Form 10-Q for MEDIZONE INTERNATIONAL INC
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12-Nov-2009
Quarterly Report
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
General
Medizone International, Inc. ("Medizone" or the "Company"), prior to 2008 had been dedicated to (i) seeking regulatory approval of a precise mixture of ozone and oxygen, and its process of inactivating lipid-enveloped viruses for the intended purpose of decontaminating blood and blood products and assisting in the treatment of certain diseases; (ii) developing or acquiring the related technology and equipment for the medical application of its products, including a drug production and delivery system; and (iii) applying its novel technology to the problem of nosocomial infections world-wide. Beginning in 2008, management re-positioned the Company to pursue an initiative in the field of hospital sterilization.
Corporate Redirection
Early in 2008, our management and board of directors began to consider other applications of our core technologies and new technologies with lower development costs with the objective of moving us to revenue production in the shortest period of time.
Since that time, management has worked to position us to pursue an initiative in the field of hospital sterilization. This change in focus is based, in part, on a review of published data on hospital-derived infections, an area of rapidly growing concern in the medical community. Management believes that there is an opportunity to build on our experience with ozone technologies and its bio-oxidative qualities in pursuing this initiative. We have shifted our near term efforts towards one of its founding tenets, namely that under the right conditions, ozone can be extremely effective at sterilizing biological fluids (blood, serum, and plasma and its fractionates) as well as biologically contaminated equipment and spaces.
We believe that our unique ozone generating technologies could play a vital role in addressing what public health officials and surgeons world-wide are beginning to recognize as "the silent epidemic" (American Academy of Orthopedic Surgeons, May 2008, copy on file with the Company ("AAOS Study")), a reference to MRSA (methicillin-resistant staphylococcus aureus) infection. This is a strain of Staphylococcus aureus bacteria ("staph") that is resistant to the broad-spectrum antibiotics commonly used to treat it. MRSA can be fatal. According to the AAOS Study, "the number of hospital admissions for MRSA has exploded in the past decade. By 2005, admissions were triple the number in 2000 and 10-fold higher than in 1995. In 2005, in the United States alone, 368,600 hospital admissions for MRSA - including 94,000 invasive infections - resulted in 18,650 deaths. The number of MRSA fatalities in 2005 surpassed the number of fatalities from hurricane Katrina and AIDS combined and is substantially higher than fatalities at the peak of the U. S. polio epidemic." Indeed, biological contamination of medical treatment areas such as hospitals and chronic care facilities has recently been identified by several world renowned public health institutions, including the Centers for Disease Control or "CDC" (CDC Report, 17 Oct, 2007, copy on file with the Company), as one of the greatest threats to public health and safety in the industrial world. This concern was reflected in an article recently published in the journal Science (18 July 2008, Vol 321, pp 356-361, copy on file with the Company) which estimated that hospital-based infections in 2006 accounted for almost 100,000 deaths in the US alone.
In response to this situation, we are currently developing a highly portable, low-cost, ozone-based technology ("AsepticSure�") specifically for the purpose of decontaminating and sterilizing hospital surgical suites, emergency rooms, and intensive care units. Since this technology is not considered a medical treatment or a diagnostic, its development pathway is not subject to a stringent and expensive regulatory review process. The development pathway will be based on independent peer-reviewed science and engineering excellence.
In 2008, we entered into a five-year agreement with BiOzone Corporation ("BiOzone"). Under the agreement, BiOzone has been developing, along with us, equipment for specialized laboratory trials, a prototype AsepticSure� system for hospital beta-testing and ozone destruct technology. The agreement also covers initial product manufacturing by BiOzone exclusively for Medizone. Under this agreement, we retain the right to outsource additional manufacturing capacity.
During May 2009, we commenced the first of a series of trials designed to confirm that our AsepticSure� Hospital Sterilization System can rapidly eliminate hospital-based bacterial pathogens known to be responsible for the growing number of deaths and serious infections currently plaguing the healthcare system worldwide. We have engaged an internationally recognized expert in medical microbiology and hospital infections to lead the trials. A second series of laboratory trials were commenced in early June 2009, after the first series produced results that management believes to have demonstrated significant bactericidal effects against C-difficile, E-coli, Pseudomonas aeruginous, MRSA and VRE, the main causative agents of hospital derived nosocomial infections. This second series
of laboratory trials resulted in what management believes to be levels of bactericidal action necessary to achieve our commercial objectives.
A third series of laboratory trials were commenced during October 2009 in order to establish the precise protocols necessary in order to obtain maximum bactericidal action in combination with minimum turn-around times in keeping with normal hospital flow patterns. Most recently, our research has shown that the technology can now achieve a level of bacterial decontamination heretofore unseen in open space settings using conventional means. We now believe that this development will significantly expand the utility for the AsepticSure� technology.
Simultaneously with this recent testing, a development prototype is being finalized in order to conduct a full room scale hospital mock-up. If the hospital mock-up is successful, we will proceed to hospital beta testing of the production prototype in preparation for marketing. Commercialization of the system, with first product deliveries, is expected during the first half of 2010.
In addition to the hospital sterilization initiative, we have developed an ozone-destruct unit which is used following sterilization of the treated infrastructure to reverse the ozone gas (O3) in the space, and turn it back into O2 in a short period of time. We have targeted initially the treatment of a typically sized surgical suite including sterilization followed by ozone destruct to habitable standards in two hours or less. This short turn-around period is considered of great importance relative to commercialization of the technology.
In parallel research recently conducted at BiOzone, our engineering development partner, it was confirmed that the AsepticSure� hospital sterilization system can complete the entire decontamination process with minimal disturbance to normal hospital flow patterns. We believe that from a commercial viewpoint, the higher the "kill rate" in the shortest turn-around time, the more favorably physicians and hospital administrators will view the system.
An application for registration of a trademark has been filed for the system with the United States Patent and Trademark Office for the mark AsepticSure�. The mark is used to describe a portable decontamination and sterilization system for hospitals, government buildings, schools and other functionally critical environments that might currently require, or need to be prepared for countermeasures capability from contamination by infectious biological agents such as C difficile, E coli, Pseudomonas aeruginous, MRSA and VRE (Vanocomycin-resistant Enterococci - another drug-resistant bacteria).
In July 2009, we filed a patent application for the AsepticSure� technology in order to establish protection of its commercial rights to this technology internationally. The patent covers disinfection for rooms and their contents within all healthcare facilities, mobile or stationary, and other critical infrastructure such as schools and government buildings. A second patent filing is expected in the near future to cover the recent testing results as explained above. Also effective July 1, 2009, we entered into a lease agreement and established our own certified laboratory located at Innovation Park, Queen's University in Kingston, Ontario, Canada, which will provide us with a primary research and development platform as we proceed towards commercialization of the AsepticSure � product.
We believe our research and development time frame as well as intellectual property development remain on track. Once the trial program for the AsepticSure� hospital sterilization system is concluded, we expect to out-source the manufacturing of the product and ultimately, partner with a large corporation for the sales and marketing of the final product.
Canadian Foundation for Global Health (CFGH) - Consolidated Variable Interest Entity
We assisted in the formation of the Canadian Foundation for Global Health ("CFGH"), a not-for-profit foundation based in Ottawa, Canada. We helped establish CFGH for two primary purposes: (1) to establish an independent not-for-profit foundation intended to have a continuing working relationship with Medizone for research purposes that is best positioned to attract the finest scientific, medical and academic professionals possible to work on projects deemed to be of social benefit; and (2) to provide a means for us to use a tiered pricing structure for services and products in emerging economies and extend the reach of our technology to as many in need as possible.
The CFGH is specifically not authorized to contract for research or other services on our behalf without prior approval. All intellectual property, including but not limited to, scientific results, patents and trademarks that are derived from work done on our behalf or at our request, by CFGH or parties contracted by CFGH with our prior approval, are the sole and exclusive property of Medizone.
The CFGH is registered as a not-for-profit corporation under Canadian Federal Charter. CFGH maintains offices at 170 Lauier Avenue West in Ottawa, Canada.
Dr. Michael E. Shannon M.A., M.Sc., M.D. is President of the CFGH and maintains offices at the CFGH. Dr. Shannon is also a member of our board of directors and is our Director of Medical Affairs. Mr. Brad Goble, President of TDVGlobal, Inc., is also a board member of the CFGH and serves
as the Secretary-Treasurer for the organization. According to its website, TDVGlobal, Inc. "is a strategic management consulting company" focusing on the public sector. It is based in Ottawa, Ontario, Canada. Other members of the CFGH board are Edwin G. Marshall (our CEO and Chairman), Daniel D. Hoyt, a director of the Company, and Jill C. Marshall, NMD, Mr. Marshall's wife and a former corporate officer of the Company.
In January 2003, the Financial Accounting Standards Board issued a new accounting standard which requires a variable interest entity ("VIE") to be consolidated by a company if that company absorbs a majority of the VIE's expected losses and/or receives a majority of the entity's expected residual returns as a result of holding variable interests, which are the ownership, contractual, or other financial interests in the entity. In addition, a legal entity is considered to be a VIE, if it does not have sufficient equity at risk to finance its own activities without relying on financial support from other parties. If the legal entity is a VIE, then the reporting entity determined to be the primary beneficiary of the VIE must consolidate it. We have determined that CFGH meets the requirements of a VIE, effective upon the first advance to CFGH on February 12, 2009. Accordingly, the financial condition and operations of CFGH are being consolidated with Medizone as of and for the nine months ended September 30, 2009.
Results of Operations
We were incorporated in January 1986. We are a development stage company primarily engaged in research into the medical uses of ozone. We have not generated, and cannot predict when or if we will generate, revenues or sufficient cash flow to fund continuing or planned operations. If we fail to obtain additional funding, we will be forced to suspend or permanently cease operations, and may need to seek protection under United States bankruptcy laws.
Three Months Ended September 30, 2009 and 2008
There were no sales during the quarters ended September 30, 2009 or 2008. For the three months ended September 30, 2009, we had a net loss of $472,994, compared with a net loss for the three months ended September 30, 2008 of $192,913. Our primary expense is payroll and other office costs, research, development, and consulting fees, together with interest expense and additional expense recorded as a result of options granted, and the extension of certain stock purchase warrants outstanding.
For the three months ended September 30, 2008, we had no research and development expenses. For the three months ended September 30, 2009, however, we incurred $165,237 in research and development costs, as a result of prototype development costs, consulting, and other research activities. Since inception, we have spent a total of $3,035,004 for research and development related to its ozone technology and related apparatus. Research and development expenses include consultant fees, interface development costs, prototypes, and research stage ozone generator and instrument development.
General and administrative expenses in the quarter ended September 30, 2009, were $301,149 compared to $186,870 during the same period in 2008. The increase in the current year as compared to the prior year was related to additional payroll and consulting fees incurred, valuation of options granted for consulting services during 2009, costs incurred for the shareholder meeting held in August 2009, and increased professional fees. The remaining general and administrative expenses include rent, office expenses and travel expenses. Our lack of cash has prevented us from paying all accrued salary and other expenses during the last eight years.
Principal amounts owed on notes payable totaled $285,206 and $280,491 at September 30, 2009 and December 31, 2008, respectively. Interest expense on these obligations during the three months ended September 30, 2009 and 2008 was $5,990 and $5,914, respectively.
Nine Months Ended September 30, 2009 and 2008
There were no sales during the nine months ended September 30, 2009 or 2008. For the nine months ended September 30, 2009, we had a net loss of $986,389, compared with a net loss for the nine months ended September 30, 2008 of $432,424. Our primary expense is payroll and other office costs, research, development, and consulting fees, together with interest expense and additional expense recorded as a result of options granted to consultants, and the extension of certain stock purchase warrants outstanding.
For the nine months ended September 30, 2008, we had no research and development expenses. For the nine months ended September 30, 2009, however, we incurred $305,883 in research and development costs, as a result of prototype development costs, consulting, and other research activities.
General and administrative expenses in the nine months ended September 30, 2009, were $617,377 compared to $342,889 during the same period in 2008. The increase in the current year as compared to the prior year was related
to additional payroll and consulting fees incurred, valuation of options granted for consulting services during 2009, costs incurred for the shareholder meeting held in August 2009, and increased professional fees. The remaining general and administrative expenses include rent, office expenses and travel expenses.
Principal amounts owed on notes payable totaled $285,206 and $280,491 at September 30, 2009 and December 31, 2008. Interest expense on these obligations during the nine months ended September 30, 2009 and 2008 was $17,818 and $24,444, respectively. Additional interest expense of $6,702 was recorded for the nine months ended September 30, 2008 on other outstanding indebtedness.
We also recorded debt forgiveness of $61,514 from a professional service firm during the nine months ended September 30, 2009.
Liquidity and Capital Resources
At September 30, 2009, our working capital deficiency was $3,265,784, compared to a working capital deficiency of $3,394,071 at December 31, 2008. The stockholders' deficit at September 30, 2009 was $3,479,870 compared to $3,615,326 at December 31, 2008.
As a development stage company, we have had no revenues. We will continue to require additional financing to fund operations and to continue to fund the research necessary to undertake our new business plans, to further the ongoing testing as previously described, and then to market a system for hospital and medical sterilization. Our only source of financing to date has been the periodic sale of common stock. During the nine months ended September 30, 2009, we generated cash of $768,000 through common stock sales at prices ranging from $0.02 to $0.03 per share. During October and November 2009, we raised an additional $232,100 through the sale of common stock at $0.06 per share.
However, we will need to raise additional capital in the near future in order to continue its research and development activities and to sustain operations.
We believe that we will be able to raise these additional needed funds from some of the same investors who have purchased shares during 2008 and 2009, although there is no assurance that these investors will purchase additional shares. However, these investors have verbally committed to continue to fund our projects on a monthly basis, as needed.
Our unaudited financial statements included in this report have been prepared on the assumption that the Company will continue as a going concern. Through the date of this report, it has been necessary to rely upon financing from the sale of our equity securities to sustain operations as indicated above. Additional financing will be required if we are to continue as a going concern. If additional financing is not obtained in the near future, we will be required to curtail or discontinue operations, or seek protection under the bankruptcy laws. Even if additional financing becomes available, there can be no assurance that it will be on terms favorable to the Company. In any event, this additional financing will likely result in immediate and possibly substantial dilution to existing shareholders.
Forward-Looking Statements and Risks Affecting the Company
The statements contained in this report on Form 10-Q that are not purely historical are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act. These statements regard our expectations, hopes, beliefs, anticipations, commitments, intentions and strategies regarding the future. They may be identified by the use of the words or phrases "believes," "expects," "anticipates," "should," "plans," "estimates," and "potential," among others. Forward-looking statements include, but are not limited to, statements contained in Management's Discussion and Analysis of Financial Condition and Results of Operations regarding our financial performance, revenue and expense levels in the future and the sufficiency of existing assets to fund future operations and capital spending needs. Actual results could differ materially from the anticipated results or other expectations expressed in such forward-looking statements for the reasons detailed in our Annual Report on Form 10-K for the year ended December 31, 2008 under the heading "Description of Business". The Company believes that many of the risks previously discussed and in its SEC filings are part of doing business in the industry in which we operate and compete and will likely be present in all periods reported. The fact that certain risks are endemic to the industry does not lessen their significance. The forward-looking statements contained in this report are made as of the date of this report and we assume no obligation to update them or to update the reasons why actual results could differ from those projected in such forward-looking statements. Among others, risks and uncertainties that may affect our business, financial condition, performance, development, and results of operations include:
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Rigorous government scrutiny and regulation of our products and planned products;
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Potential effects of adverse publicity regarding ozone and related technologies or industries;
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Failure to sustain or manage growth including the failure to continue to develop new products; and
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The ability to obtain needed financing.
Critical Accounting Policies and Estimates
This Discussion and Analysis of Financial Condition and Results of Operations are based upon our unaudited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of such statements requires management to make estimates and assumptions that affect the reported amounts of revenues and expenses during the reporting period and the reported amounts of assets and liabilities as of the date of the financial statements. These estimates are based on historical experience and other assumptions that management considers to be appropriate in the circumstances. However, actual future results may vary from these estimates, since by their nature, these judgments are subject to an inherent degree of uncertainty. On an on-going basis, we evaluate these estimates, including those related to bad debts, intangible assets, warranty obligations, product liability, revenue, and income taxes.
We account for equity securities issued for services rendered at the fair value of the securities on the date of issuance.
Recent Accounting Pronouncements
In June 2009, we adopted a new accounting standard for subsequent events, as codified in Accounting Standards Codification ("ASC") 855-10 (formerly SFAS No. 165, Subsequent Events), which establishes general accounting standards and disclosure for events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. This new standard is effective for interim and annual financial periods ending after June 15, 2009 and requires prospective application. The adoption of this new standard had no impact on our consolidated financial statements. We evaluated subsequent events through the date the accompanying financial statements were issued, which was November 9, 2009.
Effective July 1, 2009, we adopted the "FASB Accounting Standards Codification� and the Hierarchy of Generally Accepted Accounting Principles" (ASC 105), (formerly, SFAS No. 168, The FASB Accounting Standards Codification� and the Hierarchy of Generally Accepted Accounting Principles. This new standard establishes the "FASB Accounting Standards Codification�" (Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with generally accepted accounting principles (GAAP). Rules and interpretive releases of the Securities and Exchange Commission (SEC) are also sources of authoritative GAAP for SEC registrants. The Codification now supersedes all previous-existing Non-SEC accounting and reporting standards.
All other non-grandfathered Non-SEC accounting literature not included in the Codification has now become non-authoritative. Now that the Codification is in effect, all of its content carries the same level of authority. We believe that the adoption of this standard will not have a material impact on our consolidated financial statements.
