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

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2008

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

ELECTRO-OPTICAL SCIENCES, INC.

Delaware		13-3986004
(State or Other Jurisdiction of		(I.R.S. Employer
Incorporation or Organization)		Identification No.)
3 West Main Street, Suite 201
Irvington, New York		10533
(Address of Principal Executive offices)		(Zip Code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of May 1, 2008, 15,401,882 shares of the Registrant’s common stock were outstanding.

 

 

Electro-Optical Sciences, Inc.
Table of Contents

		Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Balance Sheets as of March 31, 2008 (unaudited) and December 31, 2007			2
Condensed Statements of Operations (unaudited) for the three months ended March 31, 2008 and 2007			3
Condensed Statements of Cash Flows (unaudited) for the three months ended March 31, 2008 and 2007			4
Notes to Financial Statements (unaudited)			5
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk			22
ITEM 4. Controls and Procedures			22
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings			22
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds			26
ITEM 3. Defaults Upon Senior Securities			26
ITEM 4. Submission of Matters to a Vote of Security Holders			26
ITEM 5. Other Information			26
ITEM 6. Exhibits			27
SIGNATURES			30
EXHIBIT INDEX			31
EX-31.1: CERTIFICATION
EX-31.2: CERTIFICATION
EX-32.1: CERTIFICATION

ELECTRO-OPTICAL SCIENCES, INC.

		March 31,				December 31,
		2008				2007
		(unaudited)				*
ASSETS
Current Assets:
Cash and cash equivalents		$	15,900,246			$	19,196,589
Marketable securities			1,282,418				1,719,905
Prepaid expenses and other current assets			213,178				411,554
Total Current Assets			17,395,842				21,328,048
Property and equipment, net			788,085				616,110
Patents and trademarks, net			112,176				118,138
Other assets			45,876				45,876
Total Assets		$	18,341,979			$	22,108,172
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts payable		$	717,977			$	567,987
Accrued expenses (includes related parties of $10,000 as of March 31, 2008 and as of December 31, 2007)			930,105				674,711
Deferred income			67,509				74,946
Other current liabilities			23,055				18,804
Total Current Liabilities			1,738,646				1,336,448
COMMITMENTS AND CONTINGENCIES (Note 9)
Stockholders’ Equity
Preferred stock — $0.10 par value; authorized 10,000,000 shares; issued and outstanding: none at March 31, 2008 and at December 31, 2007
Common stock — $.001 par value; authorized 30,000,000 shares; issued and outstanding 15,401,882 shares at March 31, 2008 and at December 31, 2007			15,402				15,402
Additional paid-in capital			64,042,496				63,930,689
Other comprehensive loss			(15,504	)			(12,136	)
Accumulated deficit			(47,439,061	)			(43,162,231	)
Stockholders’ Equity			16,603,333				20,771,724
Total Liabilities and Stockholders’ Equity		$	18,341,979			$	22,108,172

See accompanying notes to the financial statements

ELECTRO-OPTICAL SCIENCES, INC.

		Three months ended March 31,
		2008				2007
Operating expenses:
Research and development		$	3,045,093			$	1,953,368
General and administrative			1,439,795				1,311,190
Operating loss			(4,484,888	)			(3,264,558	)
Interest income			181,972				271,025
Other income			26,086				—
Net loss		$	(4,276,830	)		$	(2,993,533	)
Basic and diluted net loss per common share		$	(0.28	)		$	(0.22	)
Basic and diluted weighted average number of common shares outstanding			15,401,882				13,369,305

See accompanying notes to the financial statements

ELECTRO-OPTICAL SCIENCES, INC.

		Three Months Ended March 31,
		2008				2007
Cash flows from operating activities:
Net loss		$	(4,276,830	)		$	(2,993,533	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			65,479				48,898
Noncash compensation and amortization of deferred compensation			111,807				126,633
Common stock options issued for consulting fees			—				139,703
Amortization of discount on marketable securities			(285	)			—
Amortization of unearned interest income — discontinued operations			—				(6,122	)
Changes in operating assets and liabilities:
Decrease in prepaid expenses and other current assets			198,376				87,665
Increase (decrease) in accounts payable and accrued expenses			405,384				(104,876	)
Decrease in deferred income			(7,437	)			—
Increase (decrease) in other current liabilities			4,251				(583	)
Net cash used in operating activities			(3,499,255	)			(2,702,215	)
Cash flows from investing activities:
Patent costs			—				(22,242	)
Purchases of property and equipment			(231,492	)			(143,542	)
Sales of marketable securities			434,404				—
Net cash provided by (used in) investing activities			202,912				(165,784	)
Cash flows from financing activities:
Proceeds from exercise of stock options			—				85,305
Net cash provided by financing activities			—				85,305
Net decrease in cash and cash equivalents			(3,296,343	)			(2,782,694	)
Cash and cash equivalents at beginning of period			19,196,589				20,939,527
Cash and cash equivalents at end of period		$	15,900,246			$	18,156,833
Supplemental Schedule of Noncash Investing and Financing Activities
Unrealized loss on marketable securities			3,368				—

See accompanying notes to the financial statements

ELECTRO-OPTICAL SCIENCES, INC.

1. ORGANIZATION AND BASIS OF PRESENTATION

Electro-Optical Sciences, Inc., a Delaware corporation (“EOS” or the “Company”), is focused on the design and development of a non-invasive, point-of-care instrument for assisting in the early diagnosis of melanoma. The Company has entered into a Protocol Agreement with the Food and Drug Administration (“FDA”) which is an agreement for the conduct of the pivotal clinical trial and establishment of the safety and effectiveness of the MelaFind^® device. On October 12, 2006, the Company announced that the FDA informed the Company that when submitted, the MelaFind^® premarket approval, or PMA, application would receive expedited review. Expedited review means that upon filing a PMA with the FDA, it is placed at the beginning of the FDA’s queue and receives additional review resources. While the expedited review could shorten the MelaFind^® FDA approval process, there can be no assurance that this will be the case. Upon obtaining premarket approval from the FDA, the Company plans to launch MelaFind^® in the United States. The pivotal clinical trial commenced at the end of January 2007 and is continuing into the second quarter of 2008. If the pivotal trial and FDA approval process proceeds as anticipated, management believes that PMA approval could come as early as the second half of 2008.

To date the Company has not generated any revenues from MelaFind^®. All of the Company’s historical revenues have come from activities and products that have since been discontinued, including our DIFOTI^® product, a non-invasive imaging device for the detection of dental cavities. The Company discontinued all operations associated with its DIFOTI^® product effective as of April 5, 2005 in order to focus its resources on the development and commercialization of MelaFind^®. As more fully described in Note 13, in December 2006, the Company sold and licensed its rights to the DIFOTI^® assets and does not expect to have any significant continuing responsibility for the DIFOTI^® business or products.

The Company anticipates that it will continue to incur net losses for the foreseeable future in the development and commercialization of the Melafind^® device. From inception, the Company has financed operations primarily through the sale of convertible preferred stock and subsequently sold common stock as part of an initial public offering on October 28, 2005 and two private placements: one that closed in November 2006, and a second that closed in August 2007 (refer to Note 10 for further details). Management believes that the proceeds from these transactions will permit the Company to fund anticipated levels of operations into second quarter 2009. However, the Company will require additional funds to commercialize MelaFind^®. The Company faces certain risks and uncertainties which are present in many emerging medical device companies regarding future profitability, ability to obtain future capital, protection of patents and intellectual property rights, competition, rapid technological change, government regulations, changing health care marketplace, recruiting and retaining key personnel, and reliance on third party manufacturing organizations.

The unaudited condensed financial statements included herein have been prepared from the books and records of the Company pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”) for reporting on Form 10-Q. The information and note disclosures normally included in complete financial statements prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

The Company’s management is responsible for the financial statements included in this document. The Company’s interim financial statements are unaudited. Interim results may not be indicative of the results that may be expected for the year. However, the Company believes all adjustments considered necessary for a fair presentation of these interim financial statements have been included and are of a normal and recurring nature.

2. MARKETABLE SECURITIES

The Company’s marketable securities are debt securities primarily consisting of corporate debt securities with a weighted average maturity not in excess of twelve months. The Company classifies its marketable securities as available-for-sale, as defined by Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” Available-for-sale securities are carried at fair value, with unrealized gains and losses reported as a component of stockholders’ equity in accumulated other comprehensive loss. Interest income, realized gains and losses, and declines in value of securities judged to be other-than-temporary are included in the Company’s statement of operations. As of March 31, 2008, marketable securities consisted of:

		March 31, 2008
						Unrealized
		Fair Value				Gain (Loss)
Corporate debt securities		$	1,282			$	(16	)

The Company evaluates declines in the fair value of its investments in available-for-sale marketable securities to determine if these declines are other-than-temporary. When a decline in value is determined to be other-than-temporary, an impairment charge would be recorded and a new cost basis in the investment would be established.

3. COMPREHENSIVE LOSS

Comprehensive loss includes net loss and unrealized gains and losses on available-for-sale marketable securities. Cumulative unrealized gains and losses on available-for-sale marketable securities are reflected as accumulated other comprehensive loss in stockholders’ equity on the Company’s balance sheet. For the three months ended March 31, 2008, comprehensive loss was $4,280 which includes a net loss of $4,277 and an unrealized loss on available-for-sale marketable securities of $3. The Company did not hold any marketable securities for the three months ended March 31, 2007. Hence, the comprehensive loss was the same as the net loss for the three months ended March 31, 2007.

4. USE OF ESTIMATES

The preparation of financial statements in conformity with GAAP requires the use of estimates and assumptions by management that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates relate to stock based compensation arrangements and accrued expenses. Actual results could differ from these estimates.

5. RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS

In February 2007, the Financial Accounting Standards Board (“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 the Company’s financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 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 157 did not have a material impact on the

Company’s financial statements. The provisions of SFAS 157 related to other non-financial assets and liabilities will be effective for the Company on January, 1, 2009, and will be applied prospectively. The Company is currently evaluating the impact that these additional SFAS 157 provisions will have on the Company’s financial statements.

6. 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. The Company believes that the adoption of SFAS 161 will not have a material impact on the Company’s financial statement disclosures since the Company does not currently have any derivative instruments.

In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”). SFAS 141R 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 noncontrolling 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. SFAS 141R 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. The Company believes the adoption of this pronouncement will not have a material impact on the Company’s financial statements.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51 (“SFAS 160”). SFAS 160 amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling 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, SFAS 160 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 SFAS 160 was issued. SFAS 160 effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company believes the adoption of this pronouncement will not have a material impact on the Company’s financial statements.

7. NET LOSS PER COMMON SHARE

Net loss per share is presented in accordance with the provisions of SFAS No. 128, “Earnings Per Share” (“EPS”). Basic EPS excludes dilution for potentially dilutive securities and is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to dilutive options, warrants and other potential common shares outstanding during the period. Diluted net loss per common share is equal to the basic net loss per common share since all potentially dilutive securities are anti-dilutive for each of the periods presented. Potential common stock equivalents excluded consist of stock options and warrants which are summarized as follows:

		March 31,
		2008				2007
Common stock options			1,919,584				1,605,565
Warrants			1,126,886				626,845
Total			3,046,470				2,232,410

8. STOCK-BASED COMPENSATION

The Company has one stock-based compensation plan which allows the Board of Directors to grant incentives to employees, consultants, directors, officers and collaborating scientists in the form of incentive stock options, nonqualified stock options and restricted stock awards. The Company also has two other stock-based compensation plans pursuant to which stock options are outstanding but no new grants may be made.

The Company records compensation expense associated with stock options and other forms of equity compensation in accordance with SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), as interpreted by SEC Staff Accounting Bulletin No. 107. The Company has adopted the modified prospective transition method provided for under SFAS 123R. Under this transition method, compensation cost associated with stock options recognized in the three month periods ended March 31, 2007 and 2008 includes: (1) amortization related to the remaining unvested 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) 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. For performance-based grants, a compensation charge is recorded when it is probable that performance or service conditions will be satisfied. The probability of vesting is updated at each reporting period, and compensation is adjusted via a cumulative catch-up adjustment or prospectively depending upon the nature of the change.

The compensation expense recognized in the Statement of Operations in the first quarters of 2008 and 2007 for stock options and restricted stock awards amounted to $112 (of which $33 relates to development milestones) and $266 (of which $194 relates to development milestones), respectively. Cash received from options exercised under all share-based payment arrangements for the three months ended March 31, 2008 and 2007 were $0 and $85, respectively.

The fair value of each option award granted after the adoption of SFAS 123R is estimated on the date of grant using the Black-Scholes option valuation model and assumptions as noted in the following table:

		For the three Months				For the three Months
		Ended March 31, 2008				Ended March 31, 2007
Expected life		5 years				not applicable
Expected volatility			60	%		not applicable
Risk-free interest rate			2.95	%		not applicable
Dividend yield			0	%		not applicable

The expected life of the options is based on the observed and expected time to post-vesting, forfeiture and exercise. Groups of employees that have similar historical exercise behavior are considered separately for valuation purposes. The expected volatility is based on implied volatility from other publicly-traded options and other factors. The risk-free interest rate is based on the continuous rates provided by the U.S. Treasury with a term equal to the expected life of the option. The expected divided yield is zero as the Company has never paid dividends and does not currently anticipate paying any in the foreseeable future.

Stock awards under the Company’s current plans are granted at prices which are no less than the market value of the stock on the date of grant. Options granted under the 2005 Stock Incentive Plan (“2005 Plan”) are generally time-based or performance-based options, and vesting varies accordingly. Options under this plan expire five years from the date of grant.

Since the Company adopted the 2005 Plan, the Company has ceased granting awards under the Company’s previous stock option plans; however, additional shares are reserved for issuance pursuant to the 2003 Stock Incentive Plan (“2003 Plan”) in connection with a formula-based option granted to the Company’s CEO, Dr. Joseph Gulfo. The number of shares under this option is equal to that number of shares of the Company’s common stock equal to four percent of the Company’s fully diluted capital stock at the time of FDA approval of MelaFind^® minus the 81,753 underlying shares of two previous options granted to Dr. Gulfo. Based on 18,448,352 shares outstanding (on a fully-diluted basis) as of March 31, 2008, and assuming such shares remain the total number of shares outstanding on the date we receive PMA approval of MelaFind^®, the number of shares subject to Dr. Gulfo’s third stock option is 656,181. This third stock option vests 50% at the time of PMA approval of MelaFind^®, and the remaining 50% in four equal installments over the one-year period following such PMA approval of MelaFind^®.

The status of the Company’s stock option plans at March 31, 2008 is summarized in the following tables:

										Weighted
						Weighted				Average
						Average				Remaining
						Exercise				Contractual				Aggregate
		Number of				Price per				Term in				Intrinsic
		Shares				Share				Years				Value
Outstanding at December 31, 2007			1,812,084			$	2.96				3.5				—
Granted			110,104			$	4.24				4.1				—
Exercised			—				—			—					—
Forfeited or expired			(2,604	)		$	6.82			—					—
Outstanding at March 31, 2008			1,919,584			$	3.02				3.3			$	6,006
Vested and exercisable at March 31, 2008			627,401			$	3.56				3.2			$	1,612

						Options Outstanding
						Weighted-						Options Exercisable
						Average		Weighted								Weighted-
						Remaining		Average								Average
		Number				Contractual		Exercise				Number				Exercise
Range of Exercise Prices		Outstanding				Life		Price				Exercisable				Price
$.01-$.46			927,934			1.4 years		$	.46				171,753			$	.46
$.47-$1.00			119,648			4.1 years		$	1.00				119,648			$	1.00
$1.01-$7.75			872,002			3.6 years		$	6.03				336,000			$	6.06
$.01-$7.75			1,919,584			3.4 years		$	3.02				627,401			$	3.56

During the three months ended March 31, 2008 the weighted average fair value of options granted, estimated as of the grant date using the Black-Scholes option valuation model, was $2.42. During the same three month period ended March 31, 2007 there were no options granted. There were no options exercised in the first quarter of 2008. For the three months ended March 31, 2007, the total intrinsic value of options exercised was $441.

As of March 31, 2008, of the total 1,919,584 options outstanding, 1,292,183 have not vested. Of this total unvested amount, 1,158,583 will vest upon the attainment of certain milestones, and the balance will vest over the requisite service period. As of March 31, 2008, there was $3,011,760 of total unrecognized compensation cost related to unvested options.

As of March 31, 2008, there were 845,151 shares available for future grants under the Company’s 2005 Stock Incentive Plan. In addition, 188,378 shares are reserved under the 2003 Stock Incentive Plan for future allocation to Dr. Gulfo in accordance with the provisions of his formula-based stock option.

9. COMMITMENTS AND CONTINGENCIES

The Company is party to two non-cancelable operating leases for office space expiring June 2009 and January 2011. The leases are subject to escalations for increases in operating expenses. The approximate aggregate minimum future payments under these leases are due as follows:

2008		2009		2010		2011
$ 240		$256		$186		$16

On March 28, 2007, the Company announced the signing of an agreement with L’Oreal to study and assess the feasibility of using EOS’ novel multi-spectral imaging technology for the evaluation and differentiation of pigmented skin lesions of cosmetic importance. EOS has granted L’Oreal an option to take an exclusive license to use EOS technology in the field covered by the research, on terms to be mutually agreed. The option expires on the earlier to occur of six months after the completion of the Feasibility Plan, as defined in the agreement, or August 31, 2008. The laboratory and clinical research will be funded by L’Oreal. Pursuant to the agreement, L’Oreal is responsible for all costs and expenses incurred in connection with the Feasibility Program, and will reimburse EOS for expenses incurred by EOS with respect to the Feasibility Program. During the three months ended March 31, 2008, the Company earned $10 from L’Oreal as other income to offset expenses incurred by EOS under the Feasibility Program. No amounts were billed during the three months ended March 31, 2007.

In August of 2006, the Company engaged Carl Zeiss Jena GmbH on usual commercial terms to build the lenses and assemblies, as well as provide certain technical consulting, for the MelaFind^® units which will be used in the Company’s pivotal clinical trial. The Company expects this work to take place throughout 2008.

In January 2006, the Company entered into an agreement with ASKION GmbH (“ASKION”) to produce and test commercial-grade MelaFind^® hand-held imaging device systems. Under the agreement, ASKION is to produce imaging devices for the Company to be utilized in the Company’s pivotal trial and data collection sites in the United States and Europe. The Company is required to make payments to ASKION upon delivery of the MelaFind^® systems. The Company expects to maintain a relationship, which has evolved into a month-to-month agreement, with ASKION and continue with development activities throughout 2008.

The Company has an employment agreement with its President and Chief Executive Officer, Dr. Gulfo, which provides for an annual base salary, stock options and discretionary performance bonuses. The agreement, which provides for automatic one-year renewal terms, currently runs through the end of 2008. Effective March 1, 2008, the Board of Directors increased Dr. Gulfo’s annual base salary to $280 and awarded him a bonus of $65.

The Company is not currently subject to any material legal proceedings, nor to management’s knowledge is any material legal proceeding threatened against the Company.

10. PRIVATE PLACEMENTS

On October 31, 2006, the Company entered into securities purchase agreements and a registration rights agreement with certain accredited investors for the private placement of 2,312,384 shares of the Company’s common stock and warrants to purchase up to 346,857 shares of the Company’s common stock for aggregate gross proceeds of approximately $13.2 million and net proceeds of approximately $12.5 million. Pursuant to the securities purchase agreements, for a purchase price of $5.70 each investor received one share of the Company’s common stock and a warrant to purchase 0.15 of a share of the Company’s common stock. The warrants are five-year warrants with an exercise price of $6.70 per share. The private placement closed November 3, 2006.

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.

The private placement closed August 3, 2007. Pursuant to the securities purchase agreement, for a purchase price of $5.75 each investor received one share of the Company’s common stock and a warrant to purchase 0.25 of a share of common stock. The warrants are five-year warrants with an exercise price of $8.00 per share. The private placement was completed pursuant to an exemption from registration provided by Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder.

Pursuant to the terms of the registration rights agreements, the Company filed resale registration statements covering the shares in both private placements, including the shares issuable upon exercise of the warrants, with the SEC. In the unlikely event that the Company fails to meet certain deadlines, as described in the registration rights agreements, the holders would be entitled to certain monetary damages. However, in no event is the Company obligated to make payments in excess of 10% of the aggregate purchase price of the common shares. The Company has concluded that it is unlikely that the Company would be required to remit any payments to its investors for failing to maintain its effectiveness. The Company’s resale registration statements on Forms S-3 were declared effective by the SEC (file #333-139056 and file #333-145740) on February 12, 2007 and September 11, 2007, respectively.

11. WARRANTS

Warrants outstanding at March 31, 2008 include a five-year warrant to purchase 75,000 shares of the Company’s common stock at an exercise price of $7.00 per share issued to one of the Company’s consultants in 2004, and seven-year warrants to purchase an aggregate of 54,988 shares the Company’s common stock at an exercise price of $4.52 per share issued in connection with the sale of Series C redeemable convertible preferred stock.

In connection with the Company’s initial public offering which closed on November 2, 2005, the Company issued 150,000 warrants to the underwriters to purchase shares of the Company’s common stock at $6.25 per share, which became exercisable commencing October 28, 2006, and have a five-year term.

Additionally, as previously discussed, in connection with the Company’s two private placement financings the following warrants have been granted and remain outstanding as of March 31, 2008:

Financing that closed November 3, 2006: warrants to purchase up to 346,857 shares of the Company’s common stock were issued. The warrants are five-year warrants with an exercise price of $6.70 per share,

Financing that closed August 3, 2007: warrants to purchase up to 500,041 shares of the Company’s common stock were issued. The warrants are five-year warrants with an exercise price of $8.00 per share.

12. RELATED PARTY CONSULTING AGREEMENTS

The Company has in place the following consulting agreements with related parties:

Consulting Agreement with Breaux Castleman

In June 2003, the Company entered into a consulting agreement with Breaux Castleman, the Chairman of the Company’s Board of Directors, for consulting services related to the FDA approval of MelaFind^®, and the Company’s business and financial strategy. Under this agreement, Mr. Castleman receives compensation for each month of services rendered. The Company made payments, pursuant to this consulting agreement, of $6 in each of the three month periods ending March 31, 2008 and 2007. This consulting agreement is terminable by either party by providing thirty days’ prior written notice.

Consulting Agreement with Marek Elbaum, Ph.D.

Pursuant to a consulting agreement effective as of May 31, 2005, the Company retained Marek Elbaum, Ph.D., the Company’s founder and former President and Chief Science and Technology Officer, as the Company’s Chief Scientist. In consideration of the services to be provided, the Company agreed to pay Dr. Elbaum a monthly fee of $15. The term of this agreement extended for a period of two years and was automatically renewable for an additional one-year period. In the event of a non-renewal or in the event that Dr. Elbaum’s services terminate as a result of his death or disability, the Company agreed to pay Dr. Elbaum a termination fee of $100. In May of 2007 and effective June 1, 2007, Dr. Elbaum and the Company entered into an amended agreement. Under the terms of the amended agreement, Dr. Elbaum will be paid a monthly fee of $9 through January 2009.

Consulting Agreement with Robert Friedman, M.D.

Effective as of June 1, 2005, the Company retained the services of Robert Friedman, M.D., for an initial term of one year as a consultant, medical advisor to the Company’s Board of Directors, and in connection with the clinical testing of MelaFind^®. In consideration for these services, Dr. Friedman will be paid at a rate of $5 per day.

This consulting agreement automatically renewed effective June 1, 2007 for an additional one-year term, and continues to automatically renew for successive one-year terms unless either party terminates the agreement at least 30 days prior to the expiration of the agreement. The Company made payments to Dr. Friedman totaling $12.5 for the three month period ending March 31, 2008. No payments were made to Dr. Friedman for the same period a year earlier.

Consulting Agreement with Gerald Wagner, Ph.D.

On March 24, 2006, the Company entered into an amended and restated consulting agreement with Gerald Wagner, Ph.D., a member of the Company’s Board of Directors and its former Acting Chief Operating Officer. Under this amended consulting agreement, the Company agreed to pay Dr. Wagner the annual amount of $180 payable monthly over the term of the agreement. In addition, 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 trial for Melafind^® in January 2007. The Company recorded a $140 charge to operations during the quarter ended March 31, 2007.

In addition, in connection with the start of the Company’s pivotal clinical trial at the end of January 2007, Dr. Wagner transitioned out of his role as the Company’s Acting Chief Operating Officer and has entered into an amended consulting contract with the Company. Under the terms of the amended contract, Dr. Wagner will be paid a monthly retainer of $2.5 and will be paid $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. The Company incurred consulting costs pursuant to this agreement of $9.4 in the three month period ended March 31, 2008 compared to $20 for the same period a year earlier.

13. SALE AND LICENSING OF DISCONTINUED OPERATIONS

In April 2005, the Company decided to discontinue all operations associated with its DIFOTI^® product in order to focus its resources and attention on the development and commercialization of MelaFind^®. In accordance with the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” the results of operations of the DIFOTI^® business were excluded from continuing operations and have been reported as discontinued operations. The assets and liabilities of the business were classified as held for sale. During December 2006, the Company entered into a sale and exclusive licensing agreement with KaVo Dental GmbH (“KaVo”), a leading dental equipment manufacturer, which provides for KaVo to further develop and commercialize DIFOTI^®. Upon execution of the agreement, KaVo paid the Company $500. The second $500 payment was received on July 20, 2007. Beginning in 2008 or earlier, KaVo is required to pay to the Company a royalty stream based upon the worldwide aggregate net sales of the licensed product, as defined in the license agreement, or a set minimum.

During the year ended December 31, 2007, the Company recorded $28 as the balance of the gain on the sale and licensing of its remaining DIFOTI^® assets, $781 of the gain had been recorded in the year ended December 31, 2006. Royalties will be recorded when earned.

14. SUBSEQUENT EVENT

Effective as of May 1, 2008, Jon Klippel, Vice President, Marketing Operations, left the employ of the Company. In connection with Mr. Klippel’s separation from the Company, the Company entered into a letter agreement dated May 1, 2008 regarding the terms of his separation (the “Separation Agreement”). Pursuant to the Separation Agreement, Mr. Klippel will receive salary continuation of $70,000, $5,000 worth of outplacement services and payment for any accrued but unpaid vacation. In addition, Mr. Klippel is entitled to exercise his stock option, granted to him on December 17, 2004, to purchase up to 45,000 shares of the Company’s common stock for a period of ninety days following May 1, 2008.

ITEM 2.

ELECTRO-OPTICAL SCIENCES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations is intended to provide information to help you better understand and evaluate our financial condition and results of operations. We recommend that you read this section in conjunction with our Financial Statements and Notes to Financial Statements and with our Annual Report on Form 10-K for the year ended December 31, 2007.

This quarterly report on Form 10-Q, including the following management’s discussion and analysis of financial condition and results of operations, contains forward-looking statements that you should read in conjunction with the financial statements and notes to financial statements that we have included elsewhere in this report. These statements are based on our current expectations, assumptions, estimates and projections about our business and our industry, and involve known and unknown risks, uncertainties, and other factors that may cause our or our industry’s results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied in, or contemplated by, the forward-looking statements. Words such as “believe”, “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “should,” “estimate,” “predict,” “potential,” “continue,” or the negative of such terms or other similar expressions, identify forward-looking statements. Our actual results and the timing of events may differ significantly from the results discussed in the forward-looking statements, and you should not place undue reliance on these statements. Factors that might cause such a difference include those discussed below under the heading “Risk Factors,” as well as those discussed elsewhere in this quarterly report on Form 10-Q. We disclaim any intent or obligation to update any forward-looking statements as a result of developments occurring after the period covered by this report or otherwise.

Overview

We are a medical device company focused on the design and development of a non-invasive, point-of-care instrument to assist in the early diagnosis of melanoma. Our flagship product, MelaFind^®, features a hand-held imaging device that emits multiple wavelengths of light to capture images of suspicious pigmented skin lesions and extract data. We currently do not have any commercialized products or any significant source of revenue; however, the financial results for periods discussed below account for the revenues and the related expenses associated with our DIFOTI^® product, a non-invasive imaging device for the detection of dental cavities, as a discontinued operation. We decided to discontinue all operations associated with our DIFOTI^® product effective as of April 5, 2005 in order to focus our resources and attention on the development and commercialization of MelaFind^®. On December 11, 2006 we announced that we had signed a sales and exclusive licensing agreement with KaVo, a leading dental equipment manufacturer, to further develop and commercialize DIFOTI^®. In accordance with the terms of the agreement, KaVo paid us an up-front sum and has made a second payment to us on July 20, 2007. KaVo will pay us an annual royalty based on the number of systems sold or a set minimum per calendar year following their commercial re-launch of DIFOTI^®. With the completion of this transaction we do not have any significant continuing responsibility for the DIFOTI^® business.

Unless otherwise indicated, the following discussion relates to our continuing operations.

Our revenue for the foreseeable future will depend on the commercialization of MelaFind^® and may vary substantially from year to year and quarter to quarter. Our operating expenses may also vary substantially from year to year and quarter to quarter based on the timing of the pivotal trial, that began at the end of January 2007 and is continuing into the second quarter of 2008. We believe that period-to-period comparisons of our results of operations may not be meaningful and should not be relied on as indicative of our future performance.

We commenced operations in December 1989 as a New York corporation and re-incorporated as a Delaware corporation in September 1997. Since our inception, we have generated significant losses. As of March 31, 2008, we had an accumulated deficit of $47.4 million. We expect to continue to spend significant amounts on the development of MelaFind^®.

On October 28, 2005, we completed an initial public offering. We issued 4,000,000 shares of common stock on October 28, 2005 and 262,300 shares of common stock on November 15, 2005, both issuances at $5.00 per share. After deducting underwriting discounts and expenses and offering-related expenses, the initial public offering resulted in net proceeds to the Company of approximately $17.7 million.

On October 31, 2006, we entered into securities purchase agreements and a registration rights agreement with certain accredited investors for the private placement of 2,312,384 shares of the Company’s common stock and warrants to purchase up to 346,857 shares of the Company’s common stock for aggregate gross proceeds of approximately $13.2 million and net proceeds of approximately $12.5 million. The transaction closed November 3, 2006.

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 August 3, 2007.

We believe that the proceeds from these three transactions will be sufficient to fund our anticipated level of operations into second quarter 2009. We will however need to raise additional funds in order to achieve significant commercialization of MelaFind^® and generate significant revenues.

Most of our expenditures to date have been for research and development activities and general and administrative expenses. Research and development expenses represent costs incurred for product development, clinical trials and activities relating to regulatory filings and manufacturing development efforts. We expense all of our research and development costs as they are incurred.

Our research and development expenses incurred for the three months ended March 31, 2008 were expenses related primarily to the development of MelaFind^®. We expect to incur additional research and development expenses relating to MelaFind^® prior to its commercial launch in the US and selected markets outside the US. We also continue to work with ASKION, a company that has become an integral member of our MelaFind^® development team. ASKION is currently producing 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 expenses consist primarily of salaries and related expenses, general corporate activities and certain costs associated with our efforts to obtain PMA approval for MelaFind^® and toward development of a commercial infrastructure to market and sell MelaFind^®. We anticipate that general and administrative expenses will increase as a result of the expected expansion of our operations, facilities and other activities associated with the planned expansion of our business. We expect selling, general and administrative expenses to increase as we develop our sales and marketing capabilities to support placing MelaFind^® in selected markets.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are 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 and Deferred 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 2006 and 2007 includes: (1) quarterly amortization related to the remaining unvested 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 commitment 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.

Results of Operations (in thousands)

As we work on developing MelaFind^®, we continue to spend a majority of our time and money in research and development related activities. Our overall research and development spending during the first three months of 2008 increased significantly as compared to our research and development spending during the first three months of 2007. Generally this increase is attributable to the costs associated with our pivotal clinical trial and related activity. For the three months ended March 31, 2008, we had fourteen active sites (including training sites) while during the first quarter of 2007 we had just begun clinical trial operations. However, our general and administrative spending during the first three months of 2008 has remained relatively consistent with the first three months of 2007. As we work towards completing our pivotal clinical trial and the commercial launch of MelaFind^®, our costs will continue to increase.

Three Months Ended March 31, 2008 Compared to Three Months Ended March 31, 2007

Research and Development Expense

Research and development expense for the three months ended March 31, 2008 was $3,045 as compared to $1,953 for the three months ended March 31, 2007. The first quarter 2008 Research and Development costs increased $1,092, which was principally attributable to clinical studies costs which were $712 higher than the expenses incurred during the first quarter of 2007 when the pivotal clinical trial was just commencing. As the pivotal clinical trial nears completion, clinical studies activities have significantly increased which is reflected in the increased associated costs.

Product development costs, which are a component of Research and Development costs, were up $275 which primarily reflects consulting costs which increased by $288, and associated costs which decreased slightly, in the first three months of 2008 compared to the same period a year earlier. The development activities are focused on increasing manufacturing capacity as we move toward MelaFind^® commercialization and product launch.

General and Administrative Expense

General and Administrative expense for the three months ended March 31, 2008 was $1,440 as compared to $1,311 for the three months ended March 31, 2007. The increase of $129 was the result of $158 of performance bonuses awarded in March of 2008, with the balance of General and Administrative costs showing a slight decrease quarter to quarter. In 2007, performance bonuses were accrued and paid during the second quarter.

Interest income for the three months ended March 31, 2008 was $182 as compared to $271 for the comparable period a year earlier. The decrease is primarily related to the lower interest rates available for investment of our cash balances, which rates were lower in 2008 than in 2007.

Other income

During the three months ended March 31, 2008, the Company earned $26 in other income including $10 from L’Oreal as an offset to expenses the Company incurred under our joint Feasibility Program, and $10 from Kavo for product support of the discontinued dental product line the Company sold to Kavo in 2006. There were no monies received as other income during the first three months of 2007.

Deferred income

During the three months ended March 31, 2008, deferred income decreased $7. $10 of billing to L’Oreal in 2007 was earned during the quarter and $3 of billings to Kavo during the quarter remain unearned at March 31, 2008. There was no deferred income recorded during the three months ended March 31, 2007.

Liquidity and Capital Resources

Prior to our initial public offering, we financed our operations primarily through the use of working capital from private placements of equity securities and by applying for and obtaining a series of National Institute of Health Small Business Innovative Research grants and similar grants.

In October and November of 2005, we sold a total of 4,262,300 shares of common stock in an initial public offering that resulted in approximately $17.7 million in net proceeds.

On October 31, 2006 we entered into securities purchase agreements and a registration rights agreement with certain accredited investors for the private placement of 2,312,384 shares of the Company’s common stock and warrants to purchase up to 346,857 shares of the Company’s common stock for aggregate gross proceeds of approximately $13.2 million and net proceeds of approximately $12.5 million. The transaction closed November 3, 2006.

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 August 3, 2007.

To date, we have not borrowed (other than by issuing convertible notes, all of which have been converted into equity) or financed our operations through equipment leases, financing loans or other debt instruments.

As of March 31, 2008, we had $17.2 million in cash, cash equivalents and marketable securities as compared to $20.9 million at December 31, 2007 for a decrease of approximately $3.7 million. The decrease was a result of the approximately $4.3 million loss from first quarter operations, $(0.8) million net effect of changes in accrual balances and non-cash expenditures, and $0.2 million cash provided by investing activities.

Our cash and cash equivalents at March 31, 2008 are liquid investments in money market funds, government bonds, commercial paper and certificates of deposit with a commercial bank.

Cash Flows from Operating Activities

Net cash used in operations was $3,499 for the three months ended March 31, 2008. For the corresponding period in 2007, net cash used in operations was $2,702. Cash used in operations was attributable to net losses after an adjustment for non-cash charges related to depreciation and share-based compensation, and other changes in operating assets and liabilities.

Cash Flows from Investing Activities

For the three months ended March 31, 2008, net cash provided by our investing activities was $203 and was principally related to the redemption of marketable securities offset by the purchase of manufacturing related equipment in support of MelaFind^®. For the corresponding period in 2007, net cash used by our investing activities was $166 that was principally related to the purchase of property and equipment.

Cash Flows from Financing Activities

For the three months ended March 31, 2008, there was no cash provided by nor used in financing activities. For the three months ended March 31, 2007, net cash provided by financing activities was $85 and reflects proceeds from the sale of common stock upon the exercise of options.

Operating Capital and Capital Expenditure Requirements

We face certain risks and uncertainties, which are present in many emerging medical device companies. At March 31, 2008, we had an accumulated deficit of $47.4 million. To date, we have not commercialized our principal product, MelaFind^®. We anticipate that we will continue to incur net losses for the foreseeable future as we continue to develop the MelaFind^® system, expand our clinical development team and corporate infrastructure, and prepare for the potential commercial launch of MelaFind^®. We do not expect to generate significant product revenue until we successfully obtain PMA approval for and begin selling MelaFind^®. In order to achieve significant commercialization of MelaFind^® we will need to obtain additional funding. We believe that our current cash and cash equivalents and interest we earn on these balances, will be sufficient to meet our anticipated cash needs for working capital and capital expenditures and allow us to continue planned operations into second quarter 2009.

Existing cash and cash generated from our November 2006 and August 2007 financings and our 2005 initial public offering may not be sufficient to satisfy the liquidity requirements necessary to commercially launch MelaFind^® or to develop additional products. We will seek to sell additional equity or debt securities or obtain a credit facility. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any additional financing may not be available in amounts or on terms acceptable to us, or at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of, delay or eliminate some or all of planned product research and development and commercialization activities, which could harm our business.

Because of the numerous risks and uncertainties associated with the development of medical devices such as MelaFind^®, we are unable to estimate the exact amounts of capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including, but not limited to:

	•		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.

Contractual Obligations

The following table summarizes our outstanding contractual obligations as of March 31, 2008 and the effect those obligations are expected to have on our liquidity and cash flows in future periods:

						Less than												More than
		Total				1 year				1-3 years				4-5 years				5 years
Operating leases		$	698			$	322			$	376			$	—			$	—

The indicated operating leases are non-cancelable operating leases for space expiring June 2009 and January 2011. The lease on 5,000 square feet of office and laboratory space expires in June 2009. The lease on 2,800 square feet of office space and the lease for an additional 2,500 square feet of office space adjacent to our existing laboratory location expire January 2011.

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 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 will be paid $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.

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 noncontrolling 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, Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51. This statement amends ARB 51 to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. It clarifies that a noncontrolling 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.

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.

ITEM 4.

Controls and Procedures

Evaluation of disclosure controls and procedures

Based on their evaluation as of March 31, 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.

Change in internal control over financial reporting

There were no changes in our internal control over financial reporting during the quarter ended March 31, 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 three months ended March 31, 2008:

Risk of delay in product development.

We could encounter delays in our pivotal 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 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 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 months ended March 31, 2008 was approximately $4.3 million, and as of March 31, 2008, we had an accumulated deficit of approximately $47.4 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.