U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------------------------
FORM 10-QSB
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
Commission File Number: 0-230 17
SONTRA MEDICAL CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1649949
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(State or other jurisdiction of (I.R.S. Employer
Incorporation or organization) Identification Number)
58 Charles Street, Cambridge, Massachusetts 02141
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(Address of principal executive offices) (Zip Code)
(617) 494-5337
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(Registrant's telephone number, including area code)
ChoiceTel Communications, 15500 Wayzata Blvd., #1029, Wayzata Minnesota 55391
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(Former name, former address and former fiscal year if changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of the date of this filing, the Registrant had 9,246,084 shares of Common
Stock outstanding.
SONTRA MEDICAL CORPORATION
FORM 10-QSB INDEX
Page
Number
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Part I - Financial Information
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 2001 and
June 30, 2002 (Unaudited) 3
Consolidated Statements of Operations for the
Three and Six Months Ended
June 30, 2001 and 2002 (Unaudited) 4
Consolidated Statements of Cash Flows for the
Six Months Ended June 30, 2001 and 2002 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Part II - Other Information
Item 1. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 15
Item 6. Exhibits and Reports on Form 8-K 16
Signatures 16
SONTRA MEDICAL CORPORATION
Formerly ChoiceTel Communications, Inc.
(A Development Stage Company)
Consolidated Balance Sheets
Consolidated Balance Sheets
As of
June 30, December 31,
2002 2001
------------ ------------
(Unaudited)
Assets:
Current Assets:
Cash and cash equivalents $ 4,593,674 $ 381,067
Accounts receivable, net 141,971 --
Prepaid expenses and other current assets 191,909 52,054
------------ ------------
Total current assets 4,927,554 433,121
------------ ------------
Property and Equipment, at cost
Computer equipment 127,201 87,663
Office and laboratory equipment 378,650 394,696
Furniture and fixtures 9,139 9,139
Leasehold improvements 287,035 287,035
------------ ------------
802,025 778,533
Less-Accumulated depreciation and amortization (563,998) (507,616)
------------ ------------
Net property and equipment 238,027 270,917
Restricted Cash -- 10,500
Other Assets 31,675 31,675
------------ ------------
Total assets $ 5,197,256 $ 735,713
============ ============
LIABILITIES, CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Accounts payable $ 109,024 $ 164,599
Accrued expenses 798,534 208,181
------------ ------------
Total current liabilities 907,558 372,780
Series A Convertible Preferred Stock, $0.01 par value
Authorized, issued and outstanding 1,938,075 shares in 2001
and no shares in 2002 (liquidation preference of $7,000,000 at 2001) -- 7,000,000
Series B Redeemable Convertible Preferred Stock, $0.01 par value
Authorized 3,994,514 shares, issued and outstanding
1,646,354 shares in 2001 and no shares in 2002, at redemption value
(liquidation preference of $3,420,789 at 2001) -- 3,420,789
Stockholders' Equity (Deficit):
Common stock, $0.01 par value,
Authorized 20,000,000 shares
Issued and outstanding 9,246,084 shares in 2002 and 2,613,348 in 2001 92,461 26,133
Additional paid-in capital 17,769,330 1,666,225
Subscriptions receivable (17,294) (17,294)
Deficit accumulated during the development stage (13,554,799) (11,722,420)
------------ ------------
4,289,698 (10,047,356)
Total liabilities, convertible preferred stock and stockholders' equity (deficit) $ 5,197,256 $ 746,213
============ ============
The accompanying notes are an integral part of these financial statements
3
SONTRA MEDICAL CORPORATION
Formerly ChoiceTel Communications, Inc.
(A Development Stage Company)
Consolidated Statements of Operations
(Unaudited)
Cumulative
Period from
Inception
(January 29, 1996)
Three Months Ended June 30, Six Months Ended June 30, to
2002 2001 2002 2001 June 30, 2002
----------- ----------- ----------- ----------- ------------
Revenue $ -- $ -- $ -- $ -- $ 2,895,927
Operating Expenses:
Research and development 426,255 478,130 860,624 972,598 8,059,340
General and administrative 621,296 343,295 826,380 772,645 6,526,285
----------- ----------- ----------- ----------- ------------
Total operating expenses 1,047,551 821,425 1,687,004 1,745,243 14,585,625
----------- ----------- ----------- ----------- ------------
Loss from operations (1,047,551) (821,425) (1,687,004) (1,745,243) (11,689,698)
Interest income (expense), net 1,596 (55,236) 2,726 (62,524) (808,964)
----------- ----------- ----------- ----------- ------------
Net loss (1,045,955) (876,661) (1,684,278) (1,807,767) (12,498,662)
Accretion of Dividend on Series B
Redeemable Convertible Preferred
Stock (53,126) -- (148,101) (483,906)
----------- ----------- ----------- ----------- ------------
Net loss applicable to
common Shareholders $(1,099,081) $ (876,661) $(1,832,379) $(1,807,767) $(12,982,568)
=========== =========== =========== =========== ============
Net loss per common, basic and
diluted $ (0.27) $ (0.34) $ (0.55) $ (0.87)
=========== =========== =========== ===========
Basic and diluted weighted average
common shares outstanding 4,028,525 2,612,819 3,324,701 2,069,852
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
4
SONTRA MEDICAL CORPORATION
(A Development Stage Company)
Formerly ChoiceTel Communications, Inc
Consolidated Statements of Cash Flows
(Unaudited)
Cumulative Period
from Inception
Six Months Ended June 30, (January 29, 1996)
2002 2001 to June 30, 2002
------------ ----------- ----------------
Cash Flows From Operating Activities:
Net loss $ (1,684,278) $(1,807,767) $(12,498,662)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 67,403 80,821 613,265
Stock based compensation 300,000 19,104 433,948
Amortization of discount on convertible --
promissory notes -- -- 1,200,000
Changes in assets and liabilities: --
Prepaid assets and other current assets (139,855) (27,371) (191,909)
Accounts payable (55,576) 217,270 109,024
Accrued expenses 68,851 91,116 277,032
------------ ----------- ------------
Net cash used in operating activities (1,443,455) (1,426,827) (10,057,302)
------------ ----------- ------------
Cash Flows from Investing Activities:
Purchase of property and equipment (42,941) (1,950) (878,601)
Sale of fixed assets 8,428 -- 36,158
Decrease in restricted cash 10,500 -- --
(Increase) decrease in other long-term assets -- 3,000 (31,675)
------------ ----------- ------------
Net cash provided by (used in) investing activities (24,013) 1,050 (874,118)
------------ ----------- ------------
Cash Flows From Financing Activities:
Proceeds from equipment loan -- -- 491,032
Repayment of equipment loan -- (289,733) (491,032)
Net proceeds from the sale of common stock -- -- 331,726
Cash received from ChoiceTel merger 4,693,220 -- 4,693,220
Net proceeds from the sale of preferred stock 980,107 -- 9,365,091
Proceeds from issuance of convertible promissory note -- 1,200,000 1,700,000
Proceeds from stock option exercise 6,748 -- 6,788
Distribution to shareholders -- -- (572,231)
Payment of subscription receivable -- -- 500
------------ ----------- ------------
Net cash provided by financing activities 5,680,075 910,267 15,525,094
------------ ----------- ------------
Net Increase(Decrease) in Cash and Cash Equivalents 4,212,607 (515,510) 4,593,674
Cash and Cash Equivalents, beginning of period 381,067 533,803 --
------------ ----------- ------------
Cash and Cash Equivalents, end of period $ 4,593,674 $ 18,293 $ 4,593,674
============ =========== ============
Supplemental Disclosure of Non Cash Financing Transactions:
Conversion of note in Series A pfd stock $ -- $ -- $ 500,000
============ =========== ============
Conversion of note into Series B pfd stock $ -- $ -- $ 1,200,000
============ =========== ============
Accretion of dividend on Series B pfd stock $ 148,101 $ -- $ 248,998
============ =========== ============
Issuance of common stock in connection with the convertible
promissory notes $ -- $ -- $ 600,000
============ =========== ============
Beneficial conversion feature on convertible promissory notes $ -- $ -- $ 600,000
============ =========== ============
Conversion of Series A and B Preferred Stock into
common stock $ 11,548,997 $ -- $ 11,548,997
============ =========== ============
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ -- $ 62,524 $ 153,371
============ =========== ============
The accompanying notes are an integral part of these financial statements.
5
SONTRA MEDICAL CORPORATION
(Formerly ChoiceTel Communications, Inc.)
(A Development Stage Company)
Notes to Consolidated Financial Statements
June 30, 2002
(Unaudited)
(1) BASIS OF PRESENSTATION
The accompanying consolidated financial statements include the accounts of
Sontra Medical Corporation ("the Company) and its wholly-owned subsidiary,
Sontra Medical, Inc. ("Sontra"). All significant inter-company balances and
transactions have been eliminated in consolidation. The financial information
included in this report has been prepared in accordance with generally accepted
accounting principles for interim financial statements and with the instructions
to Form 10-QSB. Accordingly, they do not include all of the information and
disclosures required for annual financial statements. These financial statements
should be read in conjunction with the financial statements and related
footnotes of the predecessor company ChoiceTel Communications, Inc's annual
report filed on Form 10-KSB for the year ended December 31, 2001 and the
financial statements and related footnotes of Sontra included in the Company's
Registration Statement on Form S-4 (Registration No 333-86814 filed on May 16,
2002).
In the opinion of the Company's management, all adjustments (consisting
only of normal recurring accruals) necessary to present fairly the Company's
financial position as of June 30, 2002 and the results of operations and cash
flows for the three and six month periods ended June 30, 2002 and June 30, 2001
have been included. The results of operations for the quarter and six months
ended June 30, 2002 are not necessarily indicative of the results of operations
for the full year or any other interim period.
(2) MERGER AGREEMENT WITH CHOICETEL COMMUNICATIONS, INC.
At an annual meeting of ChoiceTel Communications, Inc. ("ChoiceTel")
shareholders and a special meeting of Sontra stockholders, each held on June 20,
2002, the stockholders of Sontra and the shareholders of ChoiceTel approved and
adopted the Agreement and Plan of Reorganization, dated as of February 27, 2002
(the "Merger Agreement"), among ChoiceTel, its wholly-owned subsidiary, CC
Merger Corp., and Sontra Medical, Inc. Pursuant to the Merger Agreement, Sontra
merged into CC Merger Corp, a wholly -owned subsidiary of ChoiceTel, with Sontra
surviving the merger as a wholly-owned subsidiary of ChoiceTel. Subsequent to
the consummation of the merger, ChoiceTel changed its name to Sontra Medical
Corporation.
For accounting purposes, the merger transaction is treated as a capital
transaction and a recapitalization, whereby the historical financial statements
of Sontra Medical, Inc. become the historical financial statements of the
combined entity. Following the merger, the business conducted by the combined
entity will be the business conducted by Sontra prior to the merger. The
accounting treatment for the recapitalization is similar to that resulting from
an acquisition, except that goodwill and other intangible assets were not
recorded.
Under the recapitalization, in exchange for the $4,794,524 of net assets that
Sontra received from ChoiceTel, the shareholders of ChoiceTel received 3,035,795
shares of the Company's common stock. In addition, the preferred stockholders of
Sontra converted their shares of Series A Preferred Stock and Series B Preferred
Stock into common stock of Sontra. The resulting 32,227,829 shares of common
stock on Sontra were then exchanged for 6,210,289 shares of the Company at a
ratio of .1927 shares of the Company's common stock for each share of Sontra
common stock. Upon completion of the merger, the Company had 9,246,084 shares of
common stock outstanding with the former ChoiceTel shareholders owning 32.83% of
the common stock and the former Sontra shareholders owning 67.17% of the
outstanding shares of the Company. All of the per share data for periods prior
to June 30, 2002 have been retroactively adjusted by the .1927 exchange ratio to
reflect the recapitalization.
The merger was effected pursuant to the Delaware General Corporation Law and is
intended to be a tax-free reorganization under Section 368(a)(1)(A) of the
Internal Revenue Code of 1986, as amended.
On April 12, 2002, Sontra granted an option to a consultant for the purchase of
38,540 shares of common stock at an exercise priceof $.52. per share in exchange
for services related to the proposed merger with ChoiceTel. The shares under
this option vested 100% upon the consummation of the merger and were valued as
of June 20, 2002 at approximately $115,000 using the Black-Scholes option
pricing model. However, since the services provided by the consultant are
considered cost associated with the merger, there is no impact on additional
paid in capital.
On June 28, 2002, Sontra granted options to its Board of Directors for a total
of 200,000 shares of common stock. The options had an exercise price of $2.50
and the fair value of the common stock on this date was $4.00. As a result,
Sontra recorded additional paid in capital and non-cash compensation expense of
$300,000 for the quarter ending June 30, 2002.
6
(3) REDEEMABLE PREFERRED STOCK
Prior to its conversion into common stock in connection with the merger, the
Series B Preferred Stock of Sontra was recorded at net sales price and the
carrying value was accreted (increased) over time such that at the earliest date
of possible redemption, the Series B Preferred Stock was carried at its
redemption value. The periodic accretion was recorded to increase the carrying
value was charged directly to the accumulated deficit in the development stage.
In the quarter ending June 30, 2002, $53,126 was charged to deficit accumulated
in the development stage related to the accretion on the Series B Preferred
Stock through the date of conversion. The carrying value of the Series A
Preferred Stock of Sontra did not accrete prior to its conversion into common
stock.
In conjunction with the merger (see Note 2) on June 20, 2002, all shares of
Sontra's Series A Preferred Stock and Series B Preferred Stock converted into an
equal number of shares of Sontra common stock.
(4) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements reflect the application of certain
accounting policies as described in this note and elsewhere in the accompanying
financial statements.
(a) Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of expenses during the reporting period.
Actual results could differ from those estimates.
(b) Cash and Cash Equivalents
Sontra considers all highly liquid investments with maturities of ninety days or
less to be cash equivalents. Cash equivalents consist primarily of commercial
paper and money market funds as of June 30,2002 and December 31,2001.
(c) Depreciation and Amortization
Sontra provides for depreciation and amortization by charges to operations for
the cost of assets using the straight-line method based on the estimated useful
lives of the related assets, as follows:
Asset Classification Estimated Useful Life
Computer equipment 3 years
Office and laboratory equipment 3-5 years
Furniture and fixtures 7 years
Leasehold improvements Life of lease
(d) Stock-Based Compensation
The Company's employee stock option plan is accounted for using the intrinsic
value-based method of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. Sontra
uses the fair value method of SFAS No. 123, Accounting for Stock-Based
Compensation to account for non-employee stock-based compensation.
In 1997 and in 1999, the Company adopted the 1997 and 1999 Stock Option and
Incentive Plans (the Plans) under which the board of directors (or committees
and/or executive officers delegated by the Board) may grant incentive and
nonqualified stock options or other awards to employees, officers, directors,
consultants and advisors. There are an aggregate of 1,500,000 shares reserved
under the 1997 plan and 866,539 shares reserved under the 1999 plan.
There were no options issued in the quarter ending March 31, 2002. In the
quarter ending June 30, 2002, the Company granted options for 1,366,041 shares
of common stock at prices from $0.52 to $3.74 which approximately fair value. In
connection with the merger as discussed in Note 2, Sontra assumed options issued
by ChoiceTel prior to the merger for a total of 212,341 shares of common stock.
As of June 30, 2002, options on common stock outstanding totaled 1,935,690 at a
weighted average exercise price of $2.31 per share.
(e) Net Loss per Common Share
Basic and diluted net loss per share of common stock are presented in conformity
with SFAS No. 128, Earnings per Share, for all periods presented. Accordingly,
basic and diluted net loss per share of common stock has been computed by
dividing the net loss applicable to common stockholders in each period by the
weighted average number of shares of common stock outstanding during the period.
(f) Research and Development Expenses
The Company charges research and development expenses to operations as incurred.
Research and development expenses primarily consist of salaries and related
expenses for personnel and consulting services. Other research and development
expenses include fees paid to consultants and outside service providers, the
costs of materials used in research and development, information technology and
facilities costs.
7
(g) Income Taxes
The Company provides for federal and state income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes. Under SFAS No. 109, deferred tax assets
and liabilities are recognized based on temporary differences between the
financial statement and tax bases of assets and liabilities. Deferred income
taxes are based on enacted rates and laws applicable to periods in which
differences are expected to reverse. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
No provision or benefit for federal or state income taxes has been recorded as
Sontra has incurred net losses for all periods presented.
(5) LITIGATION
The Company has been named in a lawsuit brought in Minneapolis District Court by
a creditor of a former ChoiceTel subsidiary, Advants, Inc In May 2002, the Court
denied the Company's motion for summary judgment and a trial in this matter is
anticipated to commence in September. The Company intends to vigorously defend
this lawsuit
Item 2. Management's Discussion and Analysis or Plan of Operation
The following discussion of the financial condition and results of
operations of Sontra Medical Corporation should be read in conjunction with the
financial statements and the related notes thereto included elsewhere in this
Form 10-QSB and the audited financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in ChoiceTel Communications Inc.'s Annual Report on Form
10-KSB for the year ended December 31, 2001 and the financial statements and
related footnotes of Sontra Medical, Inc. included in the Registration Statement
on Form S-4 (Registration No. 333-86814) filed on May 16, 2002, each of which
has been filed with the Securities and Exchange Commission. Except for the
historical information contained herein, the following discussion contains
forward-looking statements that involve risks and uncertainties, certain of
which are beyond our control. Actual results could differ materially from these
forward-looking statements as a result of a number of factors including, but not
limited to, those factors described in "Factors That May Affect Future Results"
in this Form 10-QSB and in the other aforementioned documents.
Overview
The Company was incorporated in Minnesota in 1989 as Intelliphone, Inc.,
and changed its name in April 1997 to ChoiceTel Communications, Inc. On June 20,
2002, ChoiceTel Communications, Inc. ("ChoiceTel") (the predecessor to Sontra
Medical Corporation), Sontra Medical, Inc. ("Sontra") and CC Merger Corp., a
wholly owned subsidiary of ChoiceTel, consummated a business combination whereby
CC Merger Corp. merged into Sontra with Sontra surviving as a wholly-owned
subsidiary of ChoiceTel. The merger has been accounted for as recapitalization
whereby the historical financial statements of Sontra became the historical
financial statements of the Company. Following the merger, ChoiceTel changed its
corporate name to Sontra Medical Corporation (the "Company") and began operating
in Sontra's line of business.
Sontra Medical Corporation is a development stage life sciences company
engaged in the research and development of transdermal diagnostic products,
including transdermal transport of interstitial fluid for diagnostic purposes.
The Company is also developing technology for the transdermal delivery of
therapeutics and topical components for pharmaceutical and cosmetics
applications.
The Company has incurred net losses since its inception in 1996, including
a net loss of approximately $1.4 million and $4.7 million for the six months
ended June 30, 2002 and the year ended December 31, 2001 respectively. As of
June 30, 2002, the Company had an accumulated deficit of $13.3 million. The
Company's losses have resulted principally from costs incurred in conjunction
with its research and development initiatives. The Company expects additional
losses for the foreseeable future primarily as a result of its research and
development activities and other general corporate activities.
Research and development expenses include costs related to salaries and
related expenses for personnel and consulting services. Other research and
development expenses include fees paid to consultants and outside service
providers, the cost of materials used in research and development, information
technology and facilities costs. The
8
Company expects that its research and development expenses will continue as it
continues activities to complete the development of its products, obtain
regulatory clearances or approvals, and conduct further research and
development.
General and administrative expenses consist primarily of non-research
personnel salaries and related expenses, facilities costs and professional fees.
The Company expects general and administrative expenses to increase as it hires
additional personnel and builds its infrastructure to support future growth.
Results of Operations
Comparison of the quarters ended June 30, 2002 and 2001
Research and development expenses. Research and development expenses
decreased to $426,000 for the quarter ended June 30, 2002 from $478,000 for the
quarter ended June 30, 2001. This decrease was primarily attributable to a
decrease in spending for outside consultants.
General and administrative expenses. General and administrative expenses
was substantially unchanged at $321,000 for the quarter ended June 30, 2002
versus $343,000 for the for the quarter ended June 30, 2001. The Company expects
general and administrative expenses to increase in the future due to the hiring
of members of its senior management team as well as expenses associated with
being a public company following completion of the merger.
Interest income. Interest income was $1,596 for the quarter ended June 30,
2002 versus interest expense of $55,236 for the quarter ended June 30, 2002. The
decrease in interest expense was due to elimination of all outstanding loans
during the second quarter of 2002. During the second quarter of 2001, the
Company had bridge loans outstanding in an aggregate principal amount of $1.2
million.
Comparison of the six months ended June 30, 2002 and 2001
Research and development expenses. Research and development expenses
decreased to $861,000 for the six months ended June 30, 2002 from $973,000 for
the six months ended June 30, 2001. This decrease was primarily attributable to
a decrease in spending for outside consultants. The Company expects research and
development expenses to increase substantially over the next year as it
accelerates the commercialization of its SonoPrep technology.
General and administrative expenses. Selling, general and administrative
expenses decreased to $526,000 for the six months ended June 30, 2002 from
$773,000 for the six months ended June 30, 2001. The decrease is attributable to
a decrease in expenses for outside consultants and also a decrease in
amortization and depreciation. The Company expects general and administrative
expenses to increase in the future due to the hiring of members of its senior
management team as well as expenses associated with being a public company
following completion of the merger.
Interest income(expense). Interest income was $2,726 for the six months
ended June 30, 2002 versus interest expense of $63,000 for the six months ended
June 30, 2001. The decrease in interest expense was primarily due to the
elimination of all outstanding loans during the first six months of 2002. During
the first six months of 2001, the Company had bridge loans totaling $1.2 million
outstanding and during the first quarter of 2001 outstanding equipment loans of
$290,000 were repaid.
Liquidity and Capital Resources
Sontra Medical Corporation is a development stage company and has financed
its operations since inception primarily through private sales of its preferred
stock and issuance of convertible promissory notes and with the cash received in
the merger. As of June 30, 2002, the Company had $4,594,000 in cash and cash
equivalents.
Net cash used in operating activities was $1,454,000 for the six months
ended June 30, 2002, primarily due to the net loss of $1,385,000 and an increase
in net working capital.
Net cash used in investing activities was $13,000 for the six month period
ended June 30, 2002, resulting from $23,000 used to purchase equipment and
$11,000 provided from the release of restricted cash.
9
Net cash provided by financing activities was $5,680,000 for the six months
ended June 30, 2002. The merger with Choicetel provided $4,693,000 of cash and
net proceeds from the sale of preferred stock provided $980,000. In addition,
the exercise of stock options also provided $7,000.
The Company expects that the cash and marketable securities of the combined
company will be sufficient to meet its cash requirements through June 2003. The
Company will be required to raise a substantial amount of capital in the future
to complete the commercialization of its products. The Company's future capital
requirements will depend on many factors, including the following:
o its ability to obtain funding from third parties, including any future
collaborative partners;
o its progress on research and development programs and pre-clinical and
clinical trials;
o the time and costs required to gain regulatory approvals;
o the costs of manufacturing, marketing and distributing its products,
if successfully developed and approved;
o the costs of filing, prosecuting and enforcing patents, patent
applications, patent claims and trademarks;
o the status of competing products; and
o the market acceptance and third-party reimbursement of its products,
if successfully developed and approved.
If the Company is unable to raise sufficient additional financing, its
business and operations will be materially adversely affected and it may not be
able to sustain its operations.
Factors That May Affect Future Results
The Company operates in a rapidly changing environment that involves a
number of risks, some of which are beyond our control. This discussion
highlights some of the risks which may affect future operating results.
The Company's failure to comply with Nasdaq's listing standards will subject its
stock to being delisted from the Nasdaq SmallCap Market.
On June 24, 2002, the Company received a notice from Nasdaq that the
business combination between Sontra and ChoiceTel constituted a reverse merger
and that, in addition to compliance with the Nasdaq SmallCap Market's continued
listing requirements, the Company was required to meet the more stringent
initial listing requirements of the Nasdaq SmallCap Market. The notice further
stated that the Company's common stock failed to comply with the minimum bid
price and shareholders' equity requirements for initial listing and that, as a
result, its common stock is subject to delisting from the Nasdaq SmallCap
Market. The Company appealed the Nasdaq finding at an oral hearing held on
August 8, 2002 with the Nasdaq Listing Qualifications Panel. As of the date
hereof, the Company has not yet received the results of that hearing, and the
Company is unable to predict the outcome thereof. While the Company stock
continues to be listed on the Nasdaq SmallCap market pending the determination
of the Nasdaq Listing Qualifications Panel, there can be no assurance that the
panel will grant the Company's request for continued listing. At June 30, 2002,
the Company did not meet the initial listing requirements for the Nasdaq Small
Cap Market and its stock may be delisted in the near future.
If the Company's stock is delisted from the Nasdaq SmallCap Market, it will
likely be traded on the over-the-counter bulletin board (OTCBB). If the
Company's stock is traded on the OTCBB, its value may be negatively impacted
because stocks which trade over-the-counter tend to trade with larger variations
between the bid and ask price. Further, it will likely be more difficult to
dispose of, or obtain accurate quotations as to the value of, the Company's
common stock. This lack of liquidity may cause the Company to have difficulty in
raising capital.
Sontra has a history of losses, and the Company expects losses to continue for
several years.
Sontra has generated limited revenues and has had operating losses since
its inception in 1996. Sontra's accumulated deficit was approximately $13.3
million as of June 30, 2002. It is possible that the Company will never generate
any additional revenue or generate enough additional revenue to achieve
profitability. Even if the Company obtains profitability, it may not be able to
sustain or increase profitability. The Company expects its operating losses to
continue for the foreseeable future as it continues to expend substantial
resources to conduct research and development, feasibility and pre-clinical
studies, obtain limited regulatory approvals for specific use applications of
its SonoPrep(R) device, identify and secure collaborative partnerships, and
manage and execute its obligations in strategic collaborations.
10
The Company will need additional capital in the future.
Sontra has generated limited revenue the Company and does not expect to
generate any revenues in the near future. The Company's development efforts to
date have consumed and will continue to require substantial amounts of capital
to complete the development of its SonoPrep(R) technology and to meet its other
cash requirements in the future. The Company will need substantial additional
capital to complete the development of its SonoPrep(R) technology and to meet
its other cash requirements in the future. Based on the Company's current
operating plan, the Company estimates that it will be required to raise
additional funds prior to June 2003 through public or private financing,
collaborative relationships or other arrangements the source of which is
unknown. Any future equity financing, if available, may result in substantial
dilution to existing stockholders, and debt financing, if available, may include
restrictive covenants or may require the Company to grant a lender a security
interest in its assets. To the extent that the Company attempts to raise
additional funds through third party collaboration and/or licensing
arrangements, the Company may be required to relinquish some rights to its
technologies or products currently in various stages of development, or grant
licenses on terms that are not favorable to the Company. If the Company is
unable to raise sufficient additional financing, it may not be able to sustain
its operations.
The price of the Company's stock may be volatile and trading in the stock is
likely to be limited.
The trading price of the Company's common stock has fluctuated in the past
and is expected to continue to do so in the future, as a result of a number of
factors, many of which are outside the Company's control. The Company's common
stock reached a high of $4.77 per share and traded as low as $0.70 per share
between October 1, 2001 and July 31, 2002. Since the Company's initial listing
on the Nasdaq SmallCap Market in 1998, the volume of trading in the Company's
common stock has been limited and price changes have been volatile.
In addition, the stock market has experienced price and volume fluctuations
that have affected the market prices of many companies, and that have often been
unrelated or disproportionate to the operating performance of these companies.
These broad market fluctuations could adversely affect the market price of the
Company's common stock. In the past, following periods of volatility in the
market price of a particular company's securities, securities class action
litigation has often been brought against that company. Securities class action
litigation could result in substantial costs and a diversion of the Company's
management's attention and resources.
The Company has a short operating history, which makes it difficult for you to
evaluate the Company's business.
Because limited historical information is available on the Company's
business, it may be difficult to evaluate the Company's business and prospects.
The Company's business and prospects must be considered in light of the
substantial risks, expenses, uncertainties and difficulties encountered by
entrants into the medical device industry, which is characterized by
increasingly intense competition and a high failure rate. To date, the Company
has engaged primarily in research and development efforts, prototype development
and testing, and conducting pre-clinical and feasibility studies. The Company's
results of operations will depend on, among other factors:
o research and development activities and outcomes;
o results of feasibility and pre-clinical studies;
o the ability to enter into collaborative agreements;
o the timing of payments, if any, under future collaborative agreements;
and
o costs related to obtaining, defending and enforcing patents.
The development and commercialization of the Company's potential products,
including the SonoPrep(R) device, will require the formation of strategic
partnerships with third parties, substantial further research, regulatory, sales
and marketing, manufacturing and other expenditures by the Company or a
strategic partner of the Company.
The Company's future success is dependent on successful collaborations with
strategic partners.
The Company's future success is dependent on its ability to selectively
enter into and maintain collaborative arrangements with leading medical device
and pharmaceutical companies. The Company is not currently a party to any
collaborative agreements and may not be able to enter into any collaborative
arrangements on acceptable terms, if at all. If the Company were not able to
find a collaborative partner, the business, financial condition and results of
operations of the Company could be materially adversely affected.
Even if the Company were to enter into a collaborative arrangement:
o such collaborative arrangements could terminate upon the expiration of
certain notice periods;
o funding by collaborative partners may be dependent upon the
satisfaction of certain goals or "milestones" by certain specified
dates, some of which may be outside of the Company's control;
11
o collaborative partners may retain a significant degree of discretion
regarding the timing of these activities and the amount and quality of
financial, personnel and other resources that they devote to these
activities;
o disputes may arise between the Company and any future collaborative
partner regarding their respective rights and obligations under the
collaborative arrangements, which may be costly; and
o any future collaborative partner may not be able to satisfy its
obligations under its arrangement with the Company or may
intentionally or unintentionally breach its obligations under the
arrangement.
All of the Company's products are in initial stages of development, and the
Company faces the risks of failure inherent in developing products based on new
technologies.
The Company's products under development have a high risk of failure
because they are in the early stages of development. To date, the Company has
only tested the feasibility of its SonoPrep(R) technology for various
applications, including glucose monitoring, transdermal drug delivery and
certain aesthetic applications. None of the products currently being developed
by the Company, including the SonoPrep(R) device, have been submitted for or
received regulatory approval or clearance for commercial sale. Substantial
expenditures for additional research and development, including feasibility
studies, pre-clinical studies and clinical testing, the establishment of
collaborative partnerships, and regulatory, manufacturing, sales and marketing
activities by collaborative partners will be necessary before commercial
production of any of the Company's technologies or their incorporation into
products of third parties. the Company's future prospects are substantially
dependent on forming collaborative partnerships, further developing its products
and obtaining favorable results from pre-clinical studies and clinical trials
and satisfying regulatory standards and approvals required for the market
introduction of the SonoPrep(R) device.
There can be no assurance that the Company or any future strategic partner
of the Company will not encounter unforeseen problems in the development of the
SonoPrep(R) technology, or that the Company or any such strategic partner will
be able to successfully address the problems that do arise. In addition, there
can be no assurance that any of the Company's potential products will be
successfully developed, proven safe and efficacious in clinical trials, meet
applicable regulatory standards, be capable of being produced in commercial
quantities at acceptable costs, be eligible for third-party reimbursement from
governmental or private insurers, be successfully marketed or achieve market
acceptance. If any of the Company's development programs are not successfully
completed, required regulatory approvals or clearances are not obtained, or
potential products for which approvals or clearances are obtained are not
commercially successful, the Company's business, financial condition and results
of operations would be materially adversely affected.
Failure to obtain necessary regulatory approvals will prevent the Company or its
collaborators from commercializing the Company's SonoPrep(R) device and related
product concepts currently under development.
The design, manufacturing, labeling, distribution and marketing of the
Company's potential products will be subject to extensive and rigorous
government regulation in the United States and certain other countries. The
process of obtaining and maintaining required regulatory clearance and approvals
in the United States is lengthy, expensive and uncertain. In order for the
Company to market its potential products in the United States, the Company must
obtain clearance by means of a 510(k) pre-market notification, or approval by
means of a pre-market approval ("PMA") application, from the United States Food
and Drug Administration ("FDA"). The PMA process is more rigorous and lengthier
than the 510(k) clearance process and can take several years from initial filing
and require the submission of extensive supporting data and clinical
information.
Even if the Company receives 510(k) clearance or PMA approval, there can be
no assurance that the FDA will not impose strict labeling or other requirements
as a condition of its clearance or approval, any of which could limit the
Company's ability to market its products under development. Further, if the
Company wishes to modify a product after FDA clearance or approval, including
changes in indications or other modifications that could affect safety and
efficacy, additional clearances or approvals could be required from the FDA. Any
request by the FDA for additional data or any requirement by the FDA that the
Company conduct additional clinical studies could significantly delay the
commercialization of the Company's products and require the Company to make
substantial additional research, development and other expenditures by the
Company. Similarly, any labeling or other conditions or restrictions imposed by
the FDA on the marketing of the Company's potential products could hinder the
Company's ability to effectively market these products.
A substantial portion of the intellectual property used by the Company is owned
by the Massachusetts Institute of Technology.
12
The Company has an exclusive world-wide license to use and sell certain
technology owned by the Massachusetts Institute of Technology (MIT) related to
the Company's ultrasound-mediated skin permeation technology. This license,
which includes eight issued patents in the United States, five issued foreign
patents and four pending foreign patent applications, comprises a substantial
portion of the Company's patent portfolio relating to its technology.
While under the license agreement, the Company has the right to advise and
cooperate in MIT with the prosecution and maintenance of the foregoing patents,
the Company does not control the prosecution of such patents or the strategy for
determining when such licensed patents should be enforced. Instead, the Company
relies upon MIT to determine the appropriate strategy for prosecuting and
enforcing these patents. If MIT does not adequately protect or enforce its
patent rights, the Company's ability to manufacture and market its products,
currently in various stages of development, would be adversely affected.
The Company will need to obtain and protect the proprietary information on which
its SonoPrep(R) technology relies.
The Company has an exclusive license from the Massachusetts Institute of
Technology on eight issued patents in the United States, five issued foreign
patents and four pending foreign patent applications, and as of August 16, 2002,
the Company owned 2 issued patents and 4 pending patent applications in the
United States and 1 issued foreign patent and 6pending foreign applications. The
Company can provide no assurance that patents will be issued from the patent
applications, or, if issued, that they will be issued in a form that will be
advantageous to the Company.
There can be no assurance that one or more of the patents owned or licensed
by the Company will not be successfully challenged, invalidated or circumvented
or that the Company will otherwise be able to rely on such patents for any
reason. If any of the Company's patents or any patents licensed from MIT are
successfully challenged or the Company's right or ability to manufacture its
future products (if successfully developed and commercialized) were to be
limited, the Company's ability to manufacture and market these products could be
adversely affected, which would have a material adverse effect upon the
Company's business, financial condition and results of operations.
In addition to patent protection, the Company relies on a combination of
copyright, trade secret and trademark laws, and nondisclosure, confidentiality
agreements and other contractual restrictions to protect its proprietary
technology. However, these legal means afford only limited protection and may
not adequately protect the rights or competitive advantage of the Company. The
Company may not be able to prevent the unauthorized disclosure or use of its
technical knowledge or other trade secrets by its employees. Nondisclosure and
confidentiality agreements with third parties may be breached, and there is no
assurance that the Company would have adequate remedies for any such breach.
If the Company fails to protect its intellectual property rights, the
Company's competitors may take advantage of its ideas and compete directly
against the Company. There can be no assurance that competitors, many of whom
have substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that limit the
Company's ability to make, use and sell its potential products either in the
United States or in foreign markets. Furthermore, if the Company's intellectual
property is not adequately protected, the Company's competitors may be able to
use the Company's intellectual property to enhance their products and compete
more directly with the Company, which could prevent the Company from entering
its products into the market or result in a decrease in the Company's eventual
market share.
The Company may be subject to litigation or other proceedings relating to its
patent rights.
The medical device industry has experienced extensive litigation regarding
patents and other intellectual property rights. In addition, the United States
Patent and Trademark Office may institute litigation or interference proceedings
against the Company. The defense and prosecution of intellectual property
proceedings are both costly and time consuming.
Litigation may be necessary to enforce patents issued to the Company, to
protect trade secrets or know how owned by or licensed to the Company or to
determine the enforceability, scope and validity of the proprietary rights of
others. Any litigation or interference proceedings involving the Company may
require the Company to incur substantial legal and other fees and expenses. Such
proceedings would also be time consuming and can be a significant distraction
for employees and management, resulting in slower product development and delays
in commercialization. In addition, an adverse determination in litigation or
interference proceedings could subject the Company to significant liabilities to
third parties, require the Company to obtain licenses from third parties or
prevent it from selling its products, once developed, in certain markets, or at
all, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
13
The Company's potential markets are highly competitive and most participants are
larger, better capitalized, and more experienced than the Company.
The industries in which the Company's potential products may eventually be
marketed are intensely competitive, subject to rapid change and significantly
affected by new product introductions. The Company's SonoPrep(R) device and
related product concepts will compete directly with glucose monitoring products
manufactured by Roche Diagnostics, LifeScan, Inc., a division of Johnson &
Johnson, Bayer Corporation, MediSense, a division of Abbott Laboratories,
Cygnus, Inc., SpectRx Inc. and TheraSense, Inc. and drug delivery products
manufactured by companies such as Inhale Therapeutic Systems Inc., Alkermes,
Inc. Bioject, Inc. PowderJect Pharmaceuticals PLC, Antares Pharma, Inc., Becton
Dickinson and Company, Aerogen, Inc. ALZA Corporation, a division of Johnson and
Johnson, and 3M Company.
These companies are already producing and marketing glucose monitoring or
drug delivery products, are either publicly traded or a division of a
publicly-traded company, and enjoy several competitive advantages over the
Company. In addition, several of the Company's competitors have products in
various stages of development and commercialization similar to the Company's
SonoPrep(R) device and related product concepts. At any time, these companies
and others may develop products that compete directly with its proposed product
concepts. In addition, many of the Company's competitors have resources allowing
them to spend significantly greater funds for the research, development,
promotion and sale of new or existing products, thereby allowing them to respond
more quickly to new or emerging technologies and changes in customer
requirements. For all of the foregoing reasons, the Company may not be able to
compete successfully against its current and future competitors. If any of the
Company's competitors succeeds in developing a commercially viable product and
obtaining government approval, the business, financial condition and results of
operations of the Company would be materially adversely affected.
The Company operates in an industry with significant product liability risk.
The Company's business will expose it to potential product liability claims
that are inherent in the testing, production, marketing and sale of human
diagnostic and ultrasonic transdermal drug delivery products. While the Company
intends to take steps to insure against these risks, there can be no assurance
that it will be able to obtain insurance in amounts or scope sufficient to
provide it with adequate coverage against all potential liabilities. The
Company's current product liability insurance provides for coverage in the
amount of $2,000,000 and upon successful development and commercialization of
its products, the Company intends to obtain product liability insurance in the
amount of $5,000,000. A product liability claim in excess of the Company's
product liability insurance would have to be paid out of the Company's cash
reserves, if any, and would harm the Company's reputation in the industry and
adversely affect its ability to raise additional capital.
Management of the Company has significant influence over the control the
Company.
The officers and directors of the Company own beneficially approximately
48% of the outstanding shares of the Company's common stock. Accordingly, the
Company's officers and directors will have significant influence over the
outcome of any corporate transaction or other matters submitted to the
shareholders for approval, including mergers, consolidations and the sale of all
or substantially all of the Company's assets, and also could prevent or cause a
change in control. Third parties may be discouraged from making a tender offer
or bid to acquire the Company because of this concentration of ownership.
If the Company is unable to retain or hire additional key personnel, the Company
may not be able to sustain or grow its business.
The Company's future success will depend upon its ability to successfully
attract and retain key scientists, engineers and other highly skilled personnel.
With the exception of Dr. Thomas W. Davison, its Chief Executive Officer, Sean
Moran, its Chief Financial Officer, and Dr. Kost, its Chief Scientific Officer,
the Company's employees are at-will and not subject to employment contracts and
may terminate their employment with the Company at any time. In addition, the
Company's current management team is understaffed and has very limited
experience managing a public company subject to the Securities and Exchange
Commission's periodic reporting obligations. Hiring qualified management and
technical personnel will be difficult due to the limited number of qualified
professionals in the work force in general and the intense competition for these
types of employees in the medical device industry, in particular. The Company
has in the past experienced difficulty in recruiting qualified personnel and
there can be no assurance that the Company will be successful in attracting and
retaining additional members of management if the business begins to grow.
Failure to attract and retain personnel, particularly management and technical
personnel, would materially harm the Company's business, financial condition and
results of operations.
14
The Company will rely on third party manufacturers.
To successfully commercialize its SonoPrep(R) device and related product
concepts, the Company will have to manufacture or engage others to manufacture
the particular device in compliance with regulatory requirements, in a timely
manner and in sufficient quantities while maintaining product performance,
quality and acceptable manufacturing costs. There can be no assurance that the
Company will be able to establish and maintain reliable, full-scale
manufacturing of the SonoPrep(R) device or any other related products at
commercially reasonable prices. Manufacturers often encounter difficulties in
scaling up production of new products, including problems involving product
performance, production yields, quality control and assurance, and shortages of
personnel. Difficulties encountered in manufacturing scale-up or failure by the
Company or any contract manufacturer of the Company to implement and maintain
manufacturing facilities in accordance with international quality standards or
other regulatory requirements could result in a delay or termination of
production, which could have a material adverse effect on the Company's
business, financial condition and results of operations.
The Company is engaged in preliminary discussions with potential
development and manufacturing partners to enter into a manufacturing supply
agreement. There is no assurance, however, that the Company will be successful
in entering into any such relationship. Suppliers and manufacturers of the
Company's products must operate under GMP regulations, as required by the FDA,
and there are only a limited number of contract manufacturers that operate under
GMP regulations. If the Company is not able to contract with qualified
manufacturers, the Company may not be able to produce the required numbers of
its products for commercialization. Failure to retain qualified manufacturers
will delay the Company's commercialization of its products, which could
materially adversely affect the Company's business, financial condition and
results of operations.
Part II - Other Information
Item 1. Legal Proceedings
A suit was filed on June 4, 2001 in Hennepin County, Minnesota District Court by
Leaf Industries, seeking to pierce the corporate veil and hold the Company
responsible for the debts of a former ChoiceTel subsidiary, Advants, Inc. The
suit seeks damages in excess of $50,000 from Advants, Inc. for alleged services
provided. Tomato Land Displays is also a defendant in this action and has filed
cross claims against the Company in this action. In May 2002, the Court denied
the Company's motion for summary judgment and a trial in this matter is
anticipated to commence in September. The Company intends to vigorously defend
this lawsuit. The Company has established a reserve to cover anticipated legal
costs arising as a result of this action.
Item 4. Submission of Matters to a Vote of Security Holders
On June 20, 2002, at an annual meeting of the Company's shareholders, the
shareholders of the Company approved the following proposals:
o the merger agreement, the merger and the issuance of the merger
consideration in connection with the merger between the Company and
Sontra Medical, Inc. (1,830,272 shares for; 3,100 shares against;
1,000 shares abstained; and 735,811 broker non-votes);
o an increase in the size of the Company's board of directors to eight
members and the election of the following directors to serve until the
next annual meeting of shareholders or until their successors are
elected: James McNab (2,520,233 shares for; 49,950 shares withheld),
Joseph Kost (2,520,233 shares for; 49,950 shares withheld), Robert
Langer (2,520,233 shares for; 49,950 shares withheld), Thomas Davison
(2,520,233 shares for; 49,950 shares withheld), W. Leigh Thompson
(2,520,233 shares for; 49,950 shares withheld), Martin Sutter
(2,520,233 shares for; 49,950 shares withheld), Gary Kohler (2,519,233
shares for; 50,950 shares withheld) and Michael Wigley (2,519,233
shares for; 50,950 shares withheld);
o an amendment to the Company's 1997 Long-Term Incentive and Stock
Option Plan to increase the number of shares reserved for issuance
under the Plan from 350,000 shares to 1,500,000 shares (1,826,772
shares for; 6,600 shares against; 1,000 shares abstained; and 735,811
broker non-votes); and
o an amendment to the Articles of Incorporation of the Company to
increase the number of authorized shares of common stock from
15,000,000 to 20,000,000, and to change the corporate name of the
Company to "Sontra Medical Corporation" (2,563,783 shares for; 5,400
shares against; and 1,000 shares abstained).
In addition, on June 20, 2002, at a special meeting of the stockholders of
Sontra Medical, Inc.(Sontra), the Sontra stockholders adopted and approved the
merger agreement and the merger between the Company and Sontra Medical, Inc.
(32,223,305 shares for; 0 shares against; and 4,524 shares abstained).
15
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description of Document
------ -----------------------
3.1 Articles of Amendment to the Amended and Restated Articles
of Incorporation of the Company.
10.1 Employment Agreement between the Company and Thomas W.
Davison dated May 20, 2002.
10.2 Employment Agreement between the Company and Sean Moran
dated June 22, 2002.
10.3 1997 Long-Term Incentive and Stock Option Plan of the
Company, as amended to date.
(b) Reports on Form 8-K.
During the quarter ended June 30, 2002, we filed one report on Form 8-K
on May 15, 2002, which announced the sale of the Company's remaining
pay telephone operating assets located in Puerto Rico or otherwise used
in or related to the Company's prior business in Puerto Rico, including
site contracts, equipment and dial-around compensation accruing as of
May 1, 2002. No other reports on Form 8-K were filed by us during the
quarter ended June 30, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SONTRA MEDICAL CORPORATION
Date: August 19, 2002 By: /s/ Thomas W. Davison
---------------- ------------------------------------
Thomas W. Davison
President and Chief Executive Officer
By: /s/ Sean Moran
------------------------------------
Sean Moran
Chief Financial Officer
16
EXHIBIT INDEX
Exhibit
Number Description of Document
------ -----------------------
3.1 Articles of Amendment to the Amended and Restated Articles
of Incorporation of the Company.
10.1 Employment Agreement between the Company and Thomas W.
Davison dated May 20, 2002.
10.2 Employment Agreement between the Company and Sean Moran
dated June 22, 2002.
10.3 1997 Long-Term Incentive and Stock Option Plan of the
Company, as amended to date.
17