10-K/A 1 main.txt 10KA FOR CITA UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-KSB/A [x] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal Year Ended December 31, 2001 ----------------- Commission File No. 0-109659 CITA BIOMEDICAL, INC. COLORADO 93-0962072 - ------------------------------- ----------------- (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification No.) 9025 Wilshire Blvd. Suite 301, Beverly Hills, CA 90211 ------------------------------------------------------ (Address of principal executive offices) Issuer's telephone number: (310) 550-4965 -------------- Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: $.0l Par Value Common Stock Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X___ No_____ Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B contained in this form, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part M of this Form 10-KSB or any amendment to this Form 10-KSB: [X] Issuer's revenues for the most recent fiscal year: $545,521. The aggregate market value of the voting stock held by non-affiliates of the issuer was approximately $5,215,375. The aggregate market value was based upon the closing price for the shares of common stock as reported by NASDAQ as of December 28, 2001, the last trading day of the year. Number of shares outstanding of each of the issuer's classes of common equity, as of December 31, 2001: 40,218,270 shares of common stock and 0 shares of preferred stock. 1 DOCUMENTS INCORPORATED BY REFERENCE: See Exhibits. Transitional Small Business Disclosure Format: Yes ____ No _X_ PART I ITEM 1. DESCRIPTION OF BUSINESS A. Background CITA Biomedical, Inc. (the "Company" or "CITA(R)"), was incorporated in Colorado on June 9, 1981, under the name "Blue Grass Breeders, Inc." The Company was originally formed for the purpose of engaging in the business of acquiring, breeding, racing and selling thoroughbred horses. The Company completed an initial public offering of its $.0l par value common shares in February 1983, receiving net proceeds of approximately $2,134,000. From March 1987 to May 1989, the Company engaged in the business of breeding and selling horses. The Company was dormant from May 1989 through 1997. On December 15, 1997 a special meeting of shareholders of the Company was held at which Joseph Dunn and Michael Hinton were elected to serve as Directors of the Company. On August 12, 1998 the Company purchased 100% of the outstanding capital stock of CITA Americas, Inc. (a Nevada corporation) from Aviation Industries, Inc. for 1,000 Shares of the Company's Series A Convertible Preferred Stock, par value $0.01 per share. A dispute arose between the Company and Aviation Industries, Inc. concerning the conversion formula as well as other matters relating to the original Stock Purchase Agreement relating to the acquisition of CITA Americas, Inc. from Aviation Industries, Inc. In reporting its fully diluted Common Stock, the Company has previously reported 2.2 million shares issuable upon the conversion of the Preferred Stock. However, the Company reached an agreement with Aviation Industries, Inc. as of May 1, 2001 whereby the all outstanding shares of the Preferred Stock were converted to 400,000 shares of Common Stock. CITA Americas, Inc. operates as a wholly owned subsidiary of CITA Biomedical, Inc. and is in the business of providing the technology, information, and administrative services necessary to the treatment and rapid detoxification of persons addicted to opiate based drugs whether natural or synthetic (i.e., Methadone, Heroin, Codeine, Demerol, and Percocet). The Company currently has an agreement with Centinela Hospital in Los Angeles, California whereby Centinela Hospital is licensed to treat patients using proprietary UROD(R) (Ultra Rapid Opiate Detoxification) technology. The Company is currently negotiating with other hospitals and medical facilities to establish additional treatment centers both for UROD treatments and a new set of treatments for cocaine and alcohol dependency, as described below, although it has not yet received full Federal regulatory approval of those treatment programs. In November, 2001, the Company entered an agreement with CITA S.L., a Spanish company operated by Dr. Juan Jose Legarda, the developer of CITA's UROD opiate addiction treatment program, whereby CITA acquired from CITA S.L. a license to certain technology, known as Detoxification and NeuroAdaptatoin ("DNA"),developed for the purpose of detoxifying persons 2 habituated to alcohol and cocaine, as well as a neuron adaptation process designed to "reset" the nervous system of a habituated alcohol or cocaine user to its pre-habituation state. The Company believes that, provided it can obtain capital to permit it to implement the new technology, this license represents a major step in the Company's efforts to become a leading provider of products and services for the treatment of a wide variety of chemical addictions. Also in November, 2001, the Company acquired Alternative Tobacco Products, Inc. ("AltPro"), a developer of products to assist individuals addicted to nicotine from cigarettes and other tobacco-related products. The acquisition expands the Company's range of substance dependence treatments into the area of nicotine dependence. The Company anticipates that AltPro's current nicotine treatments and tobacco alternatives will, subject to the Company's ability to obtain sufficient capital to promote the AltPro products, have an impact on the Company's revenues while simultaneously giving the Company an entree into a vast new market for tobacco-cessation products. B. The Business of the Company Products The Company's current product offering consists primarily of UROD(R), which stands for Ultra Rapid Opiate Detoxification. This revolutionary procedure offers successful detoxification from heroin, methadone and other opiate based drugs, including pharmaceuticals, to addicted individuals without the typical elongated painful withdrawal discomfort. The UROD procedure has been approved as an accepted treatment method by the American Society of Addictive Medicine. Through year end 2001, over six thousand addicted persons have been successfully treated with the UROD procedure. Patients are successfully detoxified in 4 - 6 hours with a typical hospital stay of 24 hours. Patients are put under anesthesia and are given FDA approved opiate antagonist drugs, which displace the opiates at the receptor level. The UROD(R) procedure helps to reset the natural state of the body's receptors. In November 2001 the Company announced a new family of treatments based on the DNA process, a new technology that provides revolutionary treatment for people who are substance dependent. The DNA process establishes a new treatment regiment in the fight against the disease of substance dependency. Historically the disease of addiction has been treated only through behavioral intervention, but the DNA process provides a solution for treating the physiological and psychological components of this devastating condition. By providing successful detoxification solutions that reduce the time, severity, pain and cost associated with withdrawal, DNA process allows the patient to concentrate on returning to a productive level of functioning in just hours. Substance abuse impedes normal neural functioning of the brain and body systems as a whole, not only resulting in cravings but potentially serious or even life-threatening withdrawal symptoms. The DNA process reduces or eliminates cravings while regulating the neural functioning. PET scans taken within days of the DNA process demonstrate metabolic normalization of frontal, parietal and temporal lobes of the brain. Completion rates for the DNA process far exceed standard detoxification solutions; approaching a 100% completion rate. In its first nine months of use the DNA for Addictions treatments have had a relapse rate that averages less than half of the relapse rates for people treated for substance dependence by other means. 3 The following treatments from the DNA for Addictions family have been announced and are described below: DNA for Alcohol, DNA for Cocaine, DNA for Crack Cocaine, and DNA for Alcohol and Cocaine. DNA for Alcohol: Currently, over 735,000 patients in the United States seek medical assistance for alcohol abuse every year. the Company has developed a Detoxification and NeuroAdaptation for Alcohol (DNA for Alcohol) process that cleanses the body in a 2 day period, during which time alcohol is purged from the patient's body under rigorous and intensive medical supervision. Withdrawal symptoms are treated and suppressed during the detoxification procedure and immediately after it, ensuring the most comfortable transition for the patient possible. In its first nine months of use DNA for Alcohol has a relapse rate of less than 25%, this is in contrast with the close to 75% relapse rate for people treated for alcoholism by other means. $8,000 per treatment. Patents pending. DNA for Cocaine and Crack Cocaine: There are over 237,000 patients in the United States who seek medical assistance for cocaine abuse every year. the Company has developed a Detoxification and NeuroAdaptation for Cocaine (DNA for Cocaine) offering that cleanses the body in a 2 day period, during which time cocaine is purged from the patient's body under rigorous and intensive medical supervision. Withdrawal symptoms are treated and suppressed during the detoxification procedure and immediately after it, ensuring the most comfortable transition for the patient possible. In its first nine months of use DNA for Cocaine and Crack Cocaine has a relapse rate of less than 25%. This is in contrast to the close to 70% relapse rate for people treated for cocaine and crack cocaine addiction by other means. Crack cocaine use makes up about one third of all cocaine use yet it constitutes over 67% of all cocaine users who seek treatment for substance abuse. $8,000 per treatment. Patents pending. DNA for Poly-drug: Over half of all people who seek treatment for substance dependency are poly-drug users. DNA for Alcohol and Cocaine is the first poly-drug treatment to be released in our new family of treatments, DNA for Addictions. In the past successful treatment of poly-drug use has been difficult and most treatment programs have not been designed to address poly-drug use. With DNA for Poly-drug the patient treated derives all the benefits of the single drug user in the same treatment time. A significant percent of patients treated for substance dependency are dependent on multiple substances. For instance 43% of patients treated for alcohol dependency have a secondary drug dependency. This procedure is an inherent part of any DNA procedure and it can also be administered during a UROD procedure. In the past many patients using other substances, like cocaine were ineligible for UROD. This procedure eliminates the opiates only requirement and therefore increases the UROD market. Patents pending. Flexible Intensity Treatment (FIT): Following the DNA and UROD procedures, the patient is initiated into continuing care, a long-term program consisting of flexible intensity treatment based on The American Society of Addiction Medicines Patient Placement Criteria and the patient's ongoing needs in the areas of his/her physical, mental, and spiritual life. By providing the patient with a relapse-prevention medication (UROD patients only) and an aftercare program built on the solid foundation of an abstinence-based "twelve-step" model of recovery, the patient is offered the best possible chance at ongoing, continued persistent recovery. The Company is in discussions with several hospitals regarding the provision of DNA treatments for alcohol and cocaine dependency. The latter program offers dual benefits insofar as it may be used as a standalone procedure, or in conjunction with UROD to treat patients dependent both on cocaine and opiate drugs. The Company's licensed facilities are currently unable to treat opiate addicts who test positive for cocaine as well. 4 The market for an effective alcohol treatment program is far larger than that for either opiates or cocaine. The principal advantage of the Company's alcohol treatment program over existing programs is that it can "reset" the brain's neurological function in order to prevent or ease the cravings experienced by many recovering alcoholics. Through its acquisition of AlTPro, the Company has also gained several currently available treatments for nicotine dependence in various forms. KicBac(TM) and ChewZ(TM), consist of non-nicotine smokeless alternative tobacco products with compositions that mimic the tactile feel and taste of most popular smokeless tobacco brands. Another product, CigArrestTM, is non-nicotine based smoking cessation system combining medications and behavioral therapy (Biohavioral) designed to help motivated smokers who want or need to quit smoking. This product is comparable to nicotine gum or patches, but without the nicotine. Another product, Smoker's Choice(TM), is a non-nicotine based product (mints and gum) providing relief from withdrawal for smokers who wish to smoke but are unable to because of workplace, governmental or other restrictions (e.g. on airplane flights). All of these products are currently available to the public. Staff The Company currently has a total of eleven staff members. These include two Certified Addiction Counselors, and one person with a Masters Degree in Psychology and significant work completed for her Doctorate. The Market Opiates occur naturally as alkaloids in the opium poppy, or they can be imitated synthetically. Collectively, all of these highly addictive drugs are known as opioids. Of the twenty alkaloids contained in opium, only morphine and codeine remain in clinical use. Heroin (diacetylmorphine), the other major natural opiate-derived drug, was first introduced 1898, and it was widely prescribed as a cure for morphine addiction. Since the 1960's, synthetic methadone has been heralded as a cure or palliative (depending upon point of view) for heroin addiction. Most recently, a two-drug substitute for methadone has evolved using Orlaam and buprenorphine in combination. Both of these are longer acting, and unlike the required daily intake of methadone (Dolophine), this combination needs to be taken only three times per week. Shown here are various other synthetic opioids that have been developed for various medical applications, most notably as analgesic or cough suppressants, wherein both generic and registered trade names (which are capitalized) are given: o hydrocodone: Lorcet, Lortab, Vicodin o hydromorphone: Diluadid o levorphanol: Levo-Dromoran o meperidine o oxycodone: OxyContin, Percocet, Percodan o oxymorphone: Numorphan. 5 These drugs can be prescribed by physicians, dentists, veterinarians, etc. "Medical addiction" occurs when a patient becomes addicted under medical supervision using legally prescribed drugs. Black markets also exist for these drugs. In 1999, National Institute on Drug Abuse (NIDA) studies identified hydrocodone, hydromorphone, and oxycodone as emerging narcotic drugs of abuse, noting that hospital admissions for hydrocodone, primarily Vicodin, increased from 6,115 in 1993 to 14,639 in 1999, an increase greater than 139%. Consequently, the opiate detoxification market is growing. Opiate addiction affects 0.7% of adult Americans sometime during their lifetime1. In 1998, total spending for all detoxification services amounted to approximately $10.5 billion in the U.S. alone. This represented a 6% growth over the prior two years2. Heroin and other opiate addiction is currently at an epidemic state both nationally as well as internationally. Between 1988 and 1995, according to NIDA, American users spent between $9 billion and $18 billion yearly on the purchase of opiate drugs. Recent studies estimate that there are almost two million heroin users in the U.S.3, and indications show the number is rising. Worldwide estimates are significantly greater. More importantly, and likely greater, is the population of prescription opiate abusers, which has yet to be quantified by researchers. It is estimated, for example, that as many as 4 million people in the U.S. may be abusing prescription drugs obtained, in most cases, for legitimate medical purposes. Of this number, roughly 2.5 million people misused opioid and other narcotic pain relievers.4 This number does not take into account abuse of prescription drugs obtained from black market sources. Additionally, there are over 180,000 registered methadone addicts in the U.S.5 There are an estimated 1.5 million opiate addicts in the U.S. with only 600,000 treatment slots currently available. In New York state alone, almost 30,000 opiate detoxification procedures are performed each year6 and an additional 40,000 methadone patients are addicted. The State spends almost $140 million a year on maintaining methadone addicts and $130 million for opiate detoxifications.7 Recent U.S. government data on nationwide hospital admissions for substance abuse issues has been obtained through the Office of Applied Studies, Substance Abuse and Mental Health Services Administration from its published 1998 Treatment Episode Data Set. There were 1,560,915 such admissions in that year of which opioid addiction accounted for approximately 234,000, or approximately 14% of the total. Of this approximately 234,000, about 216,000, roughly 92%, were due to heroin alone. ---------------- 1 Robbins LN, Regier DA (eds): Psychiatric Disorders in America, New York, Free Press, 1991. 2 National Institute on Drug Abuse: National Household Survey on Drug Abuse, Washington DC, US Government Printing Office, 1998. 3 American Psychiatric Association: Practice Guidelines for Treatment of Patients With Substance Abuse Disorders: Alcohol, Cocaine, Opioids, Washington DC American Psychiatric Association, 1995. 4 "Prescription Drug Abuse Said to be on the Rise," Reuters/Yahoo! News, April 12, 2001. 5 National Institute on Drug Abuse: Washington DC. 6 New York State Department of Social Services, DHLTC FFY 1995, Longitudinal Inpatient (E) 807D Report. 7 Rettig RA, Yarmolinski J (eds): Federal Regulations of Methadone Treatment, Washington D.C., National Academy Press; New York State Department of Services, Longitudinal Inpatient (E) 807D Report. 6 Other statistics published by NIDA confirm that addiction risk is rising in youthful populations. Specifically, o A 1998 Monitoring the Future (MFT) study showed that heroin use among high school seniors nationwide had doubled since 1991. o A 1997 MFT study found that 2.1% of 12th graders had used heroin at least once and that 1.2% had used it once within the last thirty days. o A Community Epidemiology Work Group study concluded that emergency room admissions for heroin within the 18 to 25-age category increased 51.4% from 1997 to 1999. Competition The Company's primary competition for rapid opiate detoxification comes from two distinct forms of treatment: (i) traditional in-patient methods of detoxification; and (ii) methadone maintenance or methadone taper detoxification. A. Traditional In-Patient Methods of Detoxification Traditional forms of detoxification are generally conducted in an in-patient setting, in a hospital facility. Examples of such treatment centers include the following: 1. Hazelden Foundation: A 28 day program, which costs more than $20,000. 2. The Betty Ford Center: A 28 day program, which costs more than $20,000. 3. Cornerstone in New York: A 7-day detoxification treatment at an estimated cost of $4,000, with no outpatient follow up. (This is the most typical form of conventional detoxification treatment). Aftercare is billed separately, totaling approximately $7,000. 4. National Recovery Institute: A 14 to 28 day program costing approximately $250 per day (average total cost $5,000). This program uses group therapy and medication, including methadone. No follow up care after detoxification is complete is included in the cost of the program. 5. Methadone Maintenance: $4000 - $8000 per year with patient remaining addicted. Most centers for treatment of opiate addiction refer the patients out to a local hospital to do the detoxification portion of the treatment, then bring the patient into an outpatient rehabilitation program. These hospital detoxifications generally cost between $4,500 and $13,000, depending on daily hospital rates, length of stay, any additional substances, etc. The main advantage these programs have over CITA is that they are generally covered by third party payors, such as insurance companies and managed care entities. However, this may change in the future if the CITA program authorized for reimbursement by private insurance companies, and managed care groups. The Company is currently working with two organization to provide first third-party reimbursement arrangement for CITA procedures, Creative Care Management in Chicago, Illinois, and The Promises Foundation, in Malibu, California. In terms of quality and strength, CITA has several distinct advantages over the conventional methods of the competition, including the following: 7 O Success rates - traditional forms of detoxification currently have a documented 7-17% average success rate; CITA consistently enjoys a documented 60% average success rate8. O The usual 6-28 days for detoxification is reduced to just 24 to 36 hours. O UROD is a guaranteed and 100% effective detoxification: all traces of opiates are removed. O Trained and board-certified UROD anesthesiologists oversee and monitor the entire detoxification process, offering an even more controlled and safer environment than conventional centers. O No painful withdrawal symptoms are experienced while under anesthesia. O Hospital stay is reduced to 23 to 36 hours: UROD frees hospital space for more efficient use of the facilities. O No traumatic transition experienced between detoxification and rehabilitative treatment, thereby increasing the chances the patient will continue to go on to further therapy and rehabilitation. O UROD allows for an earlier return to work and home. O No addictive medications are used as opiate substitutions. O UROD accelerates repair of the body's cells and increases regeneration of the natural opiates. O The CITA program reduces insurance requests for re-treatment. O The CITA program is the only viable treatment for methadone addicts. B. Methadone Developed in Germany around World War II, methadone was brought into use in the United States in the mid 1960's as a method of treating those addicted to heroin and other illegal substances. It was endorsed by the government as a daily maintenance dose of synthetic opiates to produce a pharmacological cross-tolerance, or "blockade," so that patients would not feel any narcotic or euphoric effects if they were to self-administer a normal dose of a short acting narcotic (e.g., heroin). Methadone's intended use was four fold: (1) to counter the problem of addicts' highs and lows (severe sickness and mood swings), allowing this population to go back to work and normal daily functions; (2) to control issues surrounding disease transmission through needle use; (3) to reduce criminal activity related to obtaining the substance; and (4) to contribute to the reduction of illegal drug trafficking. Methadone's intended goal was to safely taper addicts off of opiates, such as heroin, in a controlled environment, while offering counseling and support on the psychological end. The problem with methadone has become apparent in the increasing number of methadone patients, the increasing amounts per dosage that the patients are receiving, and the increasing number of methadone facilities. Many patients report that their guidance counselors at the clinics have no intention of weaning the patients off methadone, and rarely offer counseling or help to get them detoxified. Methadone clinics have become a place patients visit each and every morning, stand in line, pay their fees, take their doses, and go on with their day. There is little attempt at helping the patients overcome the addiction or work on other areas of their lives, and the clinics have no economic incentive to begin reducing memberships. It has become a prison for many, as they are told that there is no other solution. These clinics perpetuate the very problem they were set up to solve. ---------------------- 8 Rabinowitz J, Cohen H, Kotler M: One Year Outcomes of Ultra Rapid Opiate Detoxification Combined with Naltrexone Maintenence, Journal of Drug Abuse, 1996. 8 The CITA Method of detoxification is a superior solution, and CITA believes that it is the only method in existence today that can effect a rapid release of methadone addicts from their addiction. CITA's research shows that approximately 70% of the addicts receiving methadone maintenance are treatable and are capable of leading normal and functional lifestyles, with detoxification and aftercare. C. Other Rapid Detoxification Programs Although there are a few other small and little known clinics, small hospitals and sole practitioners performing one form or another of one-day opiate detoxification, their impact is not deemed significant for several reasons outlined below. The individual hospitals (CITA has identified three) that provide this treatment do so in the $6,000 - $10,000 price range, and have done such a small number of patients that CITA does not believe they will be able to continue operations indefinitely. These hospitals have no opportunity for regional or national reach, and have no capabilities of absorbing any of CITA's prospective patients or market share due to CITA's own name branding. In addition, none appear to combine the detoxification treatment with the long-term counseling necessary to relieve the patient from psychological addiction. The small clinics and individual doctors that compete in the one-day opiate detoxification market charge competitive prices in the upper $4000 to lower $6000 price range, but are based in free-standing, and often times dangerous, clinic settings, with no regional or national reach. CITA has several distinct advantages over the other rapid detoxification centers, including the following: O CITA's patented technology and proprietary program combines rapid detoxification with long-term aftercare for relapse prevention. O CITA has the only method of rapid detox that is affiliated with major hospitals. O CITA's method of rapid detox is the only method that is clinically proven to be safe and effective - based on over a decade of research. O CITA's Ultra Rapid Opiate Detoxification has been successful on over 6,000 patients worldwide, and is the only such method with no mortality, morbidity or insurance claims. Conventional Detoxification One of the serious limitations of conventional detoxification is that many patients do not complete it. In single center studies, dropout rates have been as high as 80% for outpatient detoxification9 and between 15% to 30% for inpatient detoxification10. ------------------- 9 Stark M: Dropping Out of Substance Abuse Treatment: A Clinically Oriented Review, Clin Psychol Rev 1992; 12:93-116. 10 Gossop M, Green L, Phillips G, Bradley B: Lapse, Relapse, and Survival Among Opiate Addicts After Treatment: A perspective follow-up study. Br J Psychiatry 1989; 154:348-353. 9 Multi-center studies report inpatient dropout rates without distinguishing between opiates and other substances11. In the CATOR (Comprehensive Assessment and Treatment Outcome Research) study, based on 6,000 patients from 19 treatment centers in 13 states, the dropout rates for all inpatient substance abuse programs was 16%12. In perhaps the only national study reporting dropout rates from detoxification and treatment, which was conducted in Israel, almost half of the patients abandoned inpatient detoxification during the first week of the standard 30-day stay13. In New York State, 26% of Medicaid clients drop out of inpatient detoxification14. This amounts to an expenditure of almost $30 million per year for dropouts in New York State alone. Under the CITA program, patients cannot drop out during detoxification. Another limitation of conventional detoxification is that many patients are averse to detoxification. Stark, for example, found that 34% of methadone maintenance patients do not detoxify due to detoxification phobia.15 Thus, another possible advantage of anesthesia aided detoxification is that it may facilitate the detoxification of addicted persons who are afraid to approach conventional detoxification. CITA Aftercare It is well recognized that while detoxification is an important first step, relapse prevention requires an aftercare program. The Drug Abuse Reporting Program (DARP), a national treatment outcome study conducted in the United States on several thousand patients from 52 different substance abuse programs, found that 75% to 85% of patients treated in detoxification-only programs relapsed within one year. As noted previously, completing detoxification is a barrier to treatment for many patients. Of those patients who completed conventional detoxification without dropping out and who subsequently entered an aftercare program, 50% to 80% of them returned to routine use of opiates within the first year. For example, in the DARP study, relapse rates for patients in aftercare programs ranged from 60% to 75% during the first year. Another major national study of treatment outcomes, TOPS (Treatment Outcome Prospective Study), found that of 2,280 select clients who had successfully completed detoxification and then enrolled and started after care treatment, 57.2% had relapsed during the first year.16 CITA requires that all prospective UROD treatment patients commit to a comprehensive aftercare program. CITA's aftercare program consists of six months of an opiate antagonist such as Naltrexone, up to six months of group and individual counseling and the support of a spouse or significant other during and immediately following UROD treatment. Persons who are unable to commit to all of these steps are ineligible to receive UROD detoxification. ---------------------------- 11 Stark M: Dropping Out of Substance Abuse Treatment: A Clinically Oriented Review. Clin. Psychol. Rev 1992; 12:93-116. 12 Harrison PA, Hoffman NG, Steed SG. Drug and Alcohol Addiction Treatment Outcome, Miller NS, ed. Comprehensive Handbook on Drug and Alcohol Addiction, New York, 1991, Maecel Dekker Inc. 1163 - 1197. 13 Levinson D: Comparisons of Outcomes Among Graduates of Various Detoxification Programs, Jerusalem IL, State of Israel Ministry of Health, 1993. 14 In 1995, Medicaid paid for 28,921 detoxifications in New York State. In 7,474 cases, patients left against medical advice after an average of 4.4 days. Since detoxification takes 7 days and these patients left against medical advice, they apparently dropped-out prior to completing detoxification. 15 Stark M: Droping Out of Substance Abuse Treatment: A Clinically Oriented Review. Clin. Psychol. Rev 1992. 16 Hubbard RL, Rachel JV, Craddock SG, Cavanaugh ER, Treatment Outcome Prospective Study (TOPS), NIDA Res. Monogr., 1984;51:42-68. 10 Methadone Treatment According to Federal guidelines, while the eventual goal of methadone programs is abstinence, it is recognized that some patients may need long-term methadone treatment. In practice, most programs encourage long-term methadone maintenance and do not encourage detoxification17. Not surprisingly, it is rare to find patients who have successfully detoxified from methadone without relapsing to opiate use18. In the TOPS study discussed above, which included almost 2,700 methadone maintenance patients, by 13 weeks, 32% of patients had dropped out of treatment, and by 26 weeks 48% had dropped out. Only 34% of patients remained in methadone program for over one year. Similar results were obtained in the DARPS study19. Thus, as compared to conventional detoxification, methadone appears to have a higher dropout rate. After taking into account the higher drop out rate, and the dollars spent, it is evident that the CITA treatment is far more effective and cost efficient than methadone treatment of persons addicted to opiates. The CITA Treatment Program Success Rates After adjusting for dropout rates during detoxification or methadone treatment, the literature reviewed above suggests that, of all patients who enter opiate detoxification or methadone treatment, fewer than 30% are opiate free a year later. In contrast to the relapse rates of patients treated with conventional methods, a study of patients who completed the CITA treatment program found that after 1.5 years following UROD Procedure, 57% of 113 randomly selected patients remained drug-free20. Despite the fact that the UROD study allowed more time for relapse (1.5 years vs. 1 year), the results are considerably better than most other studies. Considering that 15% to 50% of conventional inpatient detoxification patients drop out before completing the detoxification process, the success rate of the CITA treatment program in this study appears to be four times that of conventional detoxification programs. Advertising and Promotion CITA recognizes that the key to continued success and growth at this time is extensive promotion. This must be done aggressively and on a nationwide scale. Responses and success rates based on patients treated indicate that the CITA program for detoxification and rehabilitation has earned an excellent reputation among both the addicted population and substance abuse professionals. CITA intends to use this earned reputation as an important part of its advertising and promotion program. Relationships with third party payers, hospitals and community leaders are as important as traditional forms of advertising in reaching CITA's goals. CITA's strategy is to enhance, promote and support the quality of its products and services, as it continues to increase its share of the market for the treatment of opiate addiction, and to enter the market for the treatment of dependency on cocaine, alcohol, nicotine and other substances. Upon licensing medical institutions, CITA participates in the development of a comprehensive promotion plan designed to educate the public about CITA, create demand for its product, and add value to the medical institution's name and image. -------------- 18 Kleber HD: Detoxification From Methadone Maintenance; The State of the Art, International Journal of Addiction 1977; 12:807-820. 19 Hubbard RL, Mardsen ME, Rachel JV, Harwood HJ, Cavenaugh ER, Ginzburg HM: Drug Abuse Treatment: A National Study of Effectiveness, Chapel Hill, NC, The University of North Carolina Press, 1989. 20 Rabinowitz J, Cohen H, Kotler M: One Year Outcomes of Ultra Rapid Opiate Detoxification Combined with Naltrexone Maintenance, Journal of Drug Abuse, 1996. 17 Hubbard RL, Mardsen ME, Rachel JV, Harwood HJ, Cavenaugh ER, Ginzburg HM: Drug Abuse Treatment: A National Study of Effectiveness, Chapel Hill, NC, The University of North Carolina Press, 1989. 11 During the years 2000 and 2001, CITA was hampered in its efforts to promote the UROD program due to insufficient working capital. Until sufficient additional capital is available to it, CITA will be constrained and unable to engage in intensive promotion of its products. ITEM 2. DESCRIPTION OF PROPERTY The Company leases office suite services at 9025 Wilshire Blvd., Suite 301, Beverly Hills, CA 90211, as well as an office consisting of approximately 700 square feet at 20 East Main Street, Suite 46, Los Gatos, CA 95030. However, certain Company personnel occupy space in licensed facilities where UROD(R) procedures are performed, have small office spaces in their region, or telecommute. ITEM 3. LEGAL PROCEEDINGS An action against the Company and its President was brought in the Superior Court of Justice for Ontario, Canada claiming breach of contract. No one in the Company was served with process. On November 27, 2000 a default judgment against the Company and Mr. Dunn was entered in the amount of $255,000 U.S. plus $3,000 Canadian. The plaintiff has filed an action in the Los Angeles County Superior Court to enter the Canadian judgment as a California judgment. The Company has retained Canadian counsel to set aside the default on the grounds that service of process was not made on the defendants. Once the default is set aside, the Company intends to contest this matter and expects to prevail. The California litigation on the Canadian judgment is stayed by agreement of the parties pending resolution of the matter in Canada. An action was filed in the Circuit Court of Oregon on or about December 10, 2001. The claim regarded unpaid wages by a former contractor at a CITA-licensed facility in Portland, Oregon. A default judgment in the amount of $12,466.41 was entered on February 5, 2002. CITA may be required to qualify as a foreign corporation prior to moving to set aside the default. An action was filed based on a breach of contract claim in Superior Court of California on or about December 20, 2001. Plaintiff seeks a recovery of $30,237 plus fees, costs and interest. Following termination of the contract, the plaintiff withheld certain equipment owned by CITA and stored with the plaintiff. The Company is exploring its options with respect to this action. A default judgment was obtained against CITA on January 28, 2000 in regard to an action initially filed in the Superior Court of California. Plaintiff attached approximately $8,000 of CITA funds pending the outcome of the action. The court has seized or attached the $8,000 in CITA funds and has transferred said funds to plaintiff. CITA continues to owe plaintiff approximately $9,500. 12 The Company may need to obtain outside capital in order to address and resolve these pending legal actions. The Company is currently in discussion with potential funding sources, and although there can be no guarantee that any of these discussions will result in funding to resolve these pending actions, the Company is hopeful at the prospects to facilitate raising capital. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no meetings of the shareholders in the fourth quarter of 2001. PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock has been listed for quotation in the Electronic Bulletin Board owned and maintained by NASDAQ, trading under the symbol "DTOX". The number of record holders of Common Stock as of December 31, 2001 was approximately 2,695 including nominees of beneficial owners. Holders of Common Stock are entitled to receive such dividends as may be declared by the Company's Board of Directors. No dividends on the Common Stock have been paid by the Company to date nor does the Company anticipate that dividends will be paid in the foreseeable future. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview From May 1989 through 1997, the Company was inactive. At a meeting of the shareholders in December 1997, Mr. Joseph Dunn and Mr. Michael Hinton were elected to the Board of Directors with instructions to reorganize the Company, complete necessary filings required by applicable law, and to seek one or more potential businesses to acquire. Mr. Dunn was designated Chairman and CEO of the Company, and Mr. Hinton was designated as Secretary of the Company. Acquisition In August 1998, the Company acquired all of the outstanding shares of CITA Americas, Inc. from Aviation Industries, Inc. in exchange for the issuance of the Company's non-voting convertible preferred stock having a liquidation value of $2,200,000. A dispute arose between the Company and Aviation Industries, Inc. concerning the conversion formula as well as other matters relating to the original Stock Purchase Agreement relating to the acquisition of CITA Americas, Inc. from Aviation Industries, Inc. In reporting its fully diluted Common Stock, the Company has previously reported 2.2 million shares issuable upon the conversion of the Preferred Stock. However, the Company reached an agreement with Aviation Industries, Inc. as of May 1, 2001 whereby the all outstanding shares of the Preferred Stock were converted to 400,000 shares of Common Stock. In November 1998, the Company changed its name from Southwestern Environmental Corp. to CITA Biomedical, Inc. 13 Business CITA is in the business of providing innovative treatment of addictions. The Company holds a patent for the Ultra Rapid Opiate Detoxification ("UROD(R)") process, a non-invasive medical procedure administered under local anesthesia to detoxify patients addicted to opiates such as heroin, methadone, morphine, percodan, percocet, darvon and other narcotics. The procedure is performed over a four to seven hour period following which the patient has only residual opiates in his or her system. The patient then is required to undergo an intense psychotherapy recovery program. The Company generally charges a fee of $8,000 per UROD treatment. Through its acquisition of AlTPro, the Company is also engaged in the business of delivering products for treatment and management of smoking and other forms of nicotine dependence. The Company is in further discussions with hospitals and medical service providers regarding treatment programs for cocaine and alcohol dependency. License of Alcohol and Cocaine Detoxification Technology In November, 2001, the Company entered an agreement with CITA S.L., a Spanish company operated by Dr. Juan Jose Legarda, the developer of CITA's UROD opiate addiction treatment program, whereby CITA acquired from CITA S.L. a license to certain technology developed for the purpose of detoxifying persons habituated to alcohol and cocaine, as well as a neuron adaptation process designed to "reset" the nervous system of a habituated alcohol or cocaine user to its pre-habituation state (together, the "New Technologies"). The Company believes that, provided it can obtain capital to permit it to implement the New Technologies, this license represents a major step in the Company's efforts to become a leading provider of products and services for the treatment of a wide variety of chemical addictions. The agreement, which has an initial term of five years, requires the payment of monthly royalties to CITA S.L. in consideration of the exclusive right to utilize the New Technologies within the United States, Canada and Mexico, as well as the right to develop additional technologies or procedures based on the New Technologies. The Company believes that the ability to treat cocaine addiction will be of particular benefit to the Company in the near term. Currently, the Company is unable to provide its UROD treatment to persons addicted to opiates where pre-treatment testing indicates use of cocaine as well. Following acquisition of the license to the New Technologies, the Company will be able to treat individuals simultaneously for both opiate and cocaine addiction. In the longer term, the Company believes that the alcohol treatment portion of the New Technologies will dramatically increase the market for the Company's products and services. The rate of alcohol dependency in the U.S. far exceeds the rates of opiate and cocaine addictions, and the Company's ability to treat individuals dependent on alcohol represents a major new source of potential revenues. The Company will require significant additional outside capital in order to implement treatment programs incorporating the New Technologies. The Company believes that the acquisition of the New Technologies license will enhance its ability to raise such capital by virtue of the additional market opportunities presented by the New Technologies. Although the Company is in discussions with potential funding sources, there can be no assurance that the Company will obtain funds in an amount sufficient to commence treatment procedures utilizing the New Technologies. In the event that the Company is unable to raise such funds, it may be to make timely payments of royalties, and CITA S.L. could act to terminate the license and revoke the Company's ability to administer procedures using the New Technologies. 14 Acquisition of Alternative Tobacco Products, Inc. In November, 2001, the Company reached an agreement to acquire Alternative Tobacco Products, Inc. ("AltPro"), a developer of products to assist individuals addicted to nicotine from cigarettes and other tobacco-related products. The acquisition expands the Company's range of substance dependence treatments into the area of nicotine dependence. The Company anticipates that AltPro's current nicotine treatments and tobacco alternatives will, subject to the Company's ability to obtain sufficient capital to promote the AltPro products, have an impact on the Company's revenues while simultaneously giving the Company an entree into a vast new market for tobacco-cessation products. Founded in 1985 and incorporated in 2000, AltTPro is a provider of innovative, patented proprietary treatments for nicotine dependence. AltTPro currently offers products under the names CigArrest(R) and Smokers Choice(R), and has treated over 3.5M users worldwide. The Company will continue to offer AltPro products through existing sales channels. AltPro's President and CEO, John Bancroft, will become an employee of the Company, and will lead the Company's efforts in the nicotine addiction treatment market. In addition, Mr. Bancroft will be responsible for leading the Company's Research and Development targeted at the alcohol and cocaine detoxification segments, to expand the Company's revenue into other market segments as new protocols and products are developed. The Company will need to obtain significant outside capital in order to market the AltPro products to any significant degree, or to develop additional products based on AltPro's proprietary technology. The Company is currently in discussion with potential funding sources, and although there can be no guarantee that any of these discussions will result in funding to the Company sufficient to support development of the opportunities presented by the AltPro acquisition, the Company is hopeful that the AltPro acquisition will enhance the Company's prospects and facilitate capital raising activities. Suspension of CubeCentral.com Web Site In 2000, the Company established a web portal at www.cubecentral.com to provide a host of products, support and services designed to aid addicts and recovering addicts, as well as family, friends and professionals, who may be affected by addiction and addiction recovery. In mid-2001, the Company became engaged in a dispute with SiteSmith, Inc. the principal developer and host of the site. Pursuant to that dispute, the site was taken down from the Internet, and certain CITA property, including the server computer on which the CubeCentral site files reside, are currently held by SiteSmith. The Company hopes to resolve this dispute expeditiously and restore the CubeCentral web site to the Internet. 15 Year 2001 Financial Summary The Company continues to encounter difficulties as a result of its inability to raise sufficient capital to expand its operations and marketing efforts. During the first half of 2001, the Company succeeded in building on the base of operations established in 2000. The number of CITA-licensed facilities increased to five and revenues rose relative to 2000 before subsiding again. The decrease in the number of persons treated at CITA-licensed facilities was compounded by the suspension of operations at four facilities. The Company is engaged in discussions with John C. Lincoln Hospital in Phoenix, Arizona, Woodland Park Hospital in Portland, Oregon, Eden Valley Medical Center in Castro Valley, California regarding a renewal of its agreement with those facilities, and of adding the capability to provide cocaine and alcohol treatment services when those programs become available. A third CITA facility, Grant Hospital in Chicago, Illinois, is undergoing organizational restructuring and is unlikely to resume its status as a CITA-licensed facility in the near future. The Company is also in discussions with other hospitals and medical care facilities regarding licenses of CITA technology. The Company is further seeking to obtain government financing for studies to demonstrate the effective of the UROD method, especially relative to conventional opiate treatment methodologies. The Company hopes that the addition of an established line of nicotine-cessation-related products and the cocaine and alcohol treatment programs will increase the Company's prospects to raise sufficient capital to expand its operations. Revenues The Company's revenues for 2001 were $545,521 compared to revenues of $319,613 in 2000. Essentially all of this revenue was derived from UROD treatments. Revenues increased by approximately 70% relative to 2000. Cost of Revenues The Company's cost of revenues in 2001 was $287,460 resulting in a gross profit of $258,061 or a gross profit margin of 47%. This compares to $162,349 cost of revenues in 2000, resulting in a gross profit of $157,264, or a gross profit margin of 49.2%. Other Expenses General and administrative expenses in 2001 were $1,858,180. This compares to $2,188,230 for general and administrative costs in 2000. The Company incurred $398,335 in depreciation and amortization expenses in 2001 compared to $123,590 in 2000. The resulting total operating expenses of $3,827,861 in 2001 produced an operating loss of $3,282,340 compared with $2,545,085 in total operating expenses in 2000 and an operating loss of $2,225,472. The operating expenses in 2001 include a one-time write down for impairment losses on tangible assets of $1,234,231. Refer to Note 1 to consolidated financial statements for futher explanation. The Company anticipates financing its ongoing operations from net cash flow from operations and third party financing transactions. The Company intends to explore all options available to it with respect to such potential financing. 16 ITEM 7. FINANCIAL STATEMENTS See index beginning on page F-l. ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING DISCLOSURE There were no disagreements with the Company's accountants on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure for the 2001 fiscal year. PART III ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS Name AGE Position ------ --- ------- Joseph Dunn 50 Chairman, CEO, President, CFO Michael C. Hinton 54 Secretary, Director Gary Zinn 42 Director Joseph Dunn has served as an officer and director of the Company since December 15, 1998. Since 1994 he has been CEO of AVT, a firm engaged in the business of electronic operator and long distance services and Executive Vice President of Kane Gray, Inc. a firm engaged in the business of providing traffic management services to major corporations. Prior thereto and from 1980 he was Chief Executive Officer of Azonic Technology, Inc. that was engaged in the design, manufacture, sale and distribution of devices used in the etching and cleaning of silicon wafers. Mr. Dunn has also served as interim president and director of various technology firms that needed to undergo restructuring and market turnaround. Mr. Dunn graduated from Falls College in Atlanta, Georgia in 1970 with a degree in data processing and has taken courses in business at the University of California in Hayward, California and the UCLA Graduate School of Management in Los Angeles, California. Michael C. Hinton has been an officer and director of the Company since December 15, 1997. Since 1990, he has been engaged in managing his own investments and is the sole owner of Multimarket Americas Export Corp. which is engaged in exporting telephone and construction equipment and the import of food products. Mr. Hinton received a bachelor's degree in economics from Colorado State University. Gary Zinn was appointed by the Board of Directors in April, 2002 to fill a vacancy on the Board of Directors. Mr. Zinn went to work for American Home Products in 1982 and became the top representative for the region in the first 9 months. After 3 years in the food business Mr. Zinn went to work or Pac Tel Mobile Access (the first cellular phone company in Los Angeles). 17 After numerous Sales and Achievement Awards including Top Representative in the city, he started his own cellular phone company - Gary Zinn and Associates. In 1989 Mr. Zinn became a registered representative of the National Association of Securities Dealers for various Stock Brokerage firms and was a registered representative for 6 years. In 1995 Mr. Zinn went to work for a Fortune 100 firm in which he was responsible for the Legal Market of Ikon Office Solutions. In 1998 Mr. Zinn moved overseas and was C.E.O. for a major Venture Capital firm for which he was responsible for 12 different ventures. He was responsible for raising millions of dollars including, but not solely, CITA Biomedical, ProGolf of America, Pinnacle Resources, Sonicport Inc. and many other ventures. Mr. Zinn received a bachelor's degree from Cabrillo College in Aptos, California. ITEM 10. EXECUTIVE COMPENSATION The Company paid its CEO approximately $6,000 in cash compensation in 2001. Year 2000 was the first year in which Mr. Dunn received cash compensation from the Company since joining CITA as its CEO in 1997. The Board of Directors has determined Mr. Dunn's cash compensation rate to be $180,000 per year, with an understanding that payment at this rate will commence when the Company has received adequate funding. 18 The Board further acknowledged that Mr. Dunn is due $674,000 in deferred wages. The Company anticipates that Mr. Dunn will accept stock in the Company in exchange for a significant portion of the amounts owed to him for deferred wages. SUMMARY COMPENSATION TABLE
Annual Compensation Long Term Compensation --------------------- ---------------------- Name and All Other n Principal Compen-satio Position Year ($) --------------- -------- --------------------------------------- ---------------------------------------- ------------ Awards Payouts --------------- -------- --------------------------------------- ----------------------------- ---------- ------------ Other Annual Restricted Compen-sationStock Securities LTIP Salary ($) ($) Award(s) ($) Underlying Payouts Bonus ($) Options/ ($) SARs (#) --------------- -------- ------------ ------------- ------------ -------------- -------------- ---------- ------------ --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ Joseph Dunn, 1999 0 0 0 0 0 0 0 President CEO --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ 2000 $12,000 0 0 0 500,000 0 0 --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ 2001 $6,000 0 0 0 0 0 0 --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ ---------------------------------------------------------------------------------------------------------------------- Michael 1999 0 0 0 0 0 0 0 Hinton, Secretary --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ 2000 0 0 0 0 200,000 0 0 --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ 2001 0 0 0 0 0 0 0 --------------- -------- ------------ ------------- ------------ ------------- --------------- ---------- ------------ ----------------------------------------------------------------------------------------------------------------------
Employment Contracts The Company does not have employment agreements with any of its employees, executive officers or directors. Each of the Company's executive officers serves at the pleasure of the Board of Directors. 19 No officer is entitled to receive any additional compensation for his services to the Company as a director. ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT At December 31, 2001, the Company had outstanding 40,218,270 shares of common stock and 0 shares of preferred stock. Each share of Common Stock entitles the holder to one vote in any matter submitted to shareholders for approval. The following tabulates holdings of Common Stock of the Company by each person who holds of record, or is known by management of the Company to own beneficially, more than 5 % of the voting securities outstanding as of December 31, 2001, and by all directors and officers of the Company individually and as a group. To the knowledge of management, the shareholders listed below have sole voting and investment power, except as otherwise noted. Number of Shares Percent Name and Address Securities of Voting - ---------------- ---------- --------- Joseph Dunn 4,067,013(1) 9.61% Michael Hinton 400,000(2) .95% Gary Zinn 0 0.00% All Directors and Officers 4,467,013 10.56% as a group (two persons) (1) Includes 2,000,000 shares which Mr. Dunn has the right to acquire upon exercise of a fully-vested option. 2) Includes 200,000 shares which Mr. Hinton has the right to acquire upon exercise of a fully-vested option. The Company knows of no arrangement, including the pledge by any person of securities of the Company, which may at a subsequent date result in a change of control of the Company. ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None PART IV ITEM 13. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K A. Financial Statements and Schedules. See Index to Financial Statements beginning on page F- 1. B. Exhibits. The following exhibits are filed with or incorporated by reference into this report: 20 Exhibit Description 2.3 Closing Agreement between Equine Enterprises, Inc., and the Company, dated March 10, 1987. 3.1 Amended and Restated Articles of Incorporation filed January 14, 1982 with the Secretary of State of the State of Colorado. 3.2 Amended and Second Restated Articles of Incorporation filed January 3,1983 with the Secretary of State of the State of Colorado. 3.3 Amended and Second Restated Articles of Incorporation filed July 28, 1993, with the Secretary of State of the State of Colorado. 3.4 Bylaws adopted by the Company effective June 9, 1981. 4.1 Specimen certificate for Common Shares, par value $.01 per share. 10.1 Agreement between Company and Mr. Gary E. Keogh. 10.2 1993 Stock Option Plan. Incorporated by reference to the Company Form 8-K dated March 20, 1987. Incorporated by reference to the Company's Registration Statement No. 2-81022D on Form S-18 dated December 21, 1992. Incorporated by reference to the like-numbered exhibits filed with the Company's Form 8-K dated July 7, 1993. Incorporated by reference to the like-numbered exhibits filed with the Company's Form 8-K dated August 6, 1993. Incorporated by reference to the like-numbered exhibits filed with the Company's report on Form 10-KSB for the fiscal year ended September 30, 1993. 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. CITA BIOMEDICAL, INC. By: /s/ Joseph Dunn ----------------- Joseph Dunn Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated. DATE SIGNATURE TITLE April 12, 2002 /s/ Joseph Dunn Chairman of the Board, --------------------- Chief Executive Officer, Joseph Dunn President and Chief Financial Officer (Principal Financial Officer) April 12, 2002 /s/ Michael C. Hinton Director ---------------------- Michael C. Hinton April 12, 2002 /s/ Gary Zinn Director ---------------------- Gary Zinn 22 CITA BIOMEDICAL, INC. index to Consolidated Financial Statements Page -------------- Independent Auditors' Report.........................................F-2 Consolidated Balance Sheet at December 31, 2001......................F-3 Consolidated Statements of Operations for the years ended December 31, 2001 and 2000......................................F-4 Consolidated Statement of Changes in Shareholders' Deficit for the two-year period ended December 31, 2001.................F-5 Consolidated Statements of Cash Flows for the years ended December 31, 2001 and 2000......................................F-6 Notes to Consolidated Financial Statements...........................F-7 F-1 To the Board of Directors and Shareholders CITA Biomedical, Inc. INDEPENDENT AUDITORS' REPORT We have audited the accompanying consolidated balance sheet of CITA Biomedical, Inc. (a Colorado corporation) as of December 31, 2001 and the related consolidated statements of operations, shareholders' deficit and cash flows for the years ended December 31, 2001 and 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of CITA Biomedical, Inc., as of December 31, 2001 and the results of their operations and their cash flows for the years ended December 31, 2001 and 2000, in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming the Company will continue as a going concern. As shown in the accompanying consolidated financial statements, the Company has a working capital deficit and a net capital deficit at December 31, 2001. These and other factors discussed in Note 1 to the consolidated financial statements raise a substantial doubt about the ability of the Company to continue as a going concern. Management's plans in regard to those matters are also described in Note 1. The Company's ability to achieve its plans with regard to those matters, which may be necessary to permit the realization of assets and satisfaction of liabilities in the ordinary course of business, is uncertain. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Cordovano and Harvey, P.C. Denver, Colorado May 20, 2002 F-2 CITA BIOMEDICAL, INC. Consolidated Balance Sheet December 31, 2001 Assets
Current assets: Cash.....................................................................................$ 213,749 -------------- Total current assets....................................................... 213,749 Property and equipment, net of accumulated depreciation of $67,929 (Note 3)....................................................................... 24,592 Intangible assets, net of accumulated amortization of $24,480 (Note 4)....................................................................... 39,520 Deposits...................................................................................... 15,662 -------------- $ 293,523 ============== Liabilities and Shareholders' Deficit Current liabilities: Accounts payable and accrued liabilities.................................................$ 1,534,063 Short-term debt (Notes 2 and 5): Related party.......................................................................... 201,176 Other.................................................................................. 397,879 -------------- Total current liabilities................................................... 2,133,118 -------------- Contingencies (Note 8)........................................................................ Shareholders' deficit (Note 6): Preferred stock, $1.00 par value; 30,000,000 shares authorized; -0- shares issued and outstanding...................................................... Common stock, $.01 par value; 150,000,000 shares authorized; 40,218,270 shares issued and outstanding............................................... 402,183 Additional paid-in capital................................................................ 7,955,513 Outstanding stock options - 4,700,000..................................................... 183,770 Deferred compensation..................................................................... (103,324) Accumulated deficit....................................................................... (10,277,737) ----------------- Total shareholder's deficit................................................ (1,839,595) ----------------- $ 293,523 =================
See accompanying notes to consoldiated financial statements F-3 CITA BIOMEDICAL, INC. Consolidated Statements of Operations
For the Years Ended December 31, -------------------------------------- 2001 2000 --------------- -------------- Revenue, net....................................................... $ 545,521 $ 319,613 ----------------- ------------- Operating expenses: Cost of revenue.................................................. 287,460 162,349 Stock-based compensation (Note 6): Stock options.................................................. 49,655 45,791 General and administrative..................................... 15,000 240,425 General and administrative........................................ 1,843,180 1,946,836 Rent, related party (Note 2)...................................... --- 25,125 Asset impairment charges (Notes 3 and 4).......................... 1,234,231 Depreciation and amortization..................................... 398,335 124,559 ----------------- ------------- Total operating expenses......................... 3,827,861 2,545,085 ----------------- ------------- Loss from operations............................ (3,282,340) (2,225,472) Non-operating income (expense): Interest income................................................. 16,162395 Interest expense................................................ (5,035) (6,124) ----------------- -------------- Loss before income taxes......................... (3,271,213) (2,231,201) Income tax provision (Note 7)........................................ ---- ---- ----------------- -------------- Net loss....................................... $ (3,271,213) $ (2,231,201) ================= ============== Basic and diluted loss per common share............................ $ (0.11) $ (0.15) ================= ============== Weighted average common shares outstanding........................... 29,463,395 14,684,366 ================= ==============
See accompanying notes to consoldiated financial statements F-4 CITA BIOMEDICAL, INC. Consolidated Statement of Changes in Sharholders' Deficit
Preferred Stock Common Stock Additional ------------------------------ -------------------------------- Paid-In Shares Amount Shares Amount Capital ----------- ---------------- ------------- -------------- ---------------- Balance at January 1, 2000 1,000 $ 896,444 7,766,662 $ 77,667 $ 3,772,475 Common stock issued in exchange for services ($.39/share) (Note 6) -- -- 70,000 700 26,600 Common stock issued as payment for advances and related interest totaling $99,000 (Note 6) -- -- 562,647 5,627 93,373 Common stock issued in exchange for services ($.25/share) (Note 6) -- -- 852,500 8,525 204,600 Common stock sold at $.156 per share, net of $200,000 of offering costs (Note 6) -- -- 14,920,812 149,208 1,982,456 Options granted to purchase 2,500,000 shares of common stock (Note 6) -- -- -- -- -- Net loss -- -- -- -- -- ----------- ---------------- ------------- -------------- ------------- Balance at December 31, 2000 1,000 896,444 24,172,621 241,727 6,079,504 Common stock sold at $.138 per share (Note 6) -- -- 15,545,649 155,456 969,565 Common stock issued in exchange for services ($.15/share) (Note 6) -- -- 100,000 1,000 14,000 Common stock issued in settlement with Aviation Industries, Inc. (Note 1) (1,000) (896,444) 400,000 4,000 892,444 Stock options vested during 2001 (Note 6) -- -- -- -- -- Net loss -- -- -- -- -- ----------- ---------------- ------------- -------------- ------------- Balance at December 31, 2001 -- $ -- 40,218,270 $ 402,183 $ 7,955,513 =========== ================ ============= ============== =============
F-5 CITA BIOMEDICAL, INC. Consolidated Statement of Changes in Sharholders' Deficit (con't)
Outstanding Stock Deferred Accumulated Options Compensation Deficit Total ---------------- ---------------- ----------------- ----------------- Balance at January 1, 2000 $ -- $ -- $ (4,775,323) $ (28,737) Common stock issued in exchange for services ($.39/share) (Note 6) -- -- -- 27,300 Common stock issued as payment for advances and related interest totaling $99,000 (Note 6) -- -- -- 99,000 Common stock issued in exchange for services ($.25/share) (Note 6) -- -- -- 213,125 Common stock sold at $.156 per share, net of $200,000 of offering costs (Note 6) -- -- -- 2,131,664 Options granted to purchase 2,500,000 shares of common stock (Note 6) 183,770 (137,979) -- 45,791 Net loss -- -- (2,231,201) (2,231,201) ---------------- ---------------- ----------------- ----------------- Balance at December 31, 2000 183,770 (137,979) (7,006,524) 256,942 Common stock sold at $.138 per share (Note 6) -- -- -- 1,125,021 Common stock issued in exchange for services ($.15/share) (Note 6) -- -- -- 15,000 Common stock issued in settlement with Aviation Industries, Inc. (Note 1) -- -- -- -- Stock options vested during 2001 (Note 6) -- 34,655 -- 34,655 Net loss -- -- (3,271,213) (3,271,213) ---------------- ---------------- ----------------- ----------------- Balance at December 31, 2001 183,770 $ (103,324) $ (10,277,737) $ (1,839,595) ================ ================ ================= =================
See accompanying notes to consolidated financial statements F-5 (con't) CITA BIOMEDICAL, INC. Consolidated Statements of Cash Flows
For the Years Ended December 31, ------------------------------------ 2001 2000 ----------------- ----------------- Cash flows from operating activities: Net loss $ (3,271,213) $ (2,231,201) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 398,335 124,559 Asset impairment charges (Notes 3 and 4) 1,234,231 -- Stock-based compensation (Note 6) 49,655 286,216 Changes in current assets and current liabilities: Receivables 4,500 (4,500) Other assets 4,415 (6,500) Accounts payable 248,869 200,704 Accrued liabilities (71,731) 599,317 ----------------- ----------------- Net cash (used in) operating activities (1,402,939) (1,031,405) ----------------- ----------------- Cash flows from investing activities: Purchases of property and equipment (1,206) (38,915) Cash paid for web site development (18,162) (805,145) ----------------- ----------------- Net cash (used in) investing activities (19,368) (844,060) ----------------- ----------------- Cash flows from financing activities: Proceeds from sale of common stock 1,125,021 2,430,664 Advances from officers (Note 2) 95,000 268,616 Repayment of advances from officers (Note 2) (111,925) (179,805) Advances from unrelated third parties 128,147 28,875 Repayment of advances from unrelated third parties. (73,072) -- Cash paid for offering costs -- (200,000) ----------------- ----------------- Net cash provided by financing activities 1,163,171 2,348,350 ----------------- ----------------- Net change in cash (259,136) 472,885 Cash, beginning of period 472,885 -- ----------------- ----------------- Cash, end of period $ 213,749 $ 472,885 ================= ================= Supplemental disclosure of cash flow information: Income taxes $ -- $ -- ================= ================= Interest $ -- $ -- ================= ================= Non-cash financing activities: Common stock issued to repay advances and related accrued interest $ -- $ 99,000 ================= =================
F-6 CITA BIOMEDICAL, INC. Notes to Consolidated Financial Statements (1) Nature of Organization and Summary of Significant Accounting Policies Nature of Organization CITA Biomedical, Inc. (the "Company") was incorporated in the state of Colorado on June 9, 1981 under the name of Blue Grass Breeders, Inc. From inception through February 1983 the Company was involved in raising equity capital. From February 1983 through March 30, 1991, the Company was engaged in the business of acquiring, breeding and selling thoroughbreds and quarterhorses, and from October 1, 1993 through December 15, 1994, the Company was engaged in the manufacture and sale of computer hardware and software. The Company ceased operations in both industries due to continued losses and the inability to meet obligations. From April 1991 through September 1993, and from December 15, 1994 through August 11, 1998 the Company was an inactive shell corporation. During that period the Company was known as Southwestern Environmental Corp. On August 12, 1998, the Company purchased all of the outstanding shares of common stock of CITA Americas, Inc. from Aviation Industries, Inc. ("Aviation") pursuant to a Stock Purchase Agreement entered into in July 1998. The purchase price was paid through the issuance of non-voting $.10 par value redeemable convertible preferred stock of the Company. Under the terms of the Agreement, the preferred stock was redeemable for $2,200,000 in cash or convertible to common stock valued at $2,200,000 as of the date of conversion. The preferred stock was originally valued at $896,444, which in management's opinion approximated the fair value of the preferred stock at the time the shares were issued. The president and a director of the Company received 2,000,000 and 200,000 shares, respectively, of the Company's restricted common stock, valued at $103,400 in connection with the acquisition. CITA Americas, Inc., a Nevada corporation, was formed in March of 1998. CITA Americas was formed to engage in the investigation and treatment of addiction. In conjunction with the purchase, the Company changed its name from Southwestern Environmental Corp. to CITA Biomedical, Inc. During 2001, the Company settled a dispute with Aviation arising from the Stock Purchase Agreement. Following the closing of the above Stock Purchase Agreement in 1998, the Company learned that certain material misrepresentations had been made regarding, among other things, the existence of a patent on the UROD process. Such misrepresentations caused the Company to expend considerable resources to prosecute the patent, which was ultimately obtained in August 2000, and to pursue infringers of the patent. Pursuant to the Settlement Agreement between the Company and Aviation, the Company cancelled the shares of preferred stock issued to Aviation in exchange for the issuance of 400,000 shares of the Company's common stock (see Note 1 - Impairments on long-lived assets). Concurrent with the Company's acquisition of CITA Americas, Inc., on August 12, 1998 the Company entered the development stage. During the year ended December 31, 2000, the Company emerged from the development stage. All of the revenue-producing operations of the Company presented for the years ended December 31, 2001 and 2000 are results of operations of CITA Americas, Inc. As of December 31, 2001, the Company's only operations were conducted in Chicago, Illinois. As shown in the accompanying consolidated financial statements, the Company has a working capital deficit and a net capital deficit at December 31, 2001. These factors, as well as the uncertain condition that the Company faces as a new business, create an uncertainty about the Company's ability to continue as a going concern. F-7 The Company is experiencing severe liquidity problems and is operating at the forbearance of its creditors. At December 31, 2001, the Company has accounts payable and accrued liabilities totaling $1,534,063 and short-term debt obligations totaling $599,055, offset by cash of $213,749. There is no assurance that these creditors will continue to postpone collection of their claims. The Company continues to encounter difficulties as a result of its inability to raise sufficient capital to expand its operations and marketing efforts. During 2001, the Company increased borrowings from officers and unrelated third parties by $38,150 and raised $1,125,021 through the sale of its common stock under Regulation S. At December 31, 2001, the Company was operating at only one facility and its web site was shut down. Management plans to increase revenue-producing operations during the next year by entering into agreements with additional medical facilities that will administer the Company's treatment method thereby increasing the number of patients treated. The Company is also actively pursuing locations to launch its new treatment methodologies in alcohol and cocaine, which management believes will provide positive working capital. There is no assurance that the Company will be successful in raising sufficient funds to capitalize on the new opportunities presented and there is no assurance that the Company will be able to generate cash flow through operations. The ability of the Company to continue as a going concern is dependent on the success of these plans, and ultimately upon achieving profitability. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern. Summary of significant accounting policies: Principles of consolidation The Company's consolidated financial statements include the accounts of CITA Biomedical, Inc. and its wholly owned subsidiaries: CITA Americas, Inc, CubeCentral, and The CITA Foundation. All material intercompany accounts and transactions have been eliminated in consolidation. The CITA Foundation is inactive. On March 29, 2000, the Company incorporated CubeCentral, a wholly owned subsidiary, to set up and manage the Company's Internet operations. CubeCentral plans to provide an interactive forum and on-line after care to persons affected by all types of addictions. CubeCentral's web site proposes to include information and counseling services as well as referrals for the detoxification services provided by the Company. All transactions of CubeCentral were accounted for on CITA Biomedical, Inc.'s books during the years ended December 31, 2001 and 2000. As of December 31, 2001, the CubeCentral web site was not operational. Use of estimates The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-8 Reclassifications Certain prior-year amounts have been reclassified for comparative purposes to conform to the current-year presentation. Concentration of credit risk The Company maintains its cash accounts at various financial institutions. The balances, at times, may exceed federally insured limits. At December 31, 2001, the Company had cash deposits totaling $103,455 that were not federally insured. Cash and cash equivalents The Company considers all short-term, highly liquid investments with an original maturity date of three months or less to be cash equivalents. The Company had no cash equivalents at December 31, 2001. Property and equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is recorded using the straight-line method over the estimated useful lives of the assets, which is estimated to be three years. Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments, which extend the useful lives of existing equipment, are capitalized and depreciated. Upon retirement or disposition of property and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the consolidated statements of operations. Intangible assets Intangible assets are stated net of accumulated amortization and include the rights to the UROD method, the use of the name CITA, and certain patent rights. The UROD method and trade name are amortized on a straight-line basis over ten years. Amortization expense for the year ended December 31, 2000 was $103,090 and $103,090 for the years ended December 31, 2001 and 2000, respectively. The Company's patent, No. 6,103,734, was granted on August 15, 2000. The patent is amortized on a straight-line basis over twenty years. Amortization expense for the years ended December 31, 2001 and 2000 totaled $4,700 and 1,763, respectively. Product (web site) development costs Product development costs include expenses incurred by the Company to maintain, monitor, and manage the Company's web site, cubecentral.com. The Company recognizes web site development costs in accordance with Statement of Position ("SOP") 98-1, "Accounting for the Costs of Computer Software Developed or obtained for Internal Use." As such, the Company expenses all costs incurred that relate to the planning and post implementation phases of development. Costs incurred during the development phase are capitalized and recognized over the product's estimated useful life if the product is expected to have a useful life beyond one year. Costs associated with repair or maintenance of the existing site or the development of web site content are included in product development expense in the accompanying consolidated statements of operations. F-9 In addition, the Company adopted the Emerging Issues Task Force Issue No. 00-2 ("EITF 00-2"), "Accounting for Web Site Development Costs," during the year ended December 31, 2000. EITF 00-2 requires the implementation of SOP 98-1 when software is used by a vendor in providing a service to a customer but the customer does not acquire the software or the right to use it. Impairments on long-lived assets The Company evaluates the recoverability of long-lived assets in accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS No. 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. If circumstances indicate that the carrying amount of an asset may not recoverable, the Company must estimate the future cash flows expected to result from the use of the assets and its eventual disposition. Future cash flows are the future cash inflows expected to be generated by the asset less any future cash outflows expected to be necessary to obtain those inflows. Deferred offering costs Costs related to common stock offerings are recorded initially as a deferred asset until the offering is successfully completed, at which time the costs are reclassified as a reduction of gross proceeds in shareholders' equity. If the offering is unsuccessful, the costs are charged to operations. Fair value of financial instruments The Company's financial instruments, including cash, current liabilities, and short-term debt are carried at cost, which approximates their fair value because of the short-term maturity of these instruments. Income taxes Income taxes are accounted for using an asset and liability approach, which requires the recognition of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the Company's consolidated financials statements or tax returns. The measurements of current and deferred tax liabilities and assets are based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. Revenue recognition The Company utilizes the accrual method of accounting whereby revenue is recognized when earned and expenses are recognized when incurred. The Company receives payment from a patient prior to treatment. Partial refunds are only issued to patients if the client changes their mind about undergoing the procedure before the treatment has taken place. F-10 Stock-based compensation The Company accounts for stock-based employee compensation arrangements in accordance with Accounting Principles Board ("APB") Opinion 25, "Accounting for Stock Issued to Employees" and complies with the disclosure provisions of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation expense is based on the difference, if any, on the date of grant, between the fair value of the Company's stock and the exercise price. The Company accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123. SFAS 123 requires the fair value based method of accounting for stock issued to non-employees in exchange for services. Companies that elect to use the method provided in APB 25 are required to disclose pro forma net income and pro forma earnings per share information that would have resulted from the use of the fair value based method. The Company has elected to continue to determine the value of stock-based compensation arrangements under the provisions of APB 25. Pro forma disclosures have been included in Note 6. Loss per share The Company accounts for loss per share in accordance with SFAS No. 128, "Earnings Per Share" (SFAS 128). Under SFAS 128, net loss per share-basic excludes dilution and is determined by dividing loss available to common shareholders by the weighted average number of common shares outstanding during the period. Net loss per share-diluted reflects the potential dilution that could occur if securities and other contracts to issue common stock were exercised or converted into common stock. As of December 31 2001, there were 4,700,000 stock options that were not included in the calculation of net loss per share-diluted because they were antidilutive. (2) Related Party Transactions As of December 31, 2000, the Company owed an officer/director of the Company $218,101 for working capital advances. During the year ended December 31, 2001 the officer/director advanced the Company and additional $95,000 for working capital. The Company repaid the officer/director $111,925 during the year ended December 31, 2001. The amount due to the officer/director of $201,176 is included in the accompanying consolidated financial statements as indebtedness to related party. During the year ended December 31, 2000, the Company rented office space from an officer. The Company paid the officer $25,125 for rent during the year ended December 31, 2000. The $25,125 is included in the accompanying consolidated financial statements as rent, related party. (3) Property and Equipment Property and equipment consisted of the following at December 31, 2001: Computer and office equipment $ 92,521 Web site software 823,307 --------------- 915,828 Less: accumulated depreciation and amortization (341,608) --------------- 574,220 Less: Impairment charge on web site (549,628) --------------- $ 24,592 =============== F-11 Depreciation and amortization expense for the years ended December 31, 2001 and 2000 totaled $290,545 and $19,706, respectively. Impairment - Web site In the fourth quarter of 2001, the Company completed a balance sheet review that identified assets whose carrying amounts are not recoverable. As a result of this review, the Company recorded asset impairment charges of $549,628 for the write-off of unamortized web site software costs. (4) Intangible Assets Intangible assets consisted of the following at December 31, 2001: Trade name and UROD rights $ 1,030,900 Patent 94,000 ------------- 1,124,900 Less: accumulated amortization (400,777) ------------- 724,123 Less: Impairment charges on trade name, UROD and patent (684,603) ------------- $ 39,520 ============= Amortization expense for the years ended December 31, 2001 and 2000 totaled $107,790 and $104,853, respectively. Impairment - UROD method, trade name and patent In the fourth quarter of 2001, the Company completed a balance sheet review that identified assets whose carrying amounts are not recoverable. As a result of this review, the Company recorded asset impairment charges of $684,603. These charges include the write-off of unamortized patent costs of $87,536 and a $597,067 UROD and trade name asset impairment. (5) Short-Term Debt During the years ended December 31, 2001 and 2000, the Company borrowed approximately $128,147 and $112,875, respectively, from certain unrelated third parties. The loans are non-interest bearing and are due on demand. The Company made repayments on the loans of $73,072 during the year ended December 31, 2001. The loans increased the balance owed on short-term debt to $397,879 as of December 31, 2001, which is included in the accompanying consolidated financial statements as short-term loans payable. (6) Shareholders' Equity Preferred Stock The Company is authorized to issue thirty million shares of $1.00 par value preferred stock, which may be issued in series with such designations, preferences, stated values, rights, qualifications or limitations as determined by the Board of Directors. F-12 Common Stock 2001 During the year ended December 31, 2001, the Company sold 12,324,435 shares of its $.01 par value common stock for $1,125,021 ($.091 per share). The stock sales were conducted in reliance on the exemption from federal securities registration requirements provided by Regulation S under the Securities Exchange Act of 1934. During the year ended December 31, 2001, the Company issued 100,000 shares of its common stock as payment for software consulting services performed on behalf of the Company. The market value of the common stock on the date of issuance was $.15 per share. The Company recorded $15,000 of stock-based compensation related to the stock issuance. 2000 During the year ended December 31, 2000, the Company sold 14,920,812 shares of its $.01 par value common stock for $2,331,664 ($.156 per share). The stock sales were conducted in reliance on the exemption from federal securities registration requirements provided by Regulation S under the Securities Exchange Act of 1934. During the year ended December 31, 2000, the Company issued 562,647 shares of its common stock as payment for advances and accrued interest totaling $99,000 ($.176 per share). During the year ended December 31, 2000, the Company issued 70,000 shares of its common stock as payment for general and administrative services performed on behalf of the Company. The market value of the common stock on the date of issuance was $.39 per share. The Company recorded $27,300 of stock-based compensation related to the stock issuance. During the year ended December 31, 2000, the Company issued 852,500 shares of its common stock as payment for general and administrative services performed on behalf of the Company. The market value of the common stock on the date of issuance was $.25 per share. The Company recorded $213,125 of stock-based compensation related to the stock issuance. Common stock options The Company has adopted an incentive and non-qualified stock option and stock issuance plan for the benefit of key personnel and others providing significant services. An aggregate of 5,000,000 shares of common stock has been reserved under the plan. There were 2,500,000 options outstanding under this plan as of December 31, 2001. All 2,500,000 options were granted during the year ended December 31, 2000. According to the Company's policy, options granted to non-employees are accounted for under the fair value method, while options granted to employees and directors are accounted for using the intrinsic method. In addition, on June 29, 1998, the Board of Directors granted options to the Company's president and secretary for 2,000,000 and 200,000 shares of its common stock, respectively, exercisable at $.275 per share. The options are fully vested and expire on June 29, 2003. The options were priced at 110 percent of the market value of the Company's common stock as of the date of grant. F-13 Option Pricing Model The fair value of each option granted has been estimated as of the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rate of 6.0 percent, expected volatility of 80 percent, expected life of five years, and no expected dividends. During the year ended December 31, 2000, the weighted average exercise price and fair value of options granted was $.307 and $.233, respectively, on the date of grant. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options and warrants, which have no vesting restrictions and are fully transferable. Option valuation models also require the input of highly subjective assumptions such as expected option life and expected stock price volatility. Because the Company's stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, the Company believes that the existing option valuation models do not necessarily provide a reliable single measure of the fair value of its stock-based awards. Options granted to employees accounted for under the intrinsic method On December 29, 2000 the Company granted employees options to purchase 1,900,000 shares of the Company's common stock. The options vest over a period of four years commencing on the employees hire date. On December 29, 2000 the fair value of the stock was $.344. The options are exercisable at $.340 and expire on December 29, 2005. Stock-based compensation totaling $641 was recorded on the options vested as of December 31, 2000. Deferred compensation totaling $6,579 was also recorded as of December 31, 2000. During the year ended December 31, 2001, $1,805 of the deferred compensation was expensed as stock-based compensation for options that vested during 2001. Options granted to non-employees accounted for under the fair value method On December 29, 2000 the Company entered into agreements with three unrelated third party consultants to provide technical advisory services, software development services, and consulting services to the Company. The Company granted the consultants options to purchase 450,000 shares of the Company's common stock. The options vest over a period of four years. On December 29, 2000 the fair value of the stock was $.3438. The options are exercisable at $.3400 and expire on December 29, 2005. The Company determined the fair value of the options in accordance with SFAS 123 to be $.292. No stock-based compensation was recorded on the options as no significant portion of the options were vested as of December 31, 2000; however deferred compensation totaling $131,400 was recorded as of December 31, 2000. During the year ended December 31, 2001, $32,850 of the deferred compensation was expensed as stock-based compensation for options that vested during 2001. On December 31, 2000 the Company entered into an agreement with an unrelated third party consultant to provide technical advisory services to the Company. The Company granted the consultant fully vested options to purchase 150,000 shares of the Company's common stock. On December 31, 2000 the fair value of the stock was $.344. The options are exercisable at $.25 and expire on December 29, 2005. The Company determined the fair value of the options in accordance with SFAS 123 to be $.301 and recorded stock-based compensation expense of $45,150 in the accompanying consolidated financial statements. F-14 Pro forma On December 29, 2000 the Company granted employees options to purchase 1,900,000 shares of the Company's common stock. Had compensation expense been recorded based on the fair value at the grant date, and charged to expense over vesting periods, consistent with the provisions of SFAS 123, the Company's net loss and net loss per share would have increased to the pro forma amounts indicated below: December 31, --------------------------------- 2001 2000 ------------- ------------------ Net loss, as reported $ (3,271,213) $ (2,231,201) Decrease due to: Employee stock options (171,550) (3,480) ------------- ------------------ Pro forma net loss $ (3,442,763) $ (2,234,681) ============= ================== As reported: Net loss per share - basic and diluted $ (0.11) $ (0.15) ============= ================== Pro Forma: Net loss per share - basic and diluted $ (0.12) $ (0.15) ============= ================== Options granted to employees accounted for under the fair value method Summary A summary of the status of the Company's stock option awards as of December 31, 2001, and the changes during the years ended December 31, 2001 and 2000 are presented below: Fixed Options Number ---------------------------------------------------------------- Outstanding at January 1, 2000 2,200,000 Granted 2,500,000 Exercised - Canceled - ---------------- Outstanding at December 31, 2000 4,700,000 Granted - Exercised - Canceled - ---------------- Outstanding at December 31, 2001 4,700,000 ================ (7) Income Taxes A reconciliation of the U.S. statutory federal income tax rate to the effective tax rate follows for the years ended December 31, 2001 and 2000: F-15 2001 2000 -------------- ------------- U.S. federal statutory graduated rate 34.00% 34.00% State income tax rate, net of federal benefit 5.83% 5.83% Net operating loss for which no tax benefit is currently available -39.83% -39.83% -------------- ------------- -------------- ------------- 0.00% 0.00% ============== ============= At December 31, 2001, deferred tax assets consisted of a net tax asset of $2,564,278, due to operating loss carryforwards of approximately $10,277,737, which was fully allowed for, in the valuation allowance of $2,564,278. The valuation allowance offsets the net deferred tax asset for which there is no assurance of recovery. The change in the valuation allowance for the years ended December 31, 2001 and 2000 totaled $1,302,238 and $888,786, respectively. The current tax benefit also totaled $1,302,238 and $888,786 for the years ended December 31, 2001 and 2000, respectively. The net operating loss carryforward expires through the year 2021. The valuation allowance will be evaluated at each balance sheet date, considering positive and negative evidence about whether the deferred tax asset will be realized. At that time, the allowance will either be increased or reduced; reduction could result in the complete elimination of the allowance if positive evidence indicates that the value of the deferred tax assets is no longer impaired and the allowance is no longer required. Should the Company undergo an ownership change as defined in Section 382 of the Internal Revenue Code, the Company's tax net operating loss carryforwards generated prior to the ownership change will be subject to an annual limitation, which could reduce or defer the utilization of these losses. (8) Contingencies Litigation The Company is involved in other various claims and lawsuits arising in the normal course of business. Management believes that any financial responsibility that may be incurred in settlement of such claims and lawsuits would not be material to the Company's financial position.