STRATA Skin Sciences, Inc. - Quarter Report: 2008 September (Form 10-Q)

General and Administrative Expense

General and administrative expenses consist primarily of salaries and related expenses of general corporate activities, certain costs associated with our efforts to obtain PMA approval for MelaFind^® and development of a commercial infrastructure to market and sell MelaFind^®.

General and Administrative expense for the three months ended September 30, 2008 decreased 14% as compared to the same period ended September 30, 2007. This decrease is reflective of marketing consulting activities being slowed during the quarter as the pivotal clinical trial continued through the evaluation period. In 2007, a significantly greater use was being made of marketing consultants during the three month period ended September 30, 2007.

Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007

Research and Development Expense

Research and development expense increased 77% for the nine month period ended September 30, 2008 compared to the same period ended September 30, 2007, attributable to activities consistent with those described for the three month period above. The percentage increase was less over the full nine month period as the intensified clinical studies and manufacturing process activities began late in the first quarter of 2008.

We continue to work with ASKION, a company that has become an integral member of our MelaFind^® development team. ASKION is currently preparing for commercial level production and production of additional MelaFind^® systems for other clinical studies of MelaFind^®. Our research and development expenses are subject to the risks and uncertainties associated with clinical trials and the FDA regulatory review and approval process. As a result, our research and development expenses could exceed our estimated amounts, possibly materially.

General and Administrative Expense

General and administrative expense for the nine months ended September 30, 2008 experienced less than a 1% decrease compared to the same period ended September 30, 2007. Year-to-year increases in salaries, depreciation, and rent have been offset by the decreased utilization of marketing consultants. In the fourth quarter of 2008, proposed new marketing activities relating to the MelaFind^® product launch and technical support capabilities for systems to be placed in doctor’s offices could increase the level of general and administrative expense.

Interest Income/Expense

Interest income for the three and nine months ended September 30, 2008 was 62% and 51% lower than the comparable periods in 2007. The decrease is primarily related to the lower interest rates available for investment of our cash balances as well as our average cash balance being $3.9 and $3.0 million lower for the three months and nine months ended September 30, 2008, respectively, compared to the same periods a year earlier.

Other Income

During the three and nine month periods ended September 30, 2008, the Company’s other income included $45 and $98, respectively, from L’Oreal as an offset to expenses the Company incurred under our joint feasibility program, and $13 and $35, respectively, from KaVo for product support of the discontinued dental product line the Company sold to KaVo in 2006. There was $40 other income earned from L’Oreal under the joint feasibility agreement during the three and nine months ended September 30, 2007.

Deferred Income

As of September 30, 2008, deferred income of $2 was billed to KaVo but not yet earned under our product support agreement. There was no deferred income recorded during the nine months ended September 30, 2007.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our judgments related to accounting estimates. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that the following accounting policies and significant judgments and estimates relating to revenue recognition, stock-based compensation charges, and accrued expenses are most critical to aid you in fully understanding and evaluating our reported financial results.

Revenue Recognition

We currently do not have any commercialized products or any source of revenue.

Stock-Based Compensation

Effective January 1, 2006, the Company began recording compensation expense associated with stock options and other forms of equity compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”), as interpreted by SEC Staff Accounting Bulletin No. 107. Prior to January 1, 2006, the Company accounted for stock options according to the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), and related interpretations, and therefore no related compensation expense was recorded for awards granted with no intrinsic value.

The Company adopted the modified prospective transition method provided for under SFAS 123R. Under this transition method, compensation cost associated with stock options in 2007 and 2008 includes: (1) quarterly amortization related to the remaining unamortized portion of all stock option awards granted prior to January 1, 2006, over the requisite service period based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123, Accounting for Stock-Based Compensation; and (2) quarterly amortization related to all stock option awards granted on or subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R.

We have also granted to certain employees stock options that vest with the attainment of milestones not under the Company’s control. Upon the attainment of the relevant milestones, there could be a significant compensation charge based on the fair value of such options.

Options or warrants issued to non-employees for services are recorded at fair value and accounted for in accordance with Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services (“EITF 96-18”). For equity instruments that are not immediately vested, compensation costs are measured on the date such instruments vest or a performance milestone is reached, as defined in EITF 96-18. The costs are classified in the accompanying Statement of Operations based on the nature of the service performed.

Accrued Expenses

As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves identifying services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for such service where we have not been invoiced or otherwise notified of the actual cost. Examples of estimated accrued expenses include:

	•		professional service fees;
	•		contract clinical service fees;
	•		fees paid to contract manufacturers in conjunction with the production of clinical components or materials; and
	•		fees paid to third party data collection organizations and investigators in conjunction with the clinical trials.

In connection with such service fees, our estimates are most affected by our projections of the timing of services provided relative to the actual level of services incurred by such service providers. The majority of our service providers invoice us monthly in arrears for services performed. In the event that we do not identify certain costs that have begun to be incurred or we are under or over our estimate of the level of services performed or the costs of such services, our actual expenses could differ from such estimates. The date on which certain services commence, the level of services performed on or before a given date, and the cost of such services are often subjective determinations. We make these judgments based upon the facts and circumstances known to us in accordance with GAAP. This is done as of each balance sheet date in our financial statements.

Related Party Transactions

On March 24, 2006, the Company entered into an amended and restated consulting agreement with Gerald Wagner, Ph.D. which became effective as of April 1, 2006. In connection with his ongoing engagement as a consultant, Dr. Wagner received a stock option grant of 50,000 shares of the Company’s common stock which vested upon commencement of the pivotal clinical trial for MelaFind^® at the end of January 2007. As Dr. Wagner is a consultant to the Company, we utilize EITF 96-18 to account for this grant. As the pivotal clinical trial began at the end of January 2007, the Company recognized $140 in compensation expense for this grant.

In addition, on March 24, 2006, Dr. Wagner received another stock option grant of 49,500 shares of the Company’s common stock which vested immediately. The Company recorded a $162 compensation charge during the first quarter ended March 31, 2006.

The exercise price for these two stock option grants is the closing price per share of the Company’s common stock on the option grant date.

With the start of our pivotal clinical trial, Dr. Wagner has transitioned out of his role as our Acting Chief Operating Officer and has signed an amendment to his amended and restated consulting contract with the Company. Under the terms of the amended contract, Dr. Wagner is paid a monthly retainer of $2.5 and $2.5 for each additional consulting day.

This amended agreement will end at the option of Dr. Wagner or the Company at any time, by providing fifteen days’ prior written notice, or immediately upon the mutual agreement of the Company and Dr. Wagner.

For a more detailed description of our related party transactions, see our financial statements and the related notes to our financial statements in Note 12.

Off-Balance Sheet Arrangements

We do not currently have, nor have we ever had, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Recently Adopted Accounting Pronouncements

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment to SFAS No. 115” (“SFAS No. 159”). This statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reporting earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This statement is expected to expand the use of fair value measurements, which is consistent with the FASB’s long-term measurement objectives for accounting for financial instruments. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 159 did not have a material impact on our financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”). This statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. The adoption of SFAS No. 157 did not have a material impact on our financial statements.

In October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active.” The FSP clarifies the application of SFAS No. 157, “Fair Value Measurements,” when the market for a financial asset is not active. The FSP was effective upon issuance, including reporting for prior periods for which financial statements have not been issued. The adoption of the FSP for reporting as of September 30, 2008 did not have a material impact on the Company’s financial statements.

Recent Accounting Developments

In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161 “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). This new standard enhances disclosure requirements for derivative instruments in order to provide users of financial statements with an enhanced understanding of (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedged items are accounted for under Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities” and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. SFAS 161 is to be applied prospectively for the first annual reporting period beginning on or after November 15, 2008. We believe that the adoption of SFAS 161 will not have a material impact on our financial statement disclosures since we do not currently have any derivative instruments.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”). This statement replaces FASB SFAS No. 141 and establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquire. SFAS 141R also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This statement applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or

after December 15, 2008. We believe the adoption of this pronouncement will not have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. This statement amends ARB 51 to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. In addition to the amendments to ARB 51, this statement amends FASB Statement No. 128, Earnings per Share, so that earnings-per-share data will continue to be calculated the same way those data were calculated before this statement was issued. This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We believe the adoption of this pronouncement will not have a material impact on the our financial statements.

In April 2008, the FASB issued FSP FAS No. 142-3, “Determination of the Useful Life of Intangible Assets.” The FSP amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 142, “Goodwill and Other Intangible Assets.” The FSP must be applied prospectively to intangible assets acquired after the effective date. The Company will apply the guidance of the FSP to intangible assets acquired after January 1, 2009.

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk is confined to our cash, cash equivalents, and short-term investments. We invest in high-quality financial instruments, primarily money market funds, federal agency notes, and US Treasury obligations, with the average effective duration of the portfolio within one year which we believe are subject to limited credit risk. We currently do not hedge interest rate exposure. Due to the short-term nature of our investments, we do not believe that we have any material exposure to interest rate risk arising from our investments. The Company is exposed to credit risks in the event of default by the financial institutions or issuers of investments in excess of FDIC insured limits. The Company performs periodic evaluations of the relative credit standing of these financial institutions and limits the amount of credit exposure with any institution,

ITEM 4.

Controls and Procedures

Evaluation of disclosure controls and procedures

Based on their evaluation as of September 30, 2008, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended, were sufficiently effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and Form l0-Q, and that such information was accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Change in internal control over financial reporting

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the effectiveness of controls

Our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected.

ITEM 4T. Controls and Procedures

Not applicable.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not currently subject to any material legal proceedings, nor, to our knowledge, is any material legal proceeding threatened against us. From time to time, we may be a party to certain legal proceedings, incidental to the normal course of our business.

Item 1A. Risk Factors

Our business and operations entail a variety of serious risks and uncertainties, including those described in Item 1A of our Form 10-K for the year ended December 31, 2007. In addition, the following risk factors have changed during the nine months ended September 30, 2008:

We currently do not have, and may never develop, any commercialized products.

We currently do not have any commercialized products or any significant source of revenue. We have invested substantially all of our time and resources over the last six years in developing MelaFind^®. MelaFind^® will require additional development, clinical evaluation, regulatory approval, significant marketing efforts and substantial additional investment before it can provide us with any revenue. Our efforts may not lead to commercially successful products for a number of reasons, including:

	•		we may not be able to obtain regulatory approvals for MelaFind®, or the approved indication may be narrower than we seek;
	•		MelaFind® may not prove to be safe and effective in clinical trials;
	•		physicians may not receive any reimbursement from third-party payers, or the level of reimbursement may be insufficient to support widespread adoption of MelaFind®;
	•		we may experience delays in our development program;
	•		any products that are approved may not be accepted in the marketplace by physicians or patients;
	•		we may not have adequate financial or other resources to complete the development or to commence the commercialization of MelaFind® and we will not have adequate financial or other resources to achieve significant commercialization of MelaFind®;
	•		we may not be able to manufacture our products in commercial quantities or at an acceptable cost; and
	•		rapid technological change may make our technology and products obsolete.

We do not expect to be able to commercialize MelaFind^® before the middle of 2009. If we are unable to develop, obtain regulatory approval for or successfully commercialize MelaFind^®, we will be unable to generate revenue.

Risk of delay in product development.

We could encounter delays in our pivotal clinical trial or in obtaining PMA approval because of a number of factors. We will require the receipt of all information specified in our Protocol Agreement on the required number of melanomas before the pivotal clinical trial can be concluded. The MelaFind^® classifier will then be utilized to evaluate the lesions acquired during the pivotal trial, and the results will be analyzed to determine if we have achieved the endpoints specified in the Protocol Agreement.

The final training of the classifier is required to be completed before the classifier is utilized as described above. Accordingly, the classifier must be ready for final training when the data from the pivotal trial become available. To date, there are over 400 melanoma lesions in the training database. The current classifier has been trained on 221 of these melanoma lesions. Our schedule for the acquisition of these lesions is based upon the projected numbers of imaging devices to be located at participating sites, the projected productivity of those sites in terms of melanomas and other lesions biopsied per month, and the projected efficiency of the study pathologists in classifying the lesion slides presented for histological analysis (the microscopic examination of excised or biopsied tissue specimens) and reporting their results. If we are unable to produce and maintain a sufficient number of imaging devices at participating sites, if the clinicians do not maintain sufficient productivity, or if the pathologists do not produce reports with sufficient efficiency, then our ability to maintain our schedule will be adversely affected, the conclusion of the pivotal trial may be delayed, and the submission of the completed PMA will be delayed.

To date, the lesion images in the training database have been acquired using first-generation hand-held devices, which also extract data from the lesions that are used by the classifiers. Pre-commercialization hand-held devices have been developed for use in the pivotal clinical trial. If the lesion data obtained with pre-commercialization devices are not consistent with data from the first generation hand-held devices, the classifier will need to be trained solely on lesions imaged using only one or the other generation of hand-held devices. Were this need to arise, significant delay and expense could be incurred, which could jeopardize our ability to complete the development of MelaFind^®.

We have not received, and may never receive, FDA approval to market MelaFind^®.

We do not have the necessary regulatory approvals to market MelaFind^® in the US or in any foreign market. We have not filed, and currently do not have plans to file, for regulatory approval in any foreign market. We plan initially to launch MelaFind^®, once approved, in the US. The regulatory approval process for MelaFind^® in the US involves, among other things, successfully completing clinical trials and obtaining pre-market approval (PMA) from the FDA. We commenced the PMA application process for MelaFind^® by filing a proposed outline for a Modular PMA application (a compilation of well-delineated components submitted separately) on September 30, 2002. The PMA process requires us to prove the safety and effectiveness of MelaFind^® to the FDA’s satisfaction. This process is expensive and uncertain, and requires detailed and comprehensive scientific and human clinical data. FDA review may take years after a PMA application is filed. The FDA may never grant approval. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:

	•		MelaFind® may not be safe or effective to the FDA’s satisfaction;
	•		the data from our pre-clinical studies and clinical trials may be insufficient to support approval;
	•		the manufacturing process or facilities we use may not meet applicable requirements; and
	•		changes in FDA approval policies or adoption of new regulations may require additional data.

No precedent has been established for FDA approval of a device such as MelaFind^® to assist in determining the appropriateness of biopsies of suspicious pigmented skin lesions. Before submitting a PMA application, we must successfully complete a pivotal clinical trial to demonstrate that MelaFind^® is safe and effective. Product development, including clinical trials, is a long, expensive and uncertain process, and is subject to

delays and failure at any stage. Furthermore, the data obtained from the trial may be inadequate to support approval of a PMA application. While we obtained a Protocol Agreement from the FDA, FDA approval of a Protocol Agreement does not mean that the FDA will consider the data gathered in the trial sufficient to support approval of a PMA application, even if the trial’s intended endpoints are achieved. There may be unexpected findings, particularly those that may only become evident from the larger scale of the pivotal clinical trial, as compared with the smaller scale tests done to date. For example, we initiated a clinical trial and encountered several technical problems which required us to refine the MelaFind^® system. The data obtained in the pivotal trial may not be sufficient to support the anticipated indication for use, and may not support a more limited indication for use. The occurrence of unexpected findings in connection with the pivotal trial or any subsequent clinical trial required by the FDA may prevent or delay obtaining PMA approval, and may adversely affect coverage or reimbursement determinations. The FDA may also determine that additional clinical trials are necessary, in which case the PMA approval may be delayed for several months or even years while the trials are conducted and the data acquired are submitted in an amendment to the PMA. If we are unable to complete the clinical trials necessary to successfully support the MelaFind^® PMA application, our ability to commercialize MelaFind^®, and our business, financial condition, and results of operations would be materially adversely affected, thereby threatening our ability to continue operations. On October 12, 2006, we announced that the FDA had informed us that when submitted the MelaFind^® PMA application would receive expedited review. Expedited review means that upon filing a PMA application with the FDA, it is placed at the beginning of the FDA’s review queue and receives additional review resources. While the expedited review could shorten the MelaFind^® FDA approval process, we can give no assurances that this will be the case.

The accrual phase of the MelaFind^® pivotal trial concluded at the end of July 2008. Follow-up and data analysis is ongoing and will continue through the fourth quarter of 2008.

We have incurred losses for a number of years, and anticipate that we will incur continued losses for the foreseeable future.

We began operations in December 1989. At that time, we provided research services, mostly to US government agencies, on classified projects. We have financed our operations since 1999 primarily through the sale of our equity securities and have devoted substantially all of our resources to research and development relating to MelaFind^®. Our net loss for the three and nine months ended September 30, 2008 was approximately $4.2 million and $13.4 million, respectively, and as of September 30, 2008, we had an accumulated deficit of approximately $56.6 million. Our research and development expenses may continue to increase in connection with our clinical trials and other development activities related to MelaFind^®. If we receive PMA approval for MelaFind^® from the FDA, we expect to incur significant sales and marketing expenses, which will require additional funding, and manufacturing expenses. Additionally, our general and administrative expenses have also increased due to the additional operational and regulatory responsibilities applicable to public companies. As a result, we expect to continue to incur significant and increasing operating losses for the foreseeable future. These losses, among other things, have had and will continue to have an adverse effect on our stockholders’ equity.

We may be unable to complete the development and commence commercialization of MelaFind^® or other products without additional funding, and we will not be able to achieve significant commercialization without additional funding.

As of September 30, 2008, we had $18.8 million in cash and cash equivalents and $0.8 million in marketable securities. Our operations have consumed substantial amounts of cash for each of the last eight years. The Company will require additional funds to achieve significant commercialization of MelaFind^®. However, there can be no assurances that the Company will be able to raise additional capital in the future. Additional funds may not become available on acceptable terms, and there can be no assurance that any additional funding that the Company does obtain will be sufficient to meet the Company’s needs in the long term.

Any additional financing may be dilutive to stockholders, or may require us to grant a lender a security interest in our assets. The amount of funding we will need will depend on many factors, including:

	•		the schedule, costs, and results of our clinical trials;
	•		the success of our research and development efforts;
	•		the costs and timing of regulatory approval;
	•		reimbursement amounts for the use of MelaFind® that we are able to obtain from Medicare and third-party payers, or the amount of direct payments we are able to obtain from patients and/or physicians utilizing MelaFind®;
	•		the cost of commercialization activities, including product marketing and building a domestic direct sales force;
	•		the emergence of competing or complementary technological developments;
	•		the costs of filing, prosecuting, defending and enforcing any patent claims and other rights, including litigation costs and the results of such litigation;
	•		the costs involved in defending any patent infringement actions brought against us by third parties; and
	•		our ability to establish and maintain any collaborative, licensing or other arrangements, and the terms and timing of any such arrangements.

If we are unable to obtain adequate financing on a timely basis, we may be required to significantly curtail or cease one or more of our development and marketing programs. We could be required to seek funds through arrangements with collaborators or others that may require us to relinquish rights to some of our technologies, product candidates or products that we would otherwise pursue on our own. We also may have to reduce marketing, customer support and other resources devoted to our products. If we raise additional funds by issuing equity securities, our then-existing stockholders will experience ownership dilution, could experience declines in our share price and the terms of any new equity securities may have preferences over our common stock.

MelaFind^® may not be commercially viable if we fail to obtain an adequate level of reimbursement by Medicare and other third party payers. The markets for MelaFind^® may also be limited by the indications for which its use may be reimbursed.

The availability of medical insurance coverage and reimbursement for newly approved medical devices is uncertain. In the US, physicians and other healthcare providers performing biopsies for suspicious skin lesions are generally reimbursed for all or part of the cost of the diagnosis and biopsy by Medicare, Medicaid, or other third-party payers.

The long-term commercial success of MelaFind^® in both domestic and international markets will significantly depend on whether third-party coverage and reimbursement are available for services involving MelaFind^®. Medicare, Medicaid, health maintenance organizations and other third-party payers are increasingly attempting to contain healthcare costs by limiting both the scope of coverage and the level of reimbursement of new medical devices, and as a result, they may not cover or provide adequate payment for the use of MelaFind^®. In order to obtain satisfactory reimbursement arrangements, we may have to agree to a fee or sales price lower than the fee or sales price we might otherwise charge. Even if Medicare and other third-party payers decide to cover procedures involving our product, we cannot be certain that the reimbursement levels will be adequate. Accordingly, even if MelaFind^® or future products we develop are approved for commercial sale, unless government and other third-party payers provide adequate coverage and reimbursement for our products, some physicians may be discouraged from using them, and our sales would suffer.

Medicare reimburses for medical devices in a variety of ways, depending on where and how the device is used. However, Medicare only provides reimbursement if the Centers for Medicare and Medicaid Services (“CMS”) determines that the device should be covered and that the use of the device is consistent with the coverage criteria. A coverage determination can be made at the local level by the Medicare administrative contractor (formerly called carriers and fiscal intermediaries), a private contractor that processes and pays claims on behalf of CMS for the geographic area where the services were rendered, or at the national level by CMS through a national coverage determination. There are statutory provisions intended to facilitate coverage determinations for new technologies, but it is unclear how these provisions will be implemented. Coverage presupposes that the device has been cleared or approved by the FDA and further, that the coverage will be no broader than the approved intended uses of the device as approved or cleared by the FDA, but coverage can be narrower. A coverage determination may be so limited that relatively few patients will qualify for a covered use of the device. Should a very narrow coverage determination be made for MelaFind^®, it may undermine the commercial viability of MelaFind^®.

Obtaining a coverage determination, whether local or national, is a time-consuming, expensive and highly uncertain proposition, especially for a new technology, and inconsistent local determinations are possible. On average, according to an industry report, Medicare coverage determinations for medical devices lag 15 months to five years or more behind FDA approval for that device. The Medicare statutory framework is also subject to administrative rulings, interpretations and discretion that affect the amount and timing of reimbursement made under Medicare. Medicaid coverage determinations and reimbursement levels are determined on a state by state basis, because Medicaid, unlike Medicare, is administered by the states under a state plan filed with the Secretary of the US Department of Health and Human Services (HHS). Medicaid generally reimburses at lower levels than Medicare. Moreover, Medicaid programs and private insurers are frequently influenced by Medicare coverage determinations.

Our stock price is likely to be volatile, meaning purchasers of our common stock could incur substantial losses.

Our stock price is likely to be volatile. Between October 28, 2005 (the date of our initial public offering) and September 30, 2008, our stock price has ranged from $3.29 to $9.99 per share. The stock market in general and the market for medical technology companies in particular have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. The following factors, in addition to other risk factors described in this section and general market and economic conditions, may have a significant impact on the market price of our common stock:

	•		results of our research and development efforts and our clinical trials;
	•		the timing of regulatory approval for our products;
	•		failure of any of our products, if approved, to achieve commercial success;
	•		the announcement of new products or product enhancements by us or our competitors;
	•		regulatory developments in the US and foreign countries;
	•		ability to manufacture our products to commercial standards;
	•		developments concerning our clinical collaborators, suppliers or marketing partners;
	•		changes in financial estimates or recommendations by securities analysts;
	•		public concern over our products;
	•		developments or disputes concerning patents or other intellectual property rights;
	•		product liability claims and litigation against us or our competitors;

	•		the departure of key personnel;
	•		the strength of our balance sheet;
	•		variations in our financial results or those of companies that are perceived to be similar to us;
	•		changes in the structure of and third-party reimbursement in the US and other countries;
	•		changes in accounting principles or practices;
	•		general economic, industry and market conditions; and
	•		future sales of our common stock.

A decline in the market price of our common stock could cause you to lose some or all of your investment and may adversely impact our ability to attract and retain employees and raise capital. In addition, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly. Whether or not meritorious, litigation brought against us could result in substantial costs and could divert the time and attention of our management. Our insurance to cover claims of this sort, if brought, may not be adequate.

If our directors, executive officers, and principal stockholders choose to act together, they may have the ability to influence all matters submitted to stockholders for approval.

As of September 30, 2008, our directors, executive officers, holders of more than 5% of our common stock, and their affiliates in the aggregate, beneficially owned approximately 36% of our outstanding common stock. As a result, these stockholders, subject to any fiduciary duties owed to our other stockholders under Delaware law, could be able to exercise a controlling influence over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions, and will have significant control over our management and policies. Some of these persons or entities may have interests that are different from yours. For example, these stockholders may support proposals and actions with which you may disagree or which are not in your interests. The concentration of ownership could delay or prevent a change in control of our company or otherwise discourage a potential acquirer from attempting to obtain control of our company, which in turn could reduce the price of our common stock. In addition, these stockholders, some of whom have representatives sitting on our Board of Directors, could use their voting influence to maintain our existing management and directors in office, delay or prevent changes of control of our company, or support or reject other management and board proposals that are subject to stockholder approval, such as amendments to our employee stock plans and approvals of significant financing transactions.

We have limited manufacturing capabilities and manufacturing personnel, and if our manufacturing capabilities are insufficient to produce an adequate supply of MelaFind^®, our growth could be limited and our business could be harmed.

We have not yet completed the development and testing of MelaFind^®, and as a result have no experience in manufacturing MelaFind^® for commercial distribution. We currently have limited resources, facilities and experience to commercially manufacture MelaFind^®. In order to produce MelaFind^® in the quantities we anticipate to meet market demand, we will need to increase our third-party manufacturing capacity. There are technical challenges to increasing manufacturing capacity, including equipment design and automation, material procurement, problems with production yields, and quality control and assurance. Developing commercial-scale manufacturing facilities that meet FDA requirements would require the investment of substantial additional funds and the hiring and retaining of additional management and technical personnel who have the necessary manufacturing experience.

We currently plan to outsource production to contract manufacturers. Any difficulties in the ability of third-party manufacturers to supply devices of the quality, at the times, and in the quantities we need, could have a material adverse effect on our business, financial condition, and results of operations. Similarly, when we enter into contracts for the third-party manufacture of our devices, any revenue received will depend on the skills and efforts of others, and we do not know whether these efforts will be successful. Manufacturers often encounter difficulties in scaling up production of new products, including problems involving product yields, controlling and anticipating product costs, quality control and assurance, component supply, and shortages of qualified personnel. We cannot assure you that the third-party contract manufacturers with whom we have developed or are developing relationships will have or sustain the ability to produce the quantities of MelaFind^® needed for development or commercial sales, or will be willing to do so at prices that allow MelaFind^® to compete successfully in the market.

Assuming that MelaFind^® receives regulatory approval, if we are unable to manufacture or obtain a sufficient supply of product, maintain control over expenses, or otherwise adapt to anticipated growth, or if we underestimate growth, we may not have the capability to satisfy market demand, and our business will suffer. Additionally, if MelaFind^® receives regulatory approval and we then need to make manufacturing changes, we may need to obtain additional approval for these changes.

MelaFind^® is complex and may contain undetected design defects and errors when first introduced, or errors that may be introduced when enhancements are released. Such defects and errors may occur despite our testing, and may not be discovered until after our devices have been shipped to and used by our customers. The existence of these defects and errors could result in costly repairs, returns of devices, diversion of development resources and damage to our reputation in the marketplace. Any of these conditions could have a material adverse impact on our business, financial condition and results of operations. In addition, when we contract with third-party manufacturers for the production of our products, these manufacturers may inadvertently produce devices that vary from devices we have produced in unpredictable ways that cause adverse consequences.

We will not be able to sell MelaFind^® unless and until its design is verified and validated in accordance with current good manufacturing practices as set forth in the US medical device Quality System Regulations.

We are in the process, but have not yet successfully completed, all the steps necessary to verify and validate the design of the MelaFind^® system that are required to be performed prior to commercialization. If we are delayed or unable to complete verification and validation successfully, we will not be able to sell MelaFind^®, and we will not be able to meet our plans for the commercialization of MelaFind^® in the middle of 2009. Assuming that regulatory approval of MelaFind^® is granted, the approval may be subject to limitations on the indicated uses for which the product may be marketed, or may contain requirements for costly post-marketing testing and surveillance to monitor the safety or effectiveness of the device. Later discovery of previously unknown problems with MelaFind^®, including manufacturing problems, or failure to comply with regulatory requirements such as the FDA Quality System Regulations (“QSR”), may result in restrictions on MelaFind^® or its manufacturing processes, withdrawal of MelaFind^® from the market, patient or physician notification, voluntary or mandatory recalls, fines, withdrawal of regulatory approvals, refusal to approve pending applications or supplements to approved applications, refusal to permit the import or export of our products, product seizures, injunctions or the imposition of civil or criminal penalties. Should any of these enforcement actions occur, our business, financial condition and results of operations could be materially and adversely affected.

Assuming that MelaFind^® is approved by regulatory authorities, if we or our suppliers fail to comply with ongoing regulatory requirements, or if we experience unanticipated problems with MelaFind^®, it could be subject to restrictions or withdrawal from the market.

Any product for which we obtain marketing approval, along with the manufacturing processes, post-approval clinical data and promotional activities for such product, will be subject to continuous review and periodic inspections by the FDA and other regulatory bodies. In particular, we and our suppliers are required to comply with the QSR and other regulations which cover the methods and documentation of the

design, testing, production, control, quality assurance, labeling, packaging, storage, promotion, distribution, and shipping of MelaFind^®, and with record keeping practices. We also will be subject to ongoing FDA requirements, including required submissions of safety and other post-market information and reports and registration and listing requirements. To the extent that we contract with third parties to manufacture some of our products, our manufacturers will be required to adhere to current Good Manufacturing Practices (“cGMP”) requirements enforced by the FDA as part of QSR, or similar regulations required by regulatory agencies in other countries. The manufacturing facilities of our contract manufacturers must be inspected or must have been inspected, and must be in full compliance with cGMP requirements before approval for marketing. The FDA enforces the QSR and other regulatory requirements through unannounced inspections. We have not yet been inspected by the FDA for MelaFind^® and will have to complete such an inspection successfully before we ship any commercial MelaFind^® devices. However, we were previously inspected in connection with DIFOTI^®, which we have discontinued for business reasons, and were cited for failures to comply fully with QSR mandated procedures. The FDA inspectors observed deficiencies that were documented on FDA Form 483 that was issued to us following the inspection. The DIFOTI^® inspectional findings were discussed in a subsequent meeting with the FDA on April 28, 2005. An onsite consultant was hired to address these deficiencies and structure a compliant Quality System for MelaFind^®. Throughout 2006 we worked to address the deficiencies noted in accordance with the agreement reached with the FDA. On May 18, 2006, the FDA re-audited the Company’s facility for a follow-up inspection and audited our revised Quality System. No non-conformities or negative observations were reported to the Company. On December 5, 2006 we received correspondence from the FDA that reported “that all previous observations reported on the FDA-483 were corrected, and this firm no longer manufactures or distributes the DIFOTI^® 2.0 dental imaging system.” A second follow-up inspection was conducted in May 2008; no deficiencies were cited by the FDA field inspector.

Our director of quality assurance and regulatory affairs continues to work with several regulatory consultants to address the inspectional findings, particularly as they relate to current MelaFind^® design development and ultimately MelaFind^® commercial manufacturing. If we are not successful in convincing the FDA that we are capable of addressing any concerns it might have relative to MelaFind^®, or in our efforts to address any MelaFind^® deficiencies that might develop, we could be subject to additional FDA action of a type described below, which could negatively affect our ability to commercialize MelaFind^®. There can be no assurance that the future interpretations of legal requirements made by the FDA or other regulatory bodies with possible retroactive effect, or the adoption of new requirements or policies, will not adversely affect us. We may be slow to adapt, or may not be able to adapt, to these changes or new requirements. Failure by us or one of our suppliers to comply with statutes and regulations administered by the FDA and other regulatory bodies, or failure to take adequate response to any observations, could result in, among other things, any of the following actions:

	•		warning letters;
	•		fines and civil penalties;
	•		unanticipated expenditures;
	•		delays in approving or refusal to approve MelaFind®;
	•		withdrawal of approval by the FDA or other regulatory bodies;
	•		product recall or seizure;
	•		interruption of production;
	•		operating restrictions;
	•		injunctions; and
	•		criminal prosecution.

If any of these actions were to occur, it would harm our reputation and cause our product sales and profitability to suffer.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On July 31, 2007, the Company entered into a securities purchase agreement and a registration rights agreement with certain accredited investors for the private placement of 2,000,178 shares of the Company’s common stock and warrants to purchase up to 500,041 shares of the Company’s common stock for aggregate gross proceeds of approximately $11.5 million and net proceeds of approximately $10.7 million. This transaction closed on August 3, 2007.

The proceeds from this financing are being used for general corporate purposes including research and development activities.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

Not applicable.

Item 5. Other Information

	(a)		Not applicable
	(b)		Not applicable

Item 6. Exhibits

Exhibit
Number		Exhibit Title
3.1		Fourth Amended and Restated Certificate of Incorporation of the Registrant.(1)
3.2		Third Amended and Restated Bylaws of the Registrant.(2)
4.1		Specimen Stock Certificate.(2)
4.2		Second Amended and Restated Investor’s Rights Agreement dated as of October 26, 2004 by and among the Registrant and the parties listed therein.(3)
4.3		Form of Warrant.(7)
4.4		Form of Warrant.(13)
10.1*		Form of Indemnification Agreement for directors and executive officers.(2)
10.2*		1996 Stock Option Plan.(3)
10.3*		2003 Stock Incentive Plan, as amended.(3)
10.4*		2005 Stock Incentive Plan.(2)
10.5*		Employment Agreement dated as of January 5, 2004 between the Registrant and Joseph V. Gulfo.(3)
10.6		Consulting Agreement dated as of May 31, 2005 between the Registrant and Marek Elbaum.(3)
10.7		Lease Agreement dated as of December 16, 1998, by and between the Registrant and Bridge Street Properties LLC, for office space located at One Bridge Street, Irvington, New York.(3)
10.8		First Amendment to the Lease Agreement dated as of May 17, 2001 by and between the Registrant and Bridge Street Properties LLC.(3)
10.9		Second Amendment to the Lease Agreement dated as of June 19, 2003 by and between the Registrant and Bridge Street Properties LLC.(3)
10.10		Lease Agreement dated as of November 23, 2004, by and between the Registrant and Bridge Street Properties LLC, for office space located at 3 West Main Street, Irvington, New York.(3)
10.11*		Consulting Agreement dated as of June 1, 2005 between the Registrant and Gerald Wagner Consulting, LLC.(1)
10.12*		Consulting Agreement dated as of June 20, 2003 between the Registrant and Breaux Castleman, as amended.(1)
10.13		Consulting Agreement dated as of June 1, 2005 between the Registrant and Robert Friedman, M.D.(1)
10.14		Task Order Agreement dated as of July 13, 2005 between the Registrant and Battelle Memorial Institute.(2)

Exhibit
Number		Exhibit Title
10.15		Third Amendment dated as of June 6, 2005, by and between the Registrant and Bridge Street Properties LLC, for office space located at 1 Bridge Street, Irvington, New York.(1)
10.16		Production Agreement between the Registrant and ASKION GmbH dated as of January 25, 2006.(4)
10.17*		Amended and Restated Consulting Agreement effective as of April 1, 2006 between the Registrant and Gerald Wagner Consulting LLC.(11)
10.18*		Resignation Agreement, dated April 24, 2006, between the Registrant and Karen Krumeich.(5)
10.19*		Employment Offer Letter, dated April 24, 2006, between the Registrant and Richard I. Steinhart.(5)
10.20*		Employment Offer Letter, dated May 30, 2006, between the Registrant and Christiano S. Butler.(6)
10.21		Securities Purchase Agreement among the Registrant and the purchasers identified on the signature pages thereto, dated as of October 31, 2006.(8)
10.22		Securities Purchase Agreement among the Registrant and the purchasers identified on the signature pages thereto, dated as of October 31, 2006.(8)
10.23		Registration Rights Agreement among the Registrant and the purchasers identified on the signature pages thereto, dated as of October 31, 2006.(8)
10.24		Placement Agency Agreement by and between the Registrant and Jefferies & Company, Inc., dated as of October 31, 2006.(7)
10.25		Licensing Agreement between the Registrant and KaVo Dental GmbH, dated as of December 5, 2006.(9)
10.26*		Amendment No. 1 to Amended and Restated Consulting Agreement dated as of January 30, 2007 by and among the Registrant, Gerald Wagner and Gerald Wagner Consulting LLC. (10)
10.27		Research and Feasibility Agreement between the Registrant and L’Oreal S.A. dated as of March 26, 2007. (12)
10.28		Securities Purchase Agreement among the Registrant and the purchasers identified on the signature pages thereto, dated as of July 31, 2007.(13)
10.29		Registration Rights Agreement among the Registrant and the purchasers identified on the signature pages thereto, dated as of July 31, 2007.(13)
10.30		Fifth Amendment dated as of August 24, 2007, by and between the Registrant and Bridge Street Commercial, LLC, for office space located at 1 Bridge Street, Irvington, New York.(1)
10.31*		Employment Offer Letter, dated February 11, 2008, between the Registrant and Tina Cheng-Avery.(14)
10.32*		Separation Agreement dated May 1, 2008, between the Registrant and Jon I. Klippel. (15)
10.33		Form of Subscription Agreement between the Registrant and certain investors.(16)

Exhibit
Number		Exhibit Title
31.1#		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2#		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1#		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 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.

Date: November 6, 2008

EXHIBIT INDEX

Exhibit No.		Description
31.1		Certification by the Chief Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
31.2		Certification by the Chief Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) under the Securities Exchange Act of 1934, as amended.
32.1		Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.