Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). £ Yes T No
State issuer's revenue for its most recent fiscal year: $9,100.
The aggregate market value of the 6,933,287 shares of voting stock held by non-affiliates of the Company at February 9, 2008, calculated by taking the last sales price of the Company's common stock of $.11 on February 9, 2008 was $762,662.
The number of shares outstanding of the issuer’s common equity as of February 9, 2008 was 13,931,681.
Documents incorporated by reference: None
Transitional Small Business Disclosure Format (check one): £ Yes T No
TABLE OF CONTENTS
| ||
| ||
| ||
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | ||
| ||
| ||
Additional Information
Descriptions in this report are qualified by reference to the contents of any contract, agreement or other documents described herein and are not necessarily complete. Reference is made to each such contract, agreement or document filed as an exhibit to this report, or incorporated herein by reference as permitted by regulations of the Securities and Exchange Commission. (See "ITEM 13. EXHIBITS.")
Special Note Regarding Forward-Looking Statements
Please see the note under "ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION," for a description of special factors potentially affecting forward-looking statements included in this report.
ITEM 1.
History
Vitro Diagnostics, Inc. ("we" or the "Company") was incorporated under the laws of the State of Nevada on February 3, 1986. From November 1990 to July 31, 2000, the Company was engaged in the development, manufacture and distribution of purified human antigens and the development of therapeutic products and related technologies. In August 2000, the Company sold the assets used in the manufacture and sale of purified antigens for diagnostic applications. Since that time, the Company has focused on research, development and commercialization of products and technology with potential applications in biomedical research, manufacturing and therapeutics.
Our common stock is currently traded over the counter and quoted on the OTC Bulletin Board under the ticker symbol "VODG." We maintain a website at www.vitrodiag.com.
Narrative Description of Business
Our current strategy is to complete final development and commercialize new products derived from our stem cell research. We presently develop, manufacture and market products for use in research and related applications that do not require approval of the United States Food and Drug Administration ("FDA") prior to market introduction. Our existing products include the VITROCELL™ Product Line consisting of select human cell lines and related products. The sales of our VITROCELL™ products increased slightly during 2007. We have also developed products and product candidates for treatment of infertility.
The predominant focus of operations during the fiscal year ended October 31, 2007, which we refer to in this report as 2007, was to continue prior research involving the establishment and characterization of stem cell lines with applications in diabetes research and efforts to develop novel cell therapies for diabetes. The Company developed and owns 29 adult human pancreatic stem cell lines that are distinct from the limited number of embryonic stem cell lines that are presently approved for federally funded research. These cell lines have potential commercial application to diabetes research and therapy. Our current goals are to develop stem cell-derived products for distribution to research markets and for select applications in drug discovery and development; eventually, the Company's stem cell technology may lead to new therapeutic products to treat animal and human diabetes.
Stem Cell Technology and Related Products.
Based upon a desire to produce an infinite supply of human cells for various medical applications, the Company had previously developed technology for the immortalization of cells based upon genetic engineering. More recently, the Company has shifted its efforts to the discovery, characterization and development of methods to maintain indefinite proliferation and to induce differentiation of stem cells.
Stem cell lines are divided into two broad classes: embryonic and adult. Embryonic stem cells have the potential to differentiate into all cell types of the body and their isolation from an embryo generally precludes survival of the embryo. Adult stem cells are present within various non-embryonic tissues, generally differentiate into a limited number of different cell types and may be isolated without necessarily comprising viability of the donor organism, e.g., bone marrow stem cells. The Company's stem cell research focuses on the use of adult stem cells and does not involve embryonic stem cell research.
3
The Company's research efforts have focused on the generation, characterization and differentiation of stem cells that give rise to human beta islets, which are structures of the pancreas gland responsible for the production and secretion of insulin and glucagon that regulate carbohydrate metabolism. The Company developed a novel method for the generation of adult stem cells and using this method, generated 29 adult human beta islet stem cell lines that are now owned by the Company. The Company also developed another three human pancreatic stem cell lines that are jointly owned by the Company and a potential alliance partner. The role of strategic alliances in the development of the Company’s business is discussed elsewhere (See: Part II, Item 6: Management’s Discussion and Analysis or Plan of Action). The Company also developed new methods to induce differentiation of functional beta cells from these stem cells that contain and release insulin in response to elevated glucose levels. Glucose-regulated insulin secretion is a critical function of beta cells which is lost in type I diabetics due to autoimmune reaction against beta cells. The discovery of novel methods for differentiation of functional beta cells enhances the potential use of the Company's stem cell lines for cell therapy of diabetes.
During 2007, the Company continued its development of stem cell differentiation methods and discovered a refined method for differentiation involving use of conditions that more closely represent the environment present within the human body. This procedure is presently being further refined into a method suitable for the commercial production of stem cell-derived human beta islets. Our results indicate that our stem cell-derived islets share many characteristics of native islets present within the human pancreas gland including the expression and secretion of insulin. The new method results in higher yields of islets from stem cells and other advantages. Since some of the stem cell lines from which the islets are derived have demonstrated immortality or self-renewal, the new process together with the previously developed cell lines may represent an indefinite source of human beta islets that are identical to those present in the human body.
The Company also revised its business plan in 2007 based on its advanced stem cell technology. Following product commercialization, the Company plans to target markets in medical research and drug discovery and development where there appears to be an unmet market need. Sales into these target markets will not require pre-market FDA approval but may require interactions with FDA. During the two fiscal years ended October 31, 2007 and 2006, the Company spent $268,735 and $173,037, respectively, for research and development.
Type I diabetes may be successfully treated by transplantation of beta islet cells. However, there is an insufficient supply of transplantable materials to treat the number of afflicted patients and discovery of viable methods to increase the number of available beta islets for transplantation is a major goal of diabetes research in general. The Company's stem cell lines and associated differentiation methods represent a potential indefinite supply of human beta cells for use in transplantation into diabetic patients. However, the development of such a diabetes therapeutic product requires considerable resources beyond those currently available to the Company. Our strategy is to seek appropriate partnerships with third parties for the commercialization of therapeutic products and ongoing efforts to establish these alliances are described elsewhere. (See: Part II, ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.) Therapeutic applications of the Company's stem cell technology are longer-term goals of the Company.
We presently sell our VITROCELL™ products to the medical research industry. These include various human cell lines of pancreatic origin and a growth medium, called VitroPlus II. Laboratories use cell lines for various experimental purposes including the testing and discovery of new drugs and this requires growth of cells by a process called cell culture. This is a specialized area of medical research involving skilled personnel, specialized equipment and optimized growth media. VitroPlus II is a proprietary liquid formulation that has been optimized by the Company (& trade secret protected) for growth of its human pancreatic cell lines. It may also have broader application in the growth and maintenance of other stem cell lines. The Company also provides responsive technical support to our customers enabling them to rapidly incorporate our products into their ongoing research.
The VITROCELL™ products include human pancreatic cell lines and growth media optimized to support these cells. These products were sold through an existing distribution agreement and are primarily intended for use in biomedical research. Our products are especially suited for research studies of stem cell self-renewal and differentiation.
Marketing and Distribution. The Company has sold its products directly and through distributors. The Company has a non-exclusive contract for distribution of its VITROCELL™ products through Chemicon International, Inc., now a division of Millipore Inc. The Company also sells its products directly and may establish distribution agreements with other third parties in the future. The Company plans to sell its stem cell-derived human beta islets directly to target markets and may also use select distributors as are appropriate.
4
Fertility Drug Candidates.
The Company's previous manufacture and sale of purified antigens for diagnostic purposes resulted in the discovery of several products and technologies with potential application for therapeutic purposes. An initial target was the pituitary hormone FSH and related products, since FSH has been used as a drug to treat infertility for the past 35 years. The worldwide market for FSH and related products is approximately $1.3 billion per year. Since the sale of the diagnostic operation in 2000, management has continued efforts to develop these discoveries into commercially valuable assets. However, in the recent past, the Company has utilized its limited resources for its stem cell research and manufacture of the VITROCELL™ product line in an effort to establish financial support and revenue from product sales in the near term. There was no new development of the Company's technology related to fertility drugs in 2007. The Company's stem cell technology has potential application to generation of new cell lines for FSH production but this development would require additional R&D to demonstrate feasibility.
Description of Products and Product Candidates. VITROPIN™ is highly purified FSH derived from the urine of post-menopausal women. It is produced through the Company's patented technology that management believes represents a significant improvement over previous methods used to produce this product. FSH has been used for over 35 years as a drug to treat infertility by inducing follicle development in the ovary.
VITROPIN-VÔ is envisioned to be the only product on the market identical to native FSH. The Company one day hopes to produce this product through use of its cell immortalization technology. VITROPIN-V™ is still in an early development stage and is projected to require substantial funding and approximately three to four years' additional development to be marketable.
VITROJECT™ is a novel delivery device for administration of VITROPIN™, VITROPIN-V™ and other substances that provide an entire treatment regime within a single device that is easy and economical to use. FSH currently must be given by either intramuscular or subcutaneous injection at the same time in the evening, for 7 to 15 consecutive days. Many of the existing products are administered by reconstitution of a single dose, loading into a syringe and injection, with repetition of these steps in subsequent days. VITROJECTÔ may allow patients to self-inject fertility drugs by subcutaneous administration at home with fewer drug manipulations and lower cost compared to existing methods.
The U.S. Food and Drug Administration ("FDA") has not yet approved any of these products for commercial distribution within the United States.
Patents and Other Intellectual Property Protection
The Company has applied for and has obtained or is in the process of obtaining patents and other protection for its intellectual property in order to protect its investments. The United States Patent and Trademark Office, or USPTO, issued the Company's first patent on November 23, 1999 (US Patent No. 5,990,288). This invention was entitled "Methods for Purifying FSH" and details methods to manufacture highly purified FSH from various sources. Management believes this invention represents a significant advance in the methods previously used to purify FSH and to produce therapeutic FSH. The Company maintains this patent in an active status.
The Company was granted another patent by the USPTO in 2002 entitled, "Immortalized Cell Lines and Methods of Making the Same." This patent provides protection to the Company's technology related to immortalization of pituitary cells by genetic engineering. This technology has potential application to the commercial production of FSH and other human pituitary hormones through immortalization of the cells of the pituitary gland that normally produce these hormones. The Company maintains this patent in an active status.
The Company now has a pending patent application concerning its stem cell technology entitled, "GENERATION AND DIFFERENTIATION OF ADULT STEM CELL LINES" that was filed with both the USPTO and internationally in 2005, potentially allowing patents in the United States and several foreign countries. Subsequent research and new cell lines constitute additional intellectual property potentially extending coverage of the patent application. During 2007, the Company filed a request for patent in Canada through its prior application. There can be no assurance that the Company will succeed in obtaining any such patent protection or that these patents would withstand legal challenges.
5
The Company's technology related to the production of cell culture media is protected as trade secret.
The Company has established trademark claims to its products VITROPIN™, VITROJECT™, and VITROPIN-V™ informally by publication. These trademarks are thus common law marks that may be challenged by the owners of similar, established and registered marks that existed prior to initial publication by the Company, but no such challenge has occurred since original publication of these marks in 2000. The Company, also has the following trademarks registered in the State of Colorado: "Vitro Biopharma", "VITROCELL" and "Harnessing the Power of Cells"; these registrations expire on 7/2/2012, 11/25/2013 and 11/25/2013 respectively. The Company may elect to formally protect some or all of these marks through registration with the USPTO in the future. However, we do not believe the absence of formal trademark protection will adversely affect our business.
Regulatory Approval
Drugs used to treat human infertility require registration with, and approval from, appropriate government authorities prior to sale. In the United States, the U.S. Food and Drug Administration, or FDA, oversees approval of such products. Since the FDA has previously approved FSH, the Company has determined that the appropriate means to gain VITROPIN™ approval is a type of abbreviated version of a new drug application. The process of FDA can be time consuming and require millions of dollars in capital expenditures. The Company has no plans to make such application in the foreseeable future.
Competition
Human cell lines are also produced and marketed by other companies with substantially greater resources than the Company. Present suppliers of human cells and related products include Crucell N.V., Cambrex Corporation and the American Type Culture Collection. All of these firms have long-standing histories and significant financial resources.
To the best knowledge of the Company, there are presently no other commercial suppliers of stem cell-derived human beta islets. These are now provided to the medical research community sporadically through organizations that derive material for transplantation into diabetic patients. Some tissues derived from organ donors are rejected from transplantation because of viral contamination and these are then provided to medical researchers. These materials are available only infrequently and the recipients assume the risks of handling contaminated materials. However, there can be no assurance of the lack of competition to the Company's proposed products.
The Company faces competition from a number of larger, well-established entities in the area of fertility treatment. Serono-Merck controls approximately 50% of the worldwide FSH market. The Organon Biosciences, now owned by Schering Plough, has the majority of the remaining market and Ferring Pharmaceuticals has the remaining share of the market. These manufacturers have diversified product lines including impure LH/FSH combination drugs, purified urinary and recombinant FSH.
The existing market participants represent substantial competition to any entity hoping to introduce new products into the human fertility market, including the Company. All of these entities have substantially greater financial and personnel resources than the Company.
Employees
The Company presently has one full time employee, the Company's President, CEO, Chairman, and CFO. This individual provides primary support of technical operations, including research and development, production of the VITROCELL™ product line and all administrative functions of the Company. The Company's Vice President provides the Company with periodic consultation related to the achievement of its business objectives.
During 2007, the Company entered into a consulting agreement with Superior Toxicology and Wellness, a consulting firm located in Superior Colorado. Superior provides the Company with assistance in business development with an emphasis on marketing and sales of the proposed stem cell-derived human beta islets to the pharmaceutical manufacturing sector.
6
The Company also utilizes the services of other consultants and advisors to supplement the resources of its employee from time to time. These include scientific and laboratory personnel, accountants, auditors and attorneys. Some of these positions, especially those of a technical nature, may be converted to employment if and when the Company's business requires and resources permit.
ITEM 2.
The Company owns no real property. During 2007, the Company leased its office and laboratory space, consisting of 720 square feet, at 12635 East Montview Boulevard, Suite 218, Aurora, CO 80045. The lease was a full service lease allowing Company personnel access to common areas, conference rooms and use of certain laboratory equipment. The lease for this space expired December 31, 2007 and the Company presently sub-leases approximately 600 square feet at 12635 East Montview Boulevard, Suite 214, Aurora, CO 80045 on a month-to-month basis. This sub-lease expires on June 30, 2008. The Company has plans to move its operations to Golden Colorado during 2008 into a new and expanded facility.
ITEM 3.
There are currently no legal matters or other regulatory proceedings pending or, to the knowledge of our management, threatened that involve the Company or its property or any of the principal shareholders, officers or directors in their capacities as such.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this Report.
7
ITEM 5.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following information sets forth the high and low bid price for the Company's common stock for each quarter within the last two fiscal years. The Company's common stock is traded over-the-counter and quoted on the OTC Bulletin Board. The following information was obtained from Yahoo.com. The prices set forth below do not include retail mark-ups, mark-downs or commissions, and may not represent prices at which actual transactions occurred.
Fiscal Quarter Ended |
|
| High |
|
| Low |
2007 |
|
|
|
|
|
|
January 31 |
| $ | 0.15 |
| $ | 0.07 |
April 30 |
|
| 0.20 |
|
| 0.075 |
July 31 |
|
| 0.19 |
|
| 0.02 |
October 31 |
|
| 0.25 |
|
| 0.03 |
|
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
January 31 |
| $ | 0.18 |
| $ | 0.08 |
April 30 |
|
| 0.12 |
|
| 0.03 |
July 31 |
|
| 0.10 |
|
| 0.02 |
October 31 |
|
| 0.10 |
|
| 0.07 |
Penny Stock Rule
The Company's common stock is presently classified as a "penny stock" under existing securities laws since the stock is not listed on a national securities exchange and trades below $5 per share and since the Company does not meet the minimum financial requirements established by these rules. Since our stock is characterized as a penny stock, our stock is subject to rules adopted by the SEC regulating broker-dealer practices in connection with transactions in penny stocks. The broker or dealer proposing to effect a transaction in a penny stock must furnish his customer a document containing information prescribed by the SEC and obtain from the customer an executed acknowledgment of receipt of that document. The broker or dealer must also provide the customer with pricing information regarding the security prior to the transaction and with the written confirmation of the transaction. The broker or dealer must also disclose the aggregate amount of any compensation received or receivable by him in connection with such transaction prior to consummating the transaction and with the written confirmation of the trade. The broker or dealer must also send an account statement to each customer for which he has executed a transaction in a penny stock each month in which such security is held for the customer’s account. The existence of these rules may have an effect on the price of our stock, and the willingness of certain brokers to effect transactions in our stock.
Holders of our Common Stock
As of January 26, 2008, the Company had approximately 1,937 shareholders of record, not including persons who hold their shares in "street name".
Dividends
The Company has paid no dividends since inception and it is not anticipated that any will be paid in the foreseeable future. The payment of dividends in the future is dependent on the generation of revenue and profit, and the discretion of the Board of Directors based upon such matters as the Company's capital needs and costs of obtaining capital from outside sources.
8
ITEM 6.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Introduction
The following discussion and analysis summarizes the financial condition of the Company at fiscal year end October 31, 2007, and compares that to its financial condition at year-end 2006. It also analyzes our results of operation for the year ended October 31, 2007 and compares those results to the year ended October 31, 2006. This discussion and analysis should be read in conjunction with our financial statements and notes appearing elsewhere in this report. The discussion should also be read with the cautionary statements and risk factors appearing at the end of this section.
The Company's recent operations and development of its business plan have been limited due to lack of sufficient capital resources. Since mid-2002, the Company has maintained minimal operations that were financed through debt and equity funding provided by the Company's president, CEO and Chairman. These operations focused on the development and commercialization of its stem cell technology as described previously. In an effort to expand those operations, management of the Company had been engaged in efforts to obtain capital from outside sources.
Further to these efforts, the Company completed a private placement of its securities subsequent to the fiscal year end. On January 31, 2008, which we refer to as the Closing Date, the Company sold 1,250,000 units to three investors for gross proceeds of $125,000, or $0.10 per unit. Each unit consisted of one share of the Company's common stock and eight tenths (8/10) of a Class A Warrant. The Class A Warrants permit the investors to acquire an aggregate of 1,000,000 million additional shares of common stock at an exercise price of $0.125 per share and 500,000 Class B Warrants at an exercise price of $0.25 per share. The Class A Warrants are exercisable for a period of 90 days from the Closing Date and must be exercised in the event the Company reaches certain performance milestones with regard to its business plan.
The Class B warrants are exercisable for a period of seven months from the Closing Date and must be exercised in the event the Company reaches an additional milestone within the three months ending July 31, 2008. If the investors exercise the Class B warrants, they would also receive 500,000 Class C Warrants to acquire an additional 500,000 shares of common stock at $0.25 per share. These Class C Warrants are exercisable for a period of ten months from the Closing Date and must be exercised if the Company reaches an additional milestone within the three months ended October 31, 2008. The proceeds of this sale, together with the proceeds from the exercise of all of the warrants, of which there is no assurance, would result in gross proceeds to the Company of $500,000. Proceeds from the offering will be used to reduce certain outstanding debt and continue commercial development of the Company's products.
The Company also received an additional $15,000 from sale of its common stock to an individual and collected its accounts receivable subsequent to the end of fiscal year 2007.
The Company is also pursuing potential strategic alliance partners. Management believes that there are opportunities for alliances to develop the Company's products and technology for therapeutic applications. There are ongoing discussions and opportunities for alliances to develop these products. However, the Company is presently focused on commercialization of its stem cell-derived beta islets for non-therapeutic applications since there is an immediate market need and the pathway to commercialization is relatively near term and less costly than development of therapeutic products.
Liquidity and Capital Resources
In 2007, the Company continued to experience a shortage of working capital and liquidity. At fiscal year end October 31, 2007, the Company had a working capital deficit of $1,325,450, consisting of current assets of $22,343 and current liabilities of $1,347,793. This represents a decrease of $309,341 from fiscal year end October 31, 2006. Current assets increased $17,402 from year-end 2006 to 2007 while total assets increased $34,901 during that time, the former from increased accounts receivable and cash while the latter was predominantly due to the acquisition of new equipment and increased deferred costs related to the Company's patent holdings. Current liabilities increased $326,743 from year-end 2006 to 2007 while total liabilities increased $340,437, each predominantly from accrued salaries and increases in the note payable and accrued interest owed to the Company's president and CEO.
9
The working capital deficit was somewhat remedied by the private placement discussed above, although the Company remains dependent on receipt of additional cash to continue its business plan and achieve profitability in the future. The report of the independent accountant that audited the Company's financial statements for the year ended October 31, 2007 includes a qualification that the Company may not continue as a going concern. In that event, the Company might be liquidated and its assets sold to satisfy any claims of creditors. See Note A to the financial statements attached to this report for a more complete description of this contingency.
During the fiscal year ended October 31, 2007, the Company's financing activities provided $132,411 to support operations. During that time, the Company's operations used $113,914 of cash compared to $93,688 of cash used during the twelve months ended October 31, 2006. The increase in cash usage was predominantly due to additional expenses and increased outlays for research and development as well as increased interest expense. The use of cash during 2007 reflects a minimum cash requirement of about $9,500 per month for operations while the cash raised from financing activities was primarily from debt and equity investments in the Company by its Chairman, President and CEO. The general increase in cash usage in the past two years reflects increased research and development activities as the Company continued to advance the development of its stem cell technology into new commercial products.
The Company had lines of credit totaling $100,500 with $9,392 in available credit at fiscal year end 2007. Credit balances have increased since then. The Company must continue to service debt and the Chairman personally guarantees most of the Company debt.
Sales of the VITROCELL products increased in 2007 and continued or increased revenues in 2008 would further contribute to satisfying capital needs in 2008. In addition, the Company's technology and product candidates related to treatment of infertility provide potential revenue generation both in the near term and through a pipeline of potential products.
Management has also conserved working capital by reducing administrative expenses and expenditures related to research activities while maintaining essential operational activities. The Company also intends to pursue other alternatives to increase its capital resources such as merger with revenue-generating private entities, sale of assets or other transactions that may be appropriate.
Results of Operations
Year Ended October 31, 2007. During the year ended October 31, 2007, the Company realized a net loss of $350,399, or ($.03) per share, with $9,100 in product revenue. The operating loss in 2007 was $83,380 less than the operating loss of $453,133 in 2006. The decreased operating loss during 2007 as compared to 2006 was primarily due to increased sales, decreased non-cash salary expense and the absence of asset write-off. Product sales were $7,460 more than in 2006. There was growth in sales of both cell lines and the media (VitroPlus II) required for continued use of the cell lines in 2007. These results indicate a growing market for these products. However, management projects greater sales of its stem cell-derived human beta islets due to additional markets within pharmaceutical manufacturing for applications in new drug discovery and development. Management does not anticipate revenue from its fertility drugs in the immediate future. Commercialization of these products depends on significant funding, further product development including clinical trials, FDA approval, and other conditions prior to commercial sale of any product.
Total operating expenses were $75,920 less in 2007 than in 2006, primarily due to reduced salary expense and the lack of asset impairment. Selling, general and administrative expenses in 2007 were $136,114 less than in 2006, primarily related to decreased accrued salaries.
Research and development expenses (R&D) increased by $95,698 during fiscal year 2007 compared to fiscal year 2006. This increase was predominantly due to the allocation of a portion of accrued salary expense to R&D and increased R&D expenses. The Company's R&D activities were oriented towards advances in the commercialization of its stem cell technology as described previously (Part I, Item 1). Management believes that these advances improve opportunities for the Company to commercialize new products with an unmet market need in the near term. Management also believes that these advances also increase opportunities for the establishment of strategic alliances.
10
Other expenses increased from fiscal 2006 to 2007, since interest expenses increased.
Year Ended October 31, 2006. During the year ended October 31, 2006, the Company realized a net loss of $536,193, or ($.05) per share, on $1,640 of revenue.
Operating expenses increased from fiscal 2005 to fiscal 2006, due to the write-off of intangible assets and increased accrued salary expenses. Selling, general and administrative expenses increased by $72,082 in 2006. Research and development expenses also increased by $40,903 in 2006.
Other expenses increased from fiscal 2005 to 2006 primarily due to increased interest expense due to increased debt.
Recent Accounting Pronouncements
In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections - a replacement of APB Opinion No. 20, Accounting Changes and SFAS No. 3, Reporting Accounting Changes in Interim Financial Statements (SFAS 154). SFAS 154 provides guidance on the accounting for and the reporting of accounting changes, including changes in principle, accounting estimates and the reporting entity, as well as, correction of errors in previously issued financial statements. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. SFAS 154 is not expected to have a material impact on the Company's results of operations or financial position.
On July 13, 2006 the FASB posted to its website the Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes, (FIN 48). FIN 48, creates a single model to address uncertainty in income tax positions. FIN 48 clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition and, clearly scopes income taxes out of FASB Statement No. 5, Accounting for Contingencies. FIN 48 applies to all tax positions related to income taxes subject to FASB Statement No. 109, Accounting for Income Taxes, (FAS 109). This includes tax positions considered to be "routine" as well as those with a high degree of uncertainty. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption to have a material impact on the Company's financial statements.
Effective November 1, 2006, the Company adopted Statement No. 123R, Share-Based Payment (SFAS 123R), which requires companies to measure and recognize compensation expense for all stock-based payments at fair value. SFAS 123R is being applied on the modified prospective basis.
Under the modified prospective approach, SFAS 123R applies to new awards and to awards that are outstanding on November 1, 2006 that are subsequently modified, repurchased, cancelled or vest. Under the modified prospective approach, compensation cost recognized after October 31, 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested on, November 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R, and compensation cost for all shared-based payments granted subsequent to November 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. Prior periods are not restated to reflect the impact of adopting the new standard.
Critical Accounting Policies and Estimates
The Company has identified the accounting policies described below as critical to its business operations and the understanding of the Company's results of operations. The impact and any associated risks related to these policies on the Company's business operations is discussed throughout this section where such policies affect the Company's reported and expected financial results.
11
Estimates
The preparation of this Annual Report requires the Company to make estimates and assumptions that affect the reported amount of assets and liabilities, revenues and expenses of the Company during the reporting period and contingent assets and liabilities as of the date of the Company's financial statements. There can be no assurance that the actual results will not differ from those estimates.
Patents, Deferred Costs and Amortization
Patents consist of costs incurred to acquire issued patents. Amortization commences once a patent is granted. Costs incurred to acquire patents that have not been issued are reported as deferred costs. If a patent application is denied or expires, the costs incurred are charged to operations in the year the application is denied or expires. The Company amortizes its patents over a period of ten years. Amortization expense totaled $2,932 and $2,932 for the years ended October 31, 2007 and 2006, respectively.
RISK FACTORS
This 10-KSB report, including Management's Discussion and Analysis or Plan of Operation, contains forward-looking statements that may be materially affected by several risk factors including those discussed below.
1.
The Company is wholly dependent on the efforts and expertise of its sole employee to further its business plan, and the loss of his service for any reason would have a material adverse effect on the Company and its business and may require a suspension of operations. Achievement of the objectives described in this report depends critically upon Dr. James Musick, who has contributed substantially to the development of the products and technology presently owned by the Company. At present, the Company has an employment contract with Dr. Musick. However, the Company does not maintain "key man" life insurance on his life. Loss of his services would adversely impact the efforts to commercialize of the Company's products.
2.
There is a very limited trading market for the Company's common stock, and investors may have difficulty selling their stock, should they desire to do so. There is presently limited liquidity in the public stock of the Company as indicated by relatively low price of the Company's stock and a relatively low volume of trading. This limited liquidity is related in part to the fact that the Company's stock is traded on the OTC Bulletin Board and is considered a "penny stock." Such limited liquidity of the Company's securities may limit the funding abilities of the Company that are related to equity transactions and may adversely affect the ability of shareholders to sell their stock at an acceptable price.
3.
We are dependent on receipt of regulatory approval to commence marketing our fertility drug candidates, and this approval process will be extremely costly and time consuming. Prior to the marketing and sale of the Company's fertility drug products, regulatory approval is essential. While the Company maintains relationships with advisors who provide counsel to the Company regarding its filings for registration by the FDA and other regulatory authorities, there can be no assurance that the Company will receive the requisite approvals to market its products. The absence of regulatory approval together with a lack of working capital, essentially blocks the commercialization of the Company's fertility drug products.
4.
Our patent relating to potential fertility drugs is subject to a lien in favor of our largest creditor, and a default under the underlying debt may result in our forfeiting that technology. Some of the Company's debt is collateralized by a lien against certain assets and a default by the Company could result in a seizure of those assets. The Company has a note payable to its Chairman and primary shareholder that is secured by a lien against FSH patents that were issued in 1999. These assets may be seized in the event of default, which would preclude the Company from developing any products related to the technology.
12
5.
We will be required to formally assess our internal controls under Section 404 of the Sarbanes-Oxley Act of 2002 and any adverse results from such assessment could result in a loss of investor confidence in our financial reports and have a material adverse effect on the price of our common stock. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we expect that we will be required to furnish a report by our management on internal controls for the fiscal year ending on or after December 2007. Such a report must contain, among other matters, an assessment of the effectiveness of our internal controls over financial reporting, including a statement as to whether or not our internal controls are effective. This assessment must include disclosure of any material weaknesses in our internal controls over financial reporting identified by our management, and our own assessment must eventually be audited by our independent accountants. Presently our personnel are limited and we lack third party checks and balances in our internal control although the individual responsible for financial control has 20 years employment with and significant ownership of the Company.
At the time of the required disclosures, we may be forced to disclose significant deficiencies and/or material weaknesses in our internal controls, depending on the status of personnel and internal controls. If we are unable to assert that our internal controls over financial reporting are effective, or if we disclose significant deficiencies or material weaknesses in our internal controls, investors could lose confidence in the accuracy and completeness of our financial reports, which could have a material adverse effect on our stock price.
ITEM 7.
Reference is made to the Index of Financial Statements following Part IV of this Report for a listing of the Company's financial statements and notes thereto.
ITEM 8.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
On January 16, 2007, the Board of Directors of the Company engaged Schumacher and Associates, Inc. as its principal accountant and independent auditor for the fiscal year ended October 31, 2006 and simultaneously accepted the resignation of Miller and McCollom, Certified Public Accountants, its former accountant.
The audit reports of the Company on its financial statements for the two fiscal years ended October 31, 2004 and 2005 did not contain any adverse opinion or disclaimer of opinion. The reports for the two years ended October 31, 2005 contained a paragraph that raised doubt about the Company's ability to continue as a going concern; otherwise, the reports were not qualified or modified as to uncertainty, audit scope or accounting principles.
During the Company's fiscal year ended October 31, 2005 and the subsequent interim period up to January 16, 2007, there were no disagreements with Miller and McCollom, whether or not resolved, on any matter of accounting principle or practice, financial statement disclosure, auditing scope or procedure which, if not resolved to Miller and McCollom's satisfaction, would have caused Miller and McCollom to make reference to the subject matter of such disagreement in connection with its report on the Company's financial statements for such periods. Miller and McCollom did not audit the Company's financial statements for the fiscal year ended October 31, 2004.
ITEM 8A.
We maintain a system of controls and procedures designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within time periods specified in the SEC’s rules and forms and to ensure that the information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including of Chief Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. As of October 31, 2007, under the supervision and with the participation of our Chief Executive Officer and Principal Financial Officer, management has evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective. There were no changes in the Company’s internal control over financial reporting during the year ended October 31, 2007 that materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
13
ITEM 9.
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
The following individuals presently serve as officers and directors of the Company:
Name |
| Age |
| Position |
James R. Musick, Ph.D. |
| 61 |
| Chairman of the Board, Chief Executive Officer, Chief Financial Officer and Secretary |
Erik D. Van Horn |
| 39 |
| Vice President |
Directors of the Company serve until the next annual meeting of shareholders and until their successors are elected and qualified. Officers serve at the will of the Board of Directors.
The Company currently has no audit or other committee of the Board of Directors and no financial experts on its Board. The entire Board of Directors performs the functions typically performed by an audit committee. There is no “audit committee financial expert” on the Board, as defined by SEC rule. The absence of a financial expert has historically been due to the Company’s inability to attract any additional candidates to its Board due to its limited working capital, but hopes to identify one or more individuals in the future to add to its existing membership.
The following represents a summary of the business history of each of the foregoing individuals for at least the last five years:
JAMES R. MUSICK, Ph.D. was appointed President and Chief Executive Officer of the Company on August 7, 2000 where he served until April 2005. He then resigned those positions to become the Chairman and Chief Operating Officer. On May 19, 2006 he was re-appointed President and Chief Executive Officer. From September 1, 1989 until August 7, 2000, Dr. Musick served as Vice President, Secretary and Chief Operating Officer of the Company. He has also served as a director of the Company since September 1, 1989. Dr. Musick received a Bachelor of Arts in Biological Sciences in 1968 and a doctorate in Biological Sciences in 1975 from Northwestern University in Evanston, Illinois.
ERIK D. VAN HORN was appointed Vice President of the Company on August 7, 2000. He was also the Production Manager from 1993 to 2000 and a director of the Company from 1993 to 2004. From 2002 to the present, he has been Supervisor of Manufacturing at Amgen Boulder Inc. He received his Bachelor of Science in Chemical Engineering from the University of Colorado in 1990.
The Company has not established a code of ethics for its principal executive officers due to the cost of such procedure, but may consider adopting such code in the future as its resources permit.
Section 16(a) Beneficial Ownership Reporting Compliance
Based solely on a review of Forms 3, 4 and 5 furnished to the Company under relevant SEC rules, no officer or director failed to file reports required under Section 16(a) of the Securities Exchange Act of 1934 during the year ended October 31, 2007.
ITEM 10.
The following table summarizes the total compensation of (i) the principal executive officer of the Company; (ii) any person who served as the principal executive officer during the last fiscal year, and (iii) the other individual who served as an executive officer at the end of the last fiscal year (the “Named Officers”):
14
SUMMARY COMPENSATION TABLE
Name | Year ended October 31, | Salary | Total |
James R. Musick, Chairman, | 2007 | $ 279,167(1) | $ 279,167 |
President, Chief Executive | 2006 | 220,833(1) | 220,833 |
Officer, Chief Operating Officer, Chief Financial Officer |
| ||
|
| ||
Eric Van Horn, Vice | 2007 | -0- | -0- |
President | 2006 | -0- | -0- |
(1)
All of the salary was accrued.
Employment Contracts
Effective April 8, 2005, the Company entered into employment agreements with Dr. Musick. This agreement provides for an initial term of three years and is automatically renewable for an additional three-year period unless either party gives notice to the other that the agreement will be terminated.
The agreement provides a base salary of $180,000 per annum for the first year, $250,000 per annum for the second year, and $300,000 per annum during the third year. The agreement also provides that if the Company obtains financing of $3 million or more during the first two years of the agreement, the base salary would automatically increase to $300,000 per annum effective with the closing of the financing. Dr. Musick has agreed to accrue salary until such time as the Company obtains sufficient working capital.
The agreement with Dr. Musick provides for the grant of stock options as follows:
·
Options to purchase 150,000 shares of the Company’s common stock at a price of $.17 per share, vesting at such time as the Company reports cumulative product sales of $125,000 during any one year as reported in any financial statement filed with the Securities and Exchange Commission on Form 10-QSB or 10-KSB; and
·
Options to purchase an additional 150,000 shares of the Company’s common stock at market price, vesting at such time as the Company reports cumulative product sales of $250,000 during any one year as reported in any financial statement filed with the Commission on Form 10-QSB or 10-KSB.
All of the options that are subject to vesting expire ten years from the date of vesting. Further, each of the options would terminate ninety days from the date the employee’s employment with the Company is terminated. All of the options are intended to be granted as “incentive stock options” under the Company’s Equity Incentive Plan of 2000, although the Plan must be amended and approved by the shareholders to increase the amount of common stock reserved under the Plan in order to provide for some of the options.
The Agreement also provides that if the Employee is terminated without cause or the employee resigns with “good reason,” the Company shall pay Employee one (1) year’s base salary at the rate prevailing for employee immediately prior to such termination as severance pay, payable in accordance with Company’s policy. Employee shall also be entitled to receive benefits to which he was entitled immediately preceding the date of termination for a period of twelve (12) months from date of termination. Resignation with good reason includes resignation following a change in control, as defined in the agreement.
Compensation of Directors
Directors are not paid any additional compensation for their services as such. However, each is entitled to be reimbursed for reasonable expenses incurred in attending meetings or other service to the Company.
15
Outstanding Equity Awards at Fiscal Year-End
The following table summarizes the amount of our executive officers’ equity-based compensation outstanding at the fiscal year ended December 31, 2007:
| Option Awards | Stock Awards | |||||||
Name | Number of Securities Underlying Unexercised Options Exercisable | Number of Securities Underlying Unexercised Options Unexercisable | Equity Incentive Plan Awards: Number of Securities Underlying Unexercised Unearned Options | Option Exercise Price | Option Expiration Date | Number of Shares or Units of Stock That Have Not Vested | Market Value of | Equity Incentive Plan Awards: Number of Unearned Shares, Units or Other Rights That Have Not Vested | Equity Incentive Plan Awards: Market or Payout Value of Unearned Shares, Units or Other Rights That Have Not Vested |
| (#) | (#) | (#) | ($) |
| (#) | (#) | (#) | ($) |
James R. Musick | 31,848 | 0 | 0 | $ 0.63 | 6/7/2009 | - | - | - | - |
James R. Musick | 200,000 | 0 | 0 | 0.08 | 2/10/2016 | - | - | - | - |
James R. Musick | 0 | 0 | 300,000 | $ 0.17 | 4/1/2015 | - | - | - | - |
Erik D. Van Horn | 100,000 | 0 | 0 | $ 0.10 | 5/4/2008 | - | - | - | - |
Erik D. Van Horn | 30,516 | 0 | 0 | $ 0.63 | 6/7/2009 | - | - | - | - |
Stock Option Plan
The Company adopted an Equity Incentive Plan on October 9, 2000 (the "Plan") for the benefit of key personnel and others providing significant services to the Company. The Plan replaced the 1992 Equity Incentive Plan (the "1992 Plan"). The 1992 Plan will remain effective only so long as options remain outstanding under the 1992 Plan. No new options will be granted under the 1992 Plan, and the only shares that will be issued under the 1992 Plan are those shares underlying currently outstanding options.
The Plan authorizes total awards of up to 1,000,000 shares of the Company's common stock. Awards may take the form of incentive stock options, non-qualified stock options, restricted stock awards, stock bonuses and other stock grants. If an award made under the Plan expires, terminates, is canceled or settled in cash without the issuance of all shares of common stock covered by the award, those shares will be available for future awards under the Plan. Awards may not be transferred except by will or the laws of descent and distribution. No awards may be granted under the Plan after September 30, 2010.
The Plan is administered by the Company's Board of Directors, which may delegate its authority to a committee of the Board of Directors. The Board of Directors has the authority to select individuals to receive awards, to determine the time and type of awards, the number of shares covered by the awards, and the terms and conditions of such awards in accordance with the terms of the Plan. In making such determinations, the Board of Directors may take into account the recipient's current and potential contributions and any other factors the Board of Directors considers relevant. The Board of Directors is authorized to establish rules and regulations and make all other determinations that may be necessary or advisable for the administration of the Plan.
All options granted pursuant to the Plan shall be exercisable at a price not less than the fair market value of the common stock on the date of grant. Unless otherwise specified, the options expire ten years from the date of grant.
The following table illustrates the number of shares remaining available for issuance under the Plan.
16
Equity Compensation Plan Information
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) |
Equity compensation plans approved by security holders | 543,500 | $ 0.15 | 425,885 |
Equity compensation plans not approved by security holders | 162,364 | $ 0.30 | 0 |
TOTAL | 705,864 |
| 0 |
Compensation plans not approved by security holders included the 1992 equity incentive plan.
ITEM 11.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth information as of February 9, 2008, based solely on information available to the Company, with respect to the ownership of the Company's common stock by all officers and directors individually, all officers and directors as a group, and all shareholders known to the Company to hold beneficially more than five percent (5%) of the Company's common stock. The percentages in the table assume that any options or warrants owned by the beneficial owner exercisable within 60 days are exercised, but that no other outstanding options or warrants are exercised. At February 9, 2008, the Company had outstanding 13,931,681 shares of common stock, the only class of voting stock outstanding.
The following shareholders have sole voting and investment power with respect to the shares, unless it is indicated otherwise.
Name and Address of Beneficial Owner |
| Number of Shares |
| % |
Officers and Directors |
|
|
|
|
|
|
|
|
|
James R. Musick(1) (2) | 4,298,110 |
| 30.3% | |
|
|
|
| |
Erik Van Horn(3) Aurora, Colorado 80010 | 330,516 |
| 2.4% | |
|
|
|
| |
Officers and Directors as a group(1) (2) (,3) | 4,628,626 |
| 32.4% | |
|
|
|
| |
Other Shareholders |
|
|
| |
|
|
|
| |
Roger D. Hurst(4) | 1,132,482 |
| 8.1% |
17
| ||||
The James R. Musick Trust | 1,480,764 | 10.6% | ||
| ||||
Lloyd Hansen | 1,100,000 | 7.9% | ||
| ||||
Nathaniel Phillips | 707,731 | 5.1% | ||
| ||||
John D. Gibbs | 1,575,000(5) | 10.7% |
___________________
(1)
Includes 231,848 shares of common stock underlying an option immediately exercisable.
(2)
Includes 1,530,764 shares held by The James R. Musick Trust, of which Mr. Musick is a trustee and beneficiary.
(3)
Includes 130,516 shares of common stock underlying options immediately exercisable.
(4)
Includes 10,386 shares owned by Compion and 3,000 owned by Compion Management Services, Inc., companies in which Mr. Hurst is the sole shareholder
(5)
Includes 700,000 shares of common stock underlying a warrant that is immediately exercisable. Excludes 700,000 shares of common stock underlying two other warrants, neither of which is currently exercisable.
Changes in Control
The Company knows of no arrangement, including the pledge by anyone of any securities of the Company that may result in a change in control.
ITEM 12.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As of February 9, 2008, the Company had no independent directors.
Between August 2002 and October 2007, the Company's Chairman, James Musick, loaned the Company $168,150 for working capital. This loan and the accrued interest of $35,483 has been represented by a single promissory note in the amount of $203,633 dated October 31, 2007 bearing interest at the rate of 10% per year. The note replaces a previous note. This note is due on October 31, 2008 and is collateralized by the Company's patents regarding purification of FSH.
During November, 2006, the Company sold 535,714 shares of its common stock to Dr. Musick of the Company for $30,000, or $.056 per share. During August 2006, the Company sold 535,714 shares of its common stock to Dr. Musick for $30,000, or $.056 per share. During May 2006, the Company sold 625,000 additional shares of its common stock to Dr. Musick for $20,000, or $.032 per share. Finally, during February 2006, the Company sold 312,500 shares of its commons stock to Dr. Musick for $20,000, or $.064 per share.
The Company's Board of Directors is of the opinion that the terms of these transactions are no less favorable than could be obtained from an unaffiliated third party.
18
ITEM 13.
The following is a list of exhibits filed or incorporated by reference into this Report:
No. |
| Description |
1 |
| Not applicable. |
2 |
| Not applicable. |
3.1.1(1) |
| Articles of Incorporation of the Company as filed March 31, 1986 with the Nevada Secretary of State. |