(DREIER LLP LOGO)
Attorneys at Law
499 Park Avenue Valerie A. Price
New York, New York 10022 Direct Dial: (212) 328-6144
Tel: (212) 328-6100 Direct Fax: (212) 652-3789
Facsimile: (212) 328-6101 Partner
vprice@dreierllp.com
July 15, 2005
SENT VIA FAX AND FEDERAL EXPRESS
United States Securities and Exchange Commission
100 F Street, N.E.
Washington, DC 20549
Attention: Peggy A. Fisher, Assistant Director, Division of Corporation Finance
Re: Electro-Optical Sciences, Inc.
Registration Statement on Form S-1
Filed June 3, 2005
File No. 333-125517
Ladies and Gentlemen:
On behalf of Electro-Optical Sciences, Inc., a Delaware corporation
(the "Company"), and pursuant to the applicable provisions of the Securities Act
of 1933, and the rules and regulations promulgated thereunder, we are submitting
for filing with the Securities and Exchange Commission Amendment No. 1 to the
above-captioned Registration Statement on Form S-1 ("Amendment No. 1"). A copy
of Amendment No. 1 to the Registration Statement has been manually signed in
accordance with Rule 302 of Regulation S-T and the signature pages thereto will
be retained by the Company for a period of five years. The Company has
authorized us to respond to the comment letter sent to Joseph V. Gulfo, M.D. of
Electro-Optical Sciences, Inc., dated June 30, 2005, from the Staff of the
Commission.
For your convenience, we enclose a marked copy of Amendment No. 1
marked to show changes to the Registration Statement, as originally filed with
the Commission on June 3, 2005.
We have referenced the appropriate page number of the prospectus
contained in Amendment No. 1 in our responses contained herein. The numbered
paragraphs below set forth the Staff's comments, together with our responses.
Unless otherwise indicated, capitalized terms used herein have the meanings
assigned to them in Amendment No. 1.
Prospectus Inside Front Cover Page
1. We note your disclosure that you "do not make any representation as to
the accuracy" of the industry data and forecasts and market research
included in your prospectus. Please note that it is inappropriate to
suggest that you do not have responsibility for the accuracy of
disclosure in the registration statement. Please revise your disclosure
accordingly.
Response: In response to Comment 1, we deleted the above-referenced
language. See the inside front cover page.
2. Please provide us with copies of the industry reports and market data
cited throughout the registration statement, clearly marking the
relevant sections, and identify any reports prepared specifically for
your use.
Response: Attached as Annex A are copies of the industry reports and
market data cited throughout the Registration Statement, together with
pages of the Registration Statement marked to cross-reference the
relevant sections to the appropriate industry report or market data.
Prospectus Summary, page 1
3. Please expand the summary to clarify that you currently do not have any
commercialized product or significant source of revenue and that your
revenues to date were derived from the DIFOTI product, which was
recently discontinued.
Response: We have provided additional disclosure on pages 1 and 44 in
response to Comment 3.
4. Also clarify your anticipated timeframe for commercialization of
MelaFind, assuming you receive premarket approval for MelaFind in 2007,
as you currently anticipate. Also disclose the length of time it may
take to obtain Medicare coverage.
Response: We have provided additional disclosure on pages 3 and 46 in
response to Comment 4.
5. We note your disclosure in the second paragraph on page 1 that you have
entered into a binding Protocol Agreement with the FDA to conduct a
pivotal trial. Please also disclose that such a trial was initiated in
2004, but that you experienced technical operational issues which
require refinement to your hardware systems. We refer you to your
disclosure in last paragraph on page 46 of the prospectus.
Response: We have provided additional disclosure on pages 1 and 44 in
response to Comment 5.
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6. Please tell us when you anticipate the completion of the websites
mentioned on page 3 of the prospectus.
Response: The websites mentioned on page 3 of the prospectus are now
complete.
The Market Opportunity, page 1
7. Revise the first few sentences to provide industry data regarding the
incidence of melanoma, which appears to be a more relevant statistic
than the incidence of all skin cancers.
Response: We have provided additional disclosure on pages 1 and 45 in
response to Comment 7.
Risk Factors, page 7
8. Please eliminate the last two sentences of the introductory paragraph
and revise as necessary to include a discussion of all material risks
in the Risk Factors section.
Response: In response to Comment 8, we deleted the above-referenced
language. See page 7.
Dilution, page 32
9. Please expand your disclosure to include the further dilution to new
investors assuming your underwriters' over-allotment is exercised in
full, if material.
Response: In response to Comment 9, we have revised the disclosure on
page 33.
Our Business, page 43
10. Throughout the filing, please define or explain medical and
regulatory terms, such as "dermatohistopathological" review on page 47,
"spectrophotometric intercutaneous" analysis on page 53, and references to "QSR"
and "ISO 9000 series" standards.
Response: We have added definitions of the medical, regulatory and
statistical terms listed below at appropriate places in the
Registration Statement.
Term Page Reference
---- --------------
Nodular melanomas See pages 8 and 52
Dermatohistopathological (changed to histological) See page 10
Histopathological (changed to histological) See page 10
Confocal microscopy See page 11
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Spectroscopy See page 11
QSR See page 17
Statistically significant greater specificity See page 48
Exact binomial lower confidence bound (changed to lower See page 48
confidence bound)
Spectrophotometric intercutaneous analysis See page 55
Medi-Spas See page 54
Spectrophotometer See page 56
Breslow thickness See page 57
Shell See page 59
ISO 9000 See page 64
MelaFind(R) Product Description, page 45
11. Please explain in greater detail the "appropriate limits" as it
pertains to the MelaFind's functionality. We refer you to your
disclosure in the penultimate paragraph on page 46.
Response: We have provided additional disclosure on page 48 in response
to Comment 11.
MelaFind(R) Regulatory Status, page 46
12. Explain statistical terms used, such as "binomia1 1ower confidence
bound," and quantify the "statistically significant greater
specificity" needed to rule out melanoma. Also explain the difference
between a "pilot" trial and a "pivotal" trial and update us as to the
status of the pilot trial. We refer you to your disclosure in the last
sentence on page 46.
Response: With respect to statistical terms, see our response to
comment 10. We have revised the disclosure on page 48 in response to
Comment 12.
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Results of Training Studies and Blinded Tests, page 48
13. It is unclear what, if any, conclusions can be gleaned from the
cumulative results of your training studies and blinded tests regarding
the effectiveness of your product. The results appear to show that
MelaFind's effectiveness varies greatly when compared to the results of
study dermatologists. Please revise and expand your disclosure to
include a conclusion as to how the latest iteration of your product
compares with the effectiveness of expert dermatologists.
Response: It is important to understand that the data described in the
"Our Business - Results of Training and Blinded Tests" include a
comprehensive review of the results obtained throughout the development
of prototype hardware systems and developmental software and
classifiers. The cumulative results are provided to assist the reader
in understanding the evolution of the MelaFind(R) system as the Company
seeks to meet the performance goals described in the Protocol
Agreement. The intention was to provide the reader with the information
to come to a conclusion regarding the likelihood of success of our
efforts in the final refinements of the hardware, software, and
classifiers. The Company believes that through the clinical studies, it
has learned a great deal regarding the optimal classifiers and design
of hardware. The Company has implemented changes based on its
experience such that steady progress toward optimal performance
criteria has been demonstrated. The results of the largest study to
date in 352 pigmented lesions using prototype systems serve as
validation of the Company's development efforts. The Company believes
that when using refined pre-commercialization hardware systems and
final software and classifiers, the results of the pivotal trial will
be similar or superior to the results obtained in the largest study to
date, which employed prototype systems. The Company also believes that
the results of the pivotal trial will satisfy the Protocol Agreement
endpoints of performance relative to study dermatologists.
Consequently, we have provided additional disclosure on page 52 in
response to Comment 13.
14. We refer you to the January 2005 Test Results on page 50. Please
provide the basis for your belief that your product's sensitivity would
have been 96.4% had the device performed within specifications.
Response: Some of the parameters of lesions imaged with the devices
used to acquire the data for the January 2005 Test were significantly
outside of the range of all the previous data. This led to the
realization that several MelaFind(R) systems had fallen out of
specifications as well as to the identification of problems with the
MelaFind(R) hardware, which provided insight into a new and more robust
design for these devices, intended to eliminate such problems in the
future. If the results from the devices that were out of specification
are removed, the sensitivity of classifiers A-4 and C-4 would have been
96.4%.
Consequently, we have provided additional disclosure on page 52 in
response to Comment 14.
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Our Reimbursement Strategy, page 51
15. Please expand your disclosure to provide more specific detail as to how
you plan to accomplish your reimbursement strategy. For example, tell
us how you plan to secure coverage by private payors and Medicaid
agencies, particularly in light of the Risk Factors mentioned on page 9
of the registration statement.
Response: We have provided additional disclosure on pages 54 in
response to Comment 15.
16. Please explain why you believe physicians might be willing to pay to
use MelaFind and not charge patients for its use. We refer you to your
disclosure in the first paragraph on page 52.
Response: In a capitated system (i.e., systems where physicians cannot
pass costs on to patients, but rather are paid a fixed amount per
patient under the plan, whether or not treated), it is possible that
physicians will pay to use MelaFind(R) without passing the cost onto
the patient since MelaFind(R) is likely to be less costly than other
procedures that are currently used to detect and diagnose melanoma,
including biopsy. In a non-capitated system, physicians may choose not
to pass the cost of MelaFind(R) onto the patients; however, they may
recoup the cost of using MelaFind(R) by performing other reimbursed
procedures (for example, biopsies) when the information provided by
MelaFind(R) indicates these are appropriate. Similarly, they may recoup
the cost of using MelaFind(R) from other procedures that they may now
have additional time to perform in the event that the MelaFind(R)
information contributes to their decision not to perform a biopsy, for
example, various cosmetic procedures. These dynamics are not likely to
be understood until MelaFind(R) is approved, marketed and evaluated by
physicians.
Consequently, we have provided additional disclosure on page 54.
Competition, page 52
17. Please explain the significance of comparing the specificity of
dermatologists in DB-Mips studies to the specificity of dermatologists
in MelaFind studies. Additionally, please disclose the reported
sensitivity of the DB-Mips system and tell us how it compares to that
of the MelaFind. We refer you to the last paragraph on page 52.
Response: The text in the Registration Statement on page 55 has been
amended to include the reported sensitivity of the DB-Mips system (95%
sensitivity in the blinded test) and to compare it to MelaFind(R)'s
sensitivity (100% in the blinded test).
We have also added a discussion of the importance of pre-biopsy
diagnoses by examining physicians. The basic problem is that the direct
comparison of diagnostic results obtained by different systems on
different databases of pigmented lesions is not, in general,
meaningful. For example, if the database for one system included only
stage III/IV melanomas (which are more early recognizable than early
stage melanomas and for
6
which no effective treatment exists) and benign freckles, this system
could easily achieve very high sensitivity and specificity when
distinguishing between these two extremes. On the other hand, if a
second system utilized a database that generally included very early
melanomas (curable by complete excision) and a number of benign lesions
that the experts had erroneously diagnosed as melanoma prior to biopsy,
this system would have much lower specificity. Nevertheless, the second
system would be a much more useful tool in assisting physicians in
detecting melanoma than a highly accurate system that focused on the
"easy calls." Thus, a good way to assess whether the diagnostic results
of two systems could be compared in a meaningful way is to compare
first the pre-biopsy clinical sensitivities and specificities of the
examining physicians.
Consequently, we have also revised the disclosure on page 54.
Intellectual Property, page 54
18. Please describe the importance to your business and the duration and
effect of all material patents. Refer to Item 101(c)(iv) of Regulation
S-K.
Response: In response to Comment 18, we have revised the table on page
56 to include the expiration dates of the patents listed in the table
and have provided additional disclosure on page 58.
Board of Directors Composition, page 63
19. Please identify the "certain directors" elected to the board pursuant
to the voting agreement among you and certain shareholders. Also, in
the Related Party Transactions section of the prospectus, please
describe the material terms of the voting agreement and disclose which
shareholders have representatives on your board of directors.
Response: In response to Comment 19, we have revised the disclosure on
page 67 to identify the "certain directors" elected to the board
pursuant to the voting agreement.
We have also provided additional disclosure on page 76 describing the
material terms of the voting agreement.
Executive Compensation, page 67
20. Confirm that you have filed all employment agreements with all named
executive officers.
Response: All employment agreements with all named executive officers
have been filed.
Consulting Agreements, page 70
21. Please tell us why you have not filed your consulting agreement with
Dr. Friedman as an exhibit to the registration statement.
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Response: The consulting agreement with Dr. Friedman is being filed as
an exhibit to Amendment No. 1.
Principal Stockholders, page 73
22. Please identify the natural persons who beneficially own the shares
held by Caremi Partners Ltd., or clarify in the footnote that such
person is Steven Ruchefsky.
Response: S. Donald Sussman is the beneficial owner of all the shares
held by Caremi Partners. Accordingly, we have revised the table on page
77 and footnote 6 on page 78 to identify Mr. Sussman as the beneficial
owner of the shares formerly identified as being beneficially owned by
Caremi Partners, Ltd. In addition, all references to "Caremi Partners,
Ltd." in the Registration Statement have been replaced by references to
"S. Donald Sussman."
Legal Matters, page 86
23. Delete the second and third sentences, since investors are entitled to
rely on the opinion to be filed as an exhibit from counsel regarding
the legality of the securities being offered.
Response: We revised the disclosure on page 90 in response to Comment
23.
Financial Statements, page F-l
24. Consideration should be given to the updating requirements of Rule 3-12
of Regulation S-X.
Response: The Company has considered the updating requirements of Rule
3-12 of Regulation S-X and has included financial statements and
related financial information for the six month periods ended June 30,
2004 and 2005.
25. Please revise to disclose all significant transactions with related
parties separately on the face of the financial statements and in the
notes to the financial statements. Refer to SFAS 57 and Rule 4-08 (k)
of Regulation S-X.
Response: In accordance with SFAS 57 and Rule 4-08 (k) of Regulation
S-X, all significant transactions with related parties have been
disclosed separately on the face of the financial statements and in
notes 5, 8, 9, and 11 to the financial statements.
Report of Independent Registered Public Accounting Firm, page F-2
26. We note your auditor's plan to render their opinion upon the
effectiveness of a one-for-two reverse common stock split. Prior to
going effective this audit report should be removed and the audit
report on the financial statements should be signed.
8
Response: Prior to going effective, the Company expects to receive the
signed standard audit report of its auditors, Eisner LLP, on the
financial statements, and will file the audit report in its
registration statement.
Statement of Stockholders' (Deficiency) Equity, page F-5
27. Provide us with an itemized chronological schedule detailing each
issuance of your common shares, preferred stock, stock options and
warrants since January 2004 through the date of your response. Include
the following information for each issuance or grant date:
- Number of shares issued or issuable in the grant
- Purchase price or exercise price per share
- Any restriction or vesting terms
- Management's fair value per share estimate
- How management determined the fair value estimate
- Identity of the recipient and relationship to the company
- Nature and terms of any concurrent transactions with the recipient
- Amount of any recorded compensation element and accounting
literature relied upon to support the accounting.
In the analysis requested above highlight any transactions with
unrelated parties believed by management to be particularly evident of
an objective fair value per share determination. Please provide us with
a chronological bridge of management's fair value per share
determinations to the current estimated IPO price per share. Also,
indicate when discussions were initiated with your underwriter(s) about
possible offering price ranges. We will delay our assessment of your
response pending inclusion of the estimated IPO price in the filing.
Response: The Company has provided the information requested in Comment
No. 27 for all common stock, preferred stock, options, and warrants
issued during the period January 1, 2004 through the date hereof in
Annexes B and C attached hereto.
The Company used three different fair values for its common stock
during this period, which corresponded to its overall value creation
and development progress. These three fair values were the basis for
the valuations for all equity transactions entered into by the Company
during these periods. These three different fair values per share for
the Company's common stock were as follows:
Period Value per Share
-----------------------------------------------------------------
January 2004 through April 2004 $0.46
May 2004 through September 2004 $1.10
October 2004 through December 2004. $4.00
9
The change in valuation from period to period reflected the operational
progress of the Company, as is the case for pre-revenue biotech and
medtech companies. There have been no equity issuances from December
31, 2004 to the date hereof.
EQUITY FAIR MARKET VALUATION FOR FINANCIAL STATEMENT PURPOSES
PER SHARE FAIR VALUE
JANUARY 04-APRIL 04
The Company has not been profitable in any of the past five years and
has incurred substantial losses. As of December 31, 2003, the Company's
accumulated deficit was $10.3 million and the Company had negative
working capital in the amount of $433,000. In addition, the future
sales potential and cash flow projections for the DIFOTI(R) product
line were significantly below the Company's original estimates. The
Company made a strategic decision during this period to redesign and
enhance the DIFOTI(R) product marketability by incorporating laser
technology. This redesign resulted in substantial changes to DIFOTI(R)
and required a FDA 510 (k) filing. The Company's Board of Directors was
concerned about the continued delays in the MelaFind(R) project
development timeline and determined that these delays were the result
of the existing management's lack of experience in commercializing a
prototype concept. During January 2004, Dr. Joseph V Gulfo joined the
Company as CEO and President. The Company recruited Dr. Gulfo on the
basis of his proven managerial and product development expertise within
the healthcare sector. At that time, cash on hand was only $100,000 and
Dr.Gulfo initially deferred his salary due to the Company's cash
constraints, and did not receive his deferred salary until October 2004
at the completion of the Series C preferred stock private placement. In
June 2003, Health Partners I, LLC ("HP I") had committed to purchase
additional shares of Series C preferred stock and warrants to purchase
common stock, subject to, among other things, satisfaction of certain
MelaFind(R) development milestones. As of February 2004, the Company
had not achieved the specified development milestones. As an inducement
in this second tranche of Series C private placement, the Company
issued additional warrants to purchase 60,840 shares of Series C
preferred stock to HP I at an exercise price of $4.52 per share.
Dr.Gulfo's three primary objectives during this period were: (1) to
establish a late stage development plan for MelaFind(R); (2) to
initiate discussions with the FDA to review the development plan for
PMA approval of MelaFind(R); and (3) to actively enter into discussions
with numerous venture capital and private equity firms to raise
additional capital. Unfortunately, no investment from any unrelated
institutional investors was consummated during this period.
Management's estimate of the fair value of the Company's common stock
took into consideration the fact that the aggregate liquidation
preferences for the Company's preferred stock outstanding exceeded the
Company's liquid assets. In view of the Company's financial condition,
the reduction in the estimated sales potential for DIFOTI(R), and the
level of resources required to complete the development of MelaFind(R),
the Company valued its common stock at $0.46 per share. This per share
value was based
10
upon a discount to the price (post split equivalent per share value of
$4.52) at which its Series C preferred stock was being sold at this
time, reflecting the rights, preferences, and privileges of the Series
C preferred stock.
MAY 04-SEPTEMBER 04
The Company experienced positive developments during this period,
resulting in an increase in the fair value of the Company's common
stock as determined by management of the Company from $0.46 per share
to $1.10 per share.
During May 2004, to fund the continued development of MelaFind(R) and
support the existing operations, the Company obtained a bridge loan in
the amount of $1.0 million from related parties and also sold 125,000
shares of common stock at a per share price of $0.46. The estimated
fair value of the Company's common stock at this stage of development
was determined to be $1.10 per share which resulted in recording an
imputed interest charge of $80,000 on the bridge loan.
During August 2004, Dr. Gulfo engaged a consultant to meet with the FDA
to discuss the design of the MelaFind(R) pivotal trial. Based on the
favorable outcome of this FDA meeting, which ultimately resulted in a
Protocol Agreement with the FDA, Dr.Gulfo prepared a business plan for
the development and commercialization of MelaFind(R).
The Company consulted with its advisors in the second quarter of 2005
to assist in determining the fair value of its common stock during this
period in anticipation of a possible initial public offering. The
methodologies presented generally followed the guidance set forth in
the AICPA Audit and Accounting Practice Aid for "Valuation Of Privately
Held Company Equity Securities Issued As Compensation" (the "Practice
Aid"). The market, income and asset based approaches to valuation, as
discussed in Chapter 6 of the Practice Aid, were considered. A
probability weighting was applied to the resulting calculated values.
The Company concluded that an asset approach should not be utilized in
determining the fair value per share. This approach resulted in no
value attributable to the equity of the Company. The Company believed
that there was value in the intangible assets related to its
technology. Such intangible value is not reflected in the asset
approach.
The Company believed that its near term revenue and lack of
profitability during this period were not indicative of its revenue
generating capabilities. The Company relied most heavily on the Income
Approach utilizing a Discounted Cash Flow Method and also utilized the
value derived from the Market Approach. The weighted value the Company
calculated was a range of $0.78 to $1.38 per share of common stock, and
the Company concluded that a fair value of $1.10 per share would be
appropriate. In addition to utilizing the above discussed approaches to
value, the Company calculated the value of the common stock utilizing
both the Current-Value Method and Option-Pricing Method as reflected in
Chapter 10 of the Practice Aid. These methods resulted in values of
$0.72 to $1.14 per share, respectively. As discussed in Chapter 10, the
Current-Value Method is more appropriate when the expectations
regarding the future of an enterprise are virtually irrelevant and
there has been no material progress on the enterprise's business plan.
The
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Company believed that its future expectations were indeed relevant and
that the Company had made material progress on its business plan.
Therefore, the management of the Company believed that the $1.14 per
share calculated utilizing the Option-Pricing Method was a better
indication of the fair value of the common stock and was consistent
with the $1.10 per share of common stock determined using the
aforementioned Discounted Cash Flow Method and Market Approach.
OCTOBER 04-DECEMBER 04
This period reflected additional positive developments for the Company,
beginning in October 2004, resulting in an increase in the fair value
of the Company's common stock as determined by management of the
Company from $1.10 per share to $4.00 per share.
During October 2004, the Company completed another round of Series C
preferred stock financing, resulting in gross proceeds of $8.1 million
at a price of $2.26 per unit (the post reverse split common stock
equivalent value was $4.52 per unit). Each unit consisted of one share
of Series C preferred stock and one warrant to purchase one share of
the Company's common stock at an exercise price of $13.00 per share.
Since no additional consideration was received for the warrant, the
consideration for the Series C preferred stock was less than $2.26 per
share. Approximately 35% of the units were acquired by new unaffiliated
investors. The common stock warrants attached to this issuance were
valued at approximately $1.48 per warrant using the Black-Scholes model
with a fair value of $4.00 per share of common stock.
During October 2004, the Company received a binding Protocol Agreement
from the FDA defining the endpoints of the pivotal clinical trial for
MelaFind(R) approval. The Company believes that the presence of a
Protocol Agreement enhances its ability to expedite the FDA approval
process. To support the future growth of the Company and the
commercialization of MelaFind(R), the Board approved in December 2004
the appointment of key executives to the Company. In addition, the
Board approved the issuance of 75,000 warrants to Allen & Company, LLC
to purchase common stock with an exercise price of $7.00 per share in
exchange for financing advice, acknowledging the need for additional
capital to support MelaFind(R) development. For these reasons, the
Company believes the fair value of its common stock during this period
was $4.00 per common share, and accordingly the valuation of options
and warrants issued during December 2004 was based upon the $4.00 per
share common stock value.
JANUARY 05-MARCH 05
During the period from January 2005 through March 2005, the Company
encountered certain technical issues relating to the development of
MelaFind(R) which led to the realization that significant additional
capital resources would be required to achieve the Company's goals and
objectives. For these reasons, the Company began financing discussions
with various investment bankers.
The management of the Company believes that the issues encountered
during this period negatively impacted the fair value of the Company's
common stock, but since no equity
12
transactions were consummated during this period, management did not
determine a new estimated fair value of its common stock during this
calendar quarter.
During January 2005, Dr.Gulfo began initial discussions with Ladenburg
Thalmann & Co. Inc. and other bankers/venture capital firms regarding
the next round of financing to support the continued development of
MelaFind(R). During February 2005, the expanded management team
undertook an in depth strategic and operational review of the status of
the MelaFind(R) development program. A study that was initiated in late
2004 under the Protocol Agreement was stopped due to technical
difficulties with some of the MelaFind(R) clinical trial instruments.
The MelaFind(R) hardware systems used in the clinical trials through
January 2005 were prototypes, which were not manufactured using the
techniques and standards applicable to the manufacture of commercial
systems. The technical difficulties observed in the pivotal trial that
was started in December 2004 mandated a different approach.
After receiving FDA 510 (k) approval to market the new DIFOTI(R) model,
the Company began selling and shipping DIFOTI(R) systems in January
2004. During February 2005, several software installation issues were
identified with the new DIFOTI(R) model that required a greater level
of technical support resources than the Company had anticipated. In
order to respond to these issues, the Company needed to redirect
dedicated MelaFind(R) resources to address these customer technical
difficulties. During the period from March 9 through March 21, 2005,
the Company was inspected by the FDA in connection with its DIFOTI(R)
product. On March 21, 2005, the Company was cited in an FDA Form 483
for failures to comply fully with FDA quality system regulation, or
QRS, mandated procedures.
APRIL 05-JUNE 05
During this period, many of the problems the Company encountered during
the first quarter of 2005 were resolved. Dr. Gerald Wagner, an
internationally renowned electro-optical systems development and
manufacturing professional, was retained by the Company as a
consultant. Dr. Wagner has agreed to direct our MelaFind(R) product
development efforts and oversee the manufacturing process. Dr. Wagner
advised the Company that developmental engineers and individuals with
expertise in the manufacturing of sophisticated electro-optical systems
were required to finalize the design and to produce commercial
MelaFind(R) systems. Dr. Wagner introduced the Company to ASKION GmbH
(Gera, Germany), a precision optics specialty manufacturer comprised of
former management employed by Zeiss. ASKION manufactures precision
electro-optical systems for Agfa, Zeiss, and Bayer. In April, the
Company entered into an agreement with ASKION to develop methods for
optimizing the design of the MelaFind(R) hardware, assisting in setting
final specifications, and devising a manufacturing process. In June
2005, the agreement was expanded by a letter of intent for the
manufacturing of the clinical trial systems in a reproducible and
scalable manner. Dr. Wagner joined the Board of Directors of our
Company in May 2005. The pre-commercialization hand-held imaging
devices which will be assembled by ASKION are expected to be available
for the pivotal trial initiation planned for early 2006.
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The Company formally discussed the possibility of an initial public
offering of its common stock with Ladenburg Thalmann & Co, Inc. in
April 2005. The Board approved and the Company signed an engagement
agreement letter with Ladenburg Thalmann & Co. Inc. for its initial
public offering during April 2005. The Stanford Group Company agreed to
be a co-manager for this offering. An initial organizational meeting
was held on April 8, 2005. A tentative price range of $10.00 to $12.00
per share was discussed.
The Company decided to discontinue all operations associated with our
DIFOTI(R) product effective as of April 5, 2005, in order to focus its
resources and attention on the development and commercialization of
MelaFind(R). The Company is currently seeking an acquirer for the
DIFOTI(R) assets, and does not expect to have any significant
continuing responsibility for the DIFOTI(R) business after its
disposition. In addition, the inspectional findings identified in the
FDA Form 483 were discussed in a subsequent meeting with the FDA on
April 28, 2005 and did not result in a product recall. The Company is
in the process of addressing the deficiencies noted.
During May and June 2005, the Company informed the FDA that it had
discontinued a study that was initiated in December 2004. The FDA
requested information regarding the nature of the technical problems
that led to the decision. The Company provided a report to the FDA and
discussed with the FDA its plan to address the technical difficulties
with the MelaFind(R) hardware systems through a design modification and
optimization process with ASKION. The Company also discussed its plan
to re-initiate a pivotal trial in 2006 under the auspices of the
Protocol Agreement once pre-commercialization hardware systems from
ASKION become available. On June 30, 2005, the Company received written
confirmation from the FDA that this plan was acceptable. Further, the
FDA informed the Company that Module 1 of our PMA was closed and that
an acceptance letter for Module 1 would be forthcoming.
Based on the considerable progress achieved during the second quarter
of 2005, as described above, the Company believes that a pre-IPO
valuation of $70 million ($11.00 IPO midpoint price times 6.5 million
shares outstanding) is appropriate given the valuation of comparable
companies in the medtech sector in late stage clinical development.
Based on discussions with the underwriters during the last week in
June, we believe the IPO price will be in the range of $10.00 to $12.00
per share.
28. We are deferring any evaluation of stock compensation recognized until
the estimated offering price is specified, and we may have further
comments in that regard when you file the amendment containing that
information.
Response: The estimated offering price is between $10 to $12 per share.
See the front cover of the prospectus.
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29. We believe that the following disclosures would be helpful to an
investor since changes in your methodologies and assumptions could have
a material impact upon your financial statements. Please revise to
provide the following disclosures in MD&A:
- Discuss the significant factors, assumptions and methodologies
used in determining fair value for options granted during the
twelve months prior to the date of the most recent balance sheet.
- Discuss each significant factor contributing to the difference
between the fair value as of the date of grant and the estimated
IPO price for options granted during the twelve months prior to
the date of the most recent balance sheet.
- Disclose the valuation method used and the reasons why you chose
that method.
- Quantify any known or expected compensation expense to be
recorded in the accounting period the offering takes place as
well as periods subsequent thereto.
Response: In response to Comment 29, we have expanded the disclosures
in MD&A to include the information listed in Comment 29. In addition,
similar information has been provided in notes 8 and 9 to the financial
statements.
Notes to Financial Statements, page F-7
Note 1. Principal Business and of Significant Accounting Policies, page F-7
30. Please revise the warranty cost accounting policy disclosures on page
F-8 to clearly indicate your policy complies with FASB Statement 5. If
necessary, tell us why your policy for these costs doesn't comply with
the Statement.
Response: In response to Comment 30, we have revised the warranty cost
accounting policy disclosures on page F-8 to indicate that the
Company's policy complies with FASB Statement No.5.
Note 8. Stockholders' (Deficiency) Equity and Redeemable Preferred Stock, page
F-14
31. We see on page F-5 that the reduction of the liquidation value of your
Series B preferred stock resulted in a charge of $2,125,600 in fiscal
2003. Additionally, we see that other modifications were made to Series
A and Series B preferred stock and see that additional shares were
issued to Series B shareholders. Please tell us in detail and revise to
explain how you valued, recorded and accounted for this transaction.
Please cite the guidance upon which you relied to support your
accounting for the modifications.
Response: In June 2003, the Company completed a private placement to HP
I of units consisting of one share of a new Series C preferred stock
and a warrant to purchase one
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share of common stock at $13.00 per share. (The Company considered the
value of the warrants to be de minimus.) In addition, holders of
promissory notes received shares of Series C preferred stock, but not
warrants, upon surrender of their notes. In connection with this
private placement, the holders of Series A and B preferred stock
consented to modifications of certain of their rights, preferences, and
privileges, including a reduction in the redemption value of Series B
preferred stock to $2.26 per share, equivalent to the redemption value
of the new Series C preferred stock. In connection with this
transaction, the Company made a stock distribution of an additional
45,000 shares of Series B preferred stock to the holders of Series B
preferred stock as a group.
The additional 45,000 shares of Series B preferred stock were valued at
$2.26 per share, which was the per share price at which the new Series
C preferred stock was sold.
The reduction in the carrying value of the shares of Series B preferred
stock, less the value of the 45,000 additional shares of Series B
preferred stock distributed, was credited to additional paid-in
capital.
These transactions are summarized as follows:
Carrying amount of Series B preferred stock $4,471,447
at date of reduction in redemption value (947,986 shares)
June 2003 Series B preferred stock distribution (45,000 shares) 101,700
June 2003 reduction in redemption value (2,329,000)
reclassified as additional paid-in capital ----------
Carrying amount of Series B preferred stock $2,244,147
after transaction
The reduction in the redemption value of the Series B preferred stock
was a capital transaction and was credited to additional paid-in
capital in accordance with our legal counsel's advice with respect to
this transaction, as appropriate under state law. The Company has made
a reclassification in the statement of stockholders' (deficiency)
equity for the year ended December 31, 2003 to reflect the
aforementioned transaction for both the distribution of 45,000 shares
of Series B preferred stock and the reduction in redemption value.
32. We see that as a result of the October 2004 sales of the Series C
preferred stock, you recorded a $2.4 million charge due to a beneficial
conversion feature. Please tell us and revise the filing to disclose
details of the calculation of the charge and discuss how the conversion
price was determined. Please tell us the authoritative guidance upon
which you relied to support your accounting.
16
Response: During 2004, the Company issued 4,507,702 shares of Series C
preferred stock with 2,253,792 warrants to purchase common stock at
$13.00 per share and 73,280 warrants to purchase Series C preferred
stock at an exercise price of $4.52 per share for aggregate gross
proceeds of $10,186,480. The net proceeds of $9,738,297 were allocated
to the Series C preferred stock and additional paid-in capital
associated with the warrants based on the relative fair values of the
Series C preferred stock and warrants (fair value of warrants
determined using Black-Scholes method - please refer to comment #34
response for detailed underlying assumptions). The Company also
recorded a beneficial conversion feature of $2,385,063, which is being
accreted to redemption value for the Series C preferred stock based on
the earliest redemption date of June 2008.
The details of the calculation are as follows:
Value %
----- -
Series C preferred stock net proceeds $9,738,927 75.51%
in 2004
Value of warrants issued in connection
with Series C preferred stock in 2004 3,158,948 24.49
--------- -----
Total 12,897,875 100.00%
Series C preferred stock net proceeds
in 2004 9,738,927 24.49%
Beneficial conversion feature $2,385,063
----------
The authoritative guidance the Company relied upon to support this
accounting treatment was EITF No. 98-5 "Accounting For Convertible
Securities With Beneficial Conversion Features" and EITF No. 00-27
"Application of Issue No. 98-5 to Certain Convertible Instruments."
33. We see that at December 31, 2004 and March 31, 2005 there are
approximately $1,506,000 and $1,674,000 of deemed but unpaid dividends.
We also see in the event the Series B and Series C preferred stock is
converted into common stock any related deemed dividends would be
forfeited. Please explain how you determined the stated amount of
unpaid deemed dividends at December 31, 2004 and March 31, 2005.
Provide us with the accounting entries that were made in connection
with recording deemed dividends. Be sure to explain how the change from
December 31, 2004 to March 31, 2005 in the amounts of deemed but unpaid
dividends make sense given the deed dividend amounts presented in your
2005 interim statements of operations. Also, tell us the accounting
implications of the forfeiture of deemed dividends, if any. Finally,
revise the filing to clarify these matters.
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Response: We have included as Annex D a detailed presentation of the
cumulative amount of deemed but unpaid preferred stock dividends
covering the five years ended December 31, 2004 and the three and six
month periods ended March 31, 2005 and June 30, 2005. In addition, the
notes to the Company's financial statements which were incorporated in
the initial Registration Statement filing presented cumulative deemed
but unpaid dividends for December 31, 2004 and March 31, 2005 of
approximately $1,506,000 and $1,674,000, respectively. As noted in
Annex D the correct amounts for the aforementioned periods are
$1,509,725 and $1,871,764, respectively. The financial statements have
been updated through June 30, 2005 and reflect the cumulative deemed
but unpaid dividends at June 30, 2005 of $2,228,789.
Note 8 to the financial statements on page F-16 under the caption
"Deemed Dividends" has been revised to reflect the cumulative deemed
but unpaid dividend numbers noted above. Please note that the deemed
dividends and net loss per common share numbers disclosed in the
Statement of Operations in the Registration Statement were presented
correctly for the respective periods.
The dividends on the Series B and Series C preferred stock may be
declared at the discretion of the Board of Directors in an amount equal
to 10% of the accreted value per share and are payable in preference
and priority to any declaration and payment of any distribution on
Series A preferred stock or common stock and are cumulative. Since no
dividends have been declared, the Company has not recorded a liability
for the deemed but unpaid dividends. In the event that the Series B and
Series C preferred stock are converted into common stock, any related
deemed but unpaid dividends will be forfeited. Since no liability has
been recorded for the deemed but unpaid dividends, there will be no
accounting impact relating to these dividends upon conversion of the
preferred stock into common stock.
Note 9. Warrants, page F-16
34. We noted various issuances of warrants in conjunction with sales of
preferred stock and as compensation to consultations. Please revise to
disclose how you accounted for and valued the issuance of these
warrants. Also, disclose the fair value of your stock at the dates of
issuance how the value was determined and the amount of any
compensation expense recorded for each of the issuances.
Response: We have expanded the disclosure in the MD&A and in notes 8
and 9 to the financial statements (pages F-14 to F-19) to indicate how
the Company accounted for and valued the issuance of its warrants. We
have also disclosed in notes 8 and 9 to the financial statements the
fair value of the Company's common stock at dates of issuances, how the
value was determined, and any compensation expense recorded for each
issuance.
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35. We see that on April 5, 2005, the Board of Directors approved, subject
to stockholder approval, the issuance of 1,305,321 shares of your
common stock in exchange for 2,610,643 outstanding warrants and also
see you consider this transaction to be an exchange of equity
instruments at fair value which will have no net effect on
stockholders' equity. Please tell us why you believe the described
accounting is appropriate. Support your assertions with references to
authoritative U.S. generally accepted accounting principles.
Response: Based on advice from the underwriters, the Company determined
that it should attempt to negotiate an exchange of the 2,610,643 common
stock warrants that were outstanding prior to the initial public
offering for a lesser number of shares of common stock. Accordingly,
the Company negotiated with the majority holders of its Series C
preferred stock to exchange these warrants for common stock. The
holders of Series C preferred stock as a class own substantially all of
the Company's outstanding common stock warrants.
After extensive negotiations involving a variety of proposed exchange
ratios, on April 5, 2005, the Company's Board of Directors approved,
subject to stockholder approval, the issuance of 1,305,321 shares of
our common stock in exchange for 2,610,643 warrants (a one-for-two
exchange ratio).
The Company believes that the transaction described represents an
exchange of equity instruments at fair value, based upon the extensive
negotiating process and the use of the Black-Scholes option pricing
model. The assumptions used in the Black-Scholes computation were:
remaining life of warrant 6.25 years, risk free interest rate of 0.032,
warrant strike price of $13.00 per share, and common stock value of
$10.00 per share, the low end of the anticipated offering price range.
Since the fair value of the common stock to be issued in exchange for
the outstanding warrants is expected to be substantially the same as
the fair value of these warrants, the Company believes the appropriate
accounting treatment should have no net effect on stockholders' equity.
Note 11. Subsequent Events, page F-18
36. We see you decided to discontinue all operations associated with your
DIFOTI product effective as of April 5, 2005. Note that for
discontinued operations that are not yet required to be reflected in
historical statements under FASB Statement 144, pro forma financial
statements reflecting transaction for the latest balance sheet and
income statements for all periods are required. Please revise the
filing as necessary based on our comment.
Response: We have included historical financial statements covering the
six months ended June 30, 2005, which included the April 5, 2005 date
when the Board of Directors approved the discontinuation of DIFOTI(R)
operations. Results of discontinued operations have been separately
shown for all periods presented.
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Part II
Item 16. Exhibits and Financial Statement Schedules
Exhibit 23.1
37. Please include a currently dated and signed consent from your independent
auditors with any amendment filed.
Response: A currently dated consent signed by our independent auditors
has been included in Amendment No.1.
* * * *
We hope that the foregoing has been responsive to the Staff's comments.
Should you have any questions relating to any of the foregoing, please
feel free to contact the undersigned at (212) 328-6144. Thank you for your
cooperation and attention to this matter.
Very truly yours,
/s/ Valerie A. Price
Valerie A. Price, Esq.
VAP/ma
Enclosure
cc: Joseph V. Gulfo, M.D
Karen Krumeich
William Bronner
Lewis B. Leventhal, CPA
David C. Peck, Esq.
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