees billed and expected to be billed for professional services rendered for the audit of our annual consolidated financial statements for the fiscal years ended December 31, 2014 and 2013, the review of our financial statements included in our reports on Form 10-Q, and accounting consultations necessary for the rendering of an opinion on our consolidated financial statements.
(2)		Audit-related fees include fees billed and expected to be billed for professional services rendered primarily for consultation and review of securities registration filings and related consents for the fiscal years ended December 31, 2014 and 2013.

 

 

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)	Documents filed as part of this report.
	(1)	Financial Statements. The following financial statements are included in Part II, Item 8 of this Annual  Report on Form 10-K:
		Reports of Independent Registered Public Accounting Firms
		Consolidated Balance Sheets as of December 31, 2014 and 2013
		Consolidated Statements of Operations for the years ended December 31, 2014 and 2013
		Consolidated Statements of Shareholders’ Equity from December 31, 2012 to December 31, 2014
		Consolidated Statements of Cash Flows for the years ended December 31, 2014 and 2013
		Notes to Consolidated Financial Statements
	(2)	Financial Statement Schedules. Not applicable.
	(3)	Exhibits. See “Exhibit Index to Form 10-K” immediately following the signature page of this Form 10-K for a description of the documents that are filed as Exhibits to this report or incorporated by reference herein.

 

 

 

 

SIGNATURES

 

Pursuant to the requirements of Sections 13 and 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.

 

	SpectraScience, Inc. (Registrant)
Date: March 20, 2015	By:	/s/   Michael P. Oliver
		Michael P. Oliver - President and Chief Executive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

/s/ Michael P. Oliver
Michael P. Oliver		Date: March 20, 2015
President and Chief Executive Officer, Director (Principal Executive Officer)
/s/ Lowell W. Giffhorn
Lowell W. Giffhorn		Date: March 20, 2015
Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)
/s/ Mark D. McWilliams
Mark D. McWilliams		Date: March 20, 2015
Director
/s/ Stanley J. Pappelbaum
Stanley J. Pappelbaum		Date: March 20, 2015
Director
/s/ Chester E. Sievert
Chester E. Sievert		Date: March 20, 2015
Director
/s/ Duwaine Townsen
Duwaine Townsen		Date: March 20, 2015
Director
/s/ Sheldon L. Miller
Sheldon L. Miller		Date: March 20, 2015
Director
/s/ Rand Mulford
Rand Mulford   Director		Date: March 20, 2015

 

  

SPECTRASCIENCE, INC.

EXHIBIT INDEX

FORM 10-K FOR FISCAL YEAR 2014

 

Exhibit  No.		Description
2.1		Stock Purchase Agreement by and among the Company, Euclid Partners IV, L.P., EuclidSR Partners, L.P., EuclidSR Biotechnology Partners IV, L.P., Stephen L. Watson and Ross Flewelling (Incorporated by reference to exhibit 2.1 to the Company’s Report on Form 8-K filed on November 13, 2007)
3.1		Certificate of Amendment to Articles of Incorporation (Incorporated by reference to exhibit 3.3 to the Company’s Report on Form 10-Q for the quarter ended December 31, 2009, filed on November 16, 2009)
3.2		Amended and Restated Articles of Incorporation(Incorporated by reference to exhibit 3.1 to the Company Report on Form 8-K filed August 6, 2004)
3.3		Amended Bylaws (Incorporated by reference to exhibit 3.2 to the Company’s Registration Statement on Form S-1 filed on April 30, 2009)
3.4		Certificate of Redesignation of Series C Preferred Stock (Incorporated by reference to exhibit 3.4 to the Company Report on Form 10-K filed April 18, 2013)
4.1		Certificate of Designation of the Relative Rights and Preferences of the Series A Preferred Stock (Incorporated by reference to exhibit 4.1 to the Company’s Report on Form 10-QSB for the quarter ended June 30, 2007, filed on August 14, 2007)
4.2		Warrant to Purchase Series A Preferred Stock of SpectraScience, Inc. (Incorporated by reference to exhibit 4.2 to the Company’s Report on Form 10-QSB for the quarter ended June 30, 2007, filed on August 14, 2007)
4.3		Common Stock Purchase Warrant issued to Placement Agent (Incorporated by reference to exhibit 4.3 to the Company’s Report on Form 10-KSB for the fiscal year ended December 31, 2005, filed on March 31, 2008)
4.4		Certificate of Designation of Rights and Preferences of Series B Preferred stock of SpectraScience, Inc. (Incorporated by reference to exhibit 4.6 to the Company’s Report on Form 8-K filed on November 6, 2009)
4.5		Form of Warrant to Purchase Common Stock of SpectraScience, Inc. issued to Holders of Series B Preferred Stock (Incorporated by reference to exhibit 4.5 to the Company’s Report on Form 8-K filed on November 6, 2009)
4.6		Form of Warrant to Purchase Common Stock of SpectraScience, Inc. issued to Holders of Series C Preferred Stock(Incorporated by reference to exhibit 4.5 to the Company Report on Form 8-K filed June 24, 2010)
4.7		Certificate of Designation of Rights and Preferences of Series C Preferred Stock of SpectraScience, Inc. (Incorporated by reference to exhibit 4.6 to the Company Report on Form 8-K filed June 24, 2010)
4.8		Form of Agent Warrant for Series C Preferred Stock offering (Incorporated by reference to exhibit 4.6 to the Company’s Registration Statement on Form S-1/A filed on August 26, 2010)
4.9		Form of Debenture issued by the Company to each subscriber in the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 4.1 to the Company’s Report on Form 8-K filed on January 30, 2013)
4.10		Form of Warrant issued by the Company to each subscriber in the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 4.2 to the Company’s Report on Form 8-K filed on January 30, 2013)
10.1		Common Stock Purchase Agreement dated as of January 30, 2009, by and between SpectraScience, Inc. and Fusion Capital Fund II, LLC (Incorporated by reference to exhibit 10.1 to the Company’s Report on Form 8-K filed on February 4, 2009)
10.2		Registration Rights Agreement dated as of January 30, 2009, by and between SpectraScience, Inc. and Fusion Capital Fund II, LLC. (Incorporated by reference to exhibit 10.2 to the Company’s Report on Form 8-K filed on February 4, 2009)
10.3*		Amended 2001 Stock Plan (Incorporated by reference to exhibit 10.27 to the Company’s Report on Form 8-K filed on August 6, 2004 and to Registration Statement on Form S-8 dated September 9, 2005)

 

  

10.4*		Form of Directors’ Option Agreement (Incorporated by reference to exhibit 10.1 to the Company’s Report on Form S-1 filed April 30, 2009)
10.5*		2011 Equity Incentive Plan (Incorporated by reference to exhibit 10.1 to the Company’s Report on Form 8-K filed on March 1, 2012)
10.6*		Form of Nonqualified Stock Option Award Agreement (Incorporated by reference to exhibit 10.2 to the Company’s Report on Form 8-K filed on March 1, 2012)
10.7*		Offer Letter to Michael P. Oliver (Incorporated by reference to Exhibit 10.7 to the Company’s Report on Form 10-K for the fiscal year ended December 31, 2010, filed on March 31, 2012)
10.8		Dealer Agreement dated April 6, 2010 by and between the Company and Felix Investments, LLC (Incorporated by reference to exhibit 10.6 to the Company’s Registration Statement on Form S-1/A filed on August 26, 2010)
10.9		Dealer Agreement dated July 2, 2009 by and between the Company and Felix Investments, LLC (Incorporated by reference to exhibit 10.5 to the Company’s Registration Statement on Form S-1/A filed on August 26, 2010)
10.10		Form of Subscription Agreement by and between the Company and each Subscriber for the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 10.1 to the Company’s Report on Form 10-K filed on April 18, 2012)
10.11		Form of Subscription Agreement by and between the Company and each Subscriber for the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 10.1 to the Company’s Report on Form 10-Q filed on March 28, 2014)
10.12		Form of Convertible Debenture by and between the Company and each Subscriber for the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 10.2 to the Company’s Report on Form 10-Q filed on March 28, 2014)
10.13		Form of Warrant for each Subscriber for the Company’s Convertible Debenture Offering (Incorporated by reference to exhibit 10.3 to the Company’s Report on Form 10-Q filed on March 28, 2014)
10.14*		Employment Agreement of Michael P. Oliver dated January 1, 2013 (Incorporated by reference to Exhibit 10.14 to the Company’s Report on Form 10-K filed on June 27, 2014)
21+		Subsidiaries of the registrant – Luma Imaging Corporation, a Delaware corporation, SpectraScience International, Inc., a Minnesota corporation, and SpectraScience (UK) Ltd., a foreign Entity
23.1+		Consent of Independent Registered Public Accounting Firm- HJ Associates & Consultants LLP
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 annual report on Form 10-K of the Company for the year ended December 31, 2014, formatted in XBRL; (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements tagged as blocks of text.
		+ Filed herewith.
		*  Denotes management compensatory plan or contract.

 

 

 

 

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