UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON D.C. 20549



FORM 10-Q



QUARTERLY REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended September
30, 2012



Commission file number 0-13092



SPECTRASCIENCE, INC.



(Exact name of registrant

as specified in its charter)



|Minnesota                                                              |  | 41-1448837                             
|---------------------------------------------------------------------- |  | ---------------------------------------
|(State or other jurisdiction
        of incorporation or organization) |  | (I.R.S. Employer Identification Number)



11568 Sorrento Valley Rd., Suite 11

San Diego, California 92121

(Address of principal executive offices,
including zip code)

(858) 847-0200

(Registrant's telephone number, including
area code)



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



Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding
12 months (or for such shorter period that the registration was required to submit and post such files). YES ̈NOx



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



|Large accelerated filero | Accelerated filero        
|------------------------ | --------------------------
|                         |                           
|Non-accelerated filero   | Smaller reporting companyx



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

YES ̈NOx



The number of shares of the registrant’s common stock,
par value $0.01 per share, outstanding on November 14, 2012 was 145,373,531.

















SPECTRASCIENCE, INC.



FORM 10-Q

For the Quarterly Period Ended September
30, 2012



TABLE OF CONTENTS



|PART I     | FINANCIAL INFORMATION:                                                                |    |   
|---------- | ------------------------------------------------------------------------------------- | -- | --
|           |                                                                                       |    |   
|Item 1.    | Financial Statements (Unaudited)                                                      |    | 3 
|           |                                                                                       |    |   
|Item 2.    | Management’s Discussion and Analysis of Financial Condition and Results of Operations |    | 14
|           |                                                                                       |    |   
|Item 3.    | Quantitative and Qualitative Disclosures About Market Risk                            |    | 17
|           |                                                                                       |    |   
|Item 4.    | Controls and Procedures                                                               |    | 17
|           |                                                                                       |    |   
|PART II    | OTHER INFORMATION                                                                     |    |   
|           |                                                                                       |    |   
|Item 1.    | Legal Proceedings                                                                     |    | 18
|           |                                                                                       |    |   
|Item 1A.   | Risk Factors                                                                          |    | 18
|           |                                                                                       |    |   
|Item 2.    | Unregistered Sales of Equity Securities and Use of Proceeds                           |    | 18
|           |                                                                                       |    |   
|Item 3.    | Defaults Upon Senior Securities                                                       |    | 18
|           |                                                                                       |    |   
|Item 4.    | Mine Safety Disclosures                                                               |    | 18
|           |                                                                                       |    |   
|Item 5.    | Other Information                                                                     |    | 18
|           |                                                                                       |    |   
|Item 6.    | Exhibits                                                                              |    | 18
|           |                                                                                       |    |   
|SIGNATURES |                                                                                       | 20



2









PART I     FINANCIAL INFORMATION:



Item 1. Financial Statements (Unaudited)



SpectraScience, Inc. and Subsidiary

CONSOLIDATED BALANCE SHEETS

(Unaudited)



|                                                                                                                                                                                                                                                            |  | September 30, 2012 |             |   | December 31, 2011 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ----------- | - | ----------------- | -
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|ASSETS                                                                                                                                                                                                                                                      |  |                    |             |   |                   |  
|Current assets:                                                                                                                                                                                                                                             |  |                    |             |   |                   |  
|Cash and cash equivalents                                                                                                                                                                                                                                   |  | $                  | 65,518      |   |                   | $
|Accounts receivable, net                                                                                                                                                                                                                                    |  |                    | 152,231     |   |                   |  
|Inventories                                                                                                                                                                                                                                                 |  |                    | 276,294     |   |                   |  
|Deferred debt issuance costs                                                                                                                                                                                                                                |  |                    | 132,170     |   |                   |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                   |  |                    | 120,029     |   |                   |  
|Total current assets                                                                                                                                                                                                                                        |  |                    | 746,242     |   |                   |  
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|Fixed assets, net                                                                                                                                                                                                                                           |  |                    | 121,797     |   |                   |  
|Patents, net                                                                                                                                                                                                                                                |  |                    | 2,269,248   |   |                   |  
|TOTAL ASSETS                                                                                                                                                                                                                                                |  | $                  | 3,137,287   |   |                   | $
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                                                                                                                                                        |  |                    |             |   |                   |  
|Current liabilities:                                                                                                                                                                                                                                        |  |                    |             |   |                   |  
|Accounts payable                                                                                                                                                                                                                                            |  | $                  | 728,115     |   |                   | $
|Convertible debt                                                                                                                                                                                                                                            |  |                    | 1,363,157   |   |                   |  
|Discount                                                                                                                                                                                                                                                    |  |                    | (318,324    | ) |                   |  
|Convertible debt, net                                                                                                                                                                                                                                       |  |                    | 1,044,833   |   |                   |  
|Derivative liability                                                                                                                                                                                                                                        |  |                    | 1,455,471   |   |                   |  
|Accrued expenses                                                                                                                                                                                                                                            |  |                    | 198,420     |   |                   |  
|Total current liabilities                                                                                                                                                                                                                                   |  |                    | 3,426,839   |   |                   |  
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|Warrant liability                                                                                                                                                                                                                                           |  |                    | 3,101,257   |   |                   |  
|TOTAL LIABILITIES                                                                                                                                                                                                                                           |  |                    | 6,528,096   |   |                   |  
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|COMMITMENTS                                                                                                                                                                                                                                                 |  |                    |             |   |                   |  
|                                                                                                                                                                                                                                                            |  |                    |             |   |                   |  
|SHAREHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                                                                              |  |                    |             |   |                   |  
|Series B Convertible Preferred Stock, $.01 par value:                                                                                                                                                                                                       |  |                    |             |   |                   |  
|Authorized – 2,585,000 shares; shares issued and outstanding - 2,585,000 shares at September 30, 2012 and December 31, 2011, liquidation value of $517,000 plus accumulated and unpaid dividends of $106,931 as of September 30, 2012 and December 31, 2011 |  |                    | 25,850      |   |                   |  
|Series C Convertible Preferred Stock, $.01 par value:                                                                                                                                                                                                       |  |                    |             |   |                   |  
|Authorized – 1,000,000 shares; shares issued and outstanding -1,000,000 shares at September 30, 2012 and December 31, 2011, $200,000 liquidation value                                                                                                      |  |                    | 10,000      |   |                   |  
|Common stock, $.01 par value:                                                                                                                                                                                                                               |  |                    |             |   |                   |  
|Authorized — 275,000,000 shares; shares issued and outstanding -136,240,247 shares at September 30, 2012 and 108,041,084 shares at December 31, 2011                                                                                                        |  |                    | 1,362,403   |   |                   |  
|Additional paid-in capital                                                                                                                                                                                                                                  |  |                    | 34,289,887  |   |                   |  
|Accumulated deficit                                                                                                                                                                                                                                         |  |                    | (39,078,949 | ) |                   |  
|TOTAL SHAREHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                                                                        |  |                    | (3,390,809  | ) |                   |  
|TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (DEFICIT)                                                                                                                                                                                                        |  | $                  | 3,137,287   |   |                   | $



Note: The balance sheet at December 31, 2011 has been derived
from the audited financial statements at that date but does not include all of the information required by accounting principles
generally accepted in the United States of America for complete financial statements.

See accompanying notes to unaudited financial
statements.





3









SpectraScience, Inc.
and Subsidiary

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)





|                                                                         |  | Three Months Ended  September 30, |             |   | Nine Months Ended September 30, |  
|------------------------------------------------------------------------ |  | --------------------------------- | ----------- | - | ------------------------------- | -
|                                                                         |  | 2012                              |             |   | 2011                            |  
|                                                                         |  |                                   |             |   |                                 |  
|Revenue                                                                  |  | $                                 | 150,750     |   |                                 | $
|Cost of revenue                                                          |  |                                   | 77,949      |   |                                 |  
|Gross profit                                                             |  |                                   | 72,801      |   |                                 |  
|                                                                         |  |                                   |             |   |                                 |  
|Operating expenses:                                                      |  |                                   |             |   |                                 |  
|Research and development                                                 |  |                                   | 235,988     |   |                                 |  
|General and administrative                                               |  |                                   | 536,656     |   |                                 |  
|Sales and marketing                                                      |  |                                   | 107,174     |   |                                 |  
|Total operating expenses                                                 |  |                                   | 879,818     |   |                                 |  
|Loss from operations                                                     |  |                                   | (807,017    | ) |                                 |  
|                                                                         |  |                                   |             |   |                                 |  
|Other expense (income)                                                   |  |                                   |             |   |                                 |  
|Interest expense                                                         |  |                                   | 105,596     |   |                                 |  
|Change in fair value of derivative and warrant liabilities               |  |                                   | (1,206,699  | ) |                                 |  
|Amortization of derivative and warrant liability discount                |  |                                   | 806,687     |   |                                 |  
|Amortization of deferred debt issuance costs and original issue discount |  |                                   | 352,544     |   |                                 |  
|Other expense (income), net                                              |  |                                   | 335         |   |                                 |  
|                                                                         |  |                                   | 58,463      |   |                                 |  
|Net (Loss)                                                               |  | $                                 | (865,480    | ) |                                 | $
|Basic and diluted net (loss) per share                                   |  | $                                 | (0.01       | ) |                                 | $
|Weighted average common shares outstanding                               |  |                                   | 117,152,589 |   |                                 |  



See accompanying notes to unaudited financial
statements.





4







SpectraScience, Inc.
and Subsidiary

CONSOLIDATED STATEMENT OF SHAREHOLDERS’
EQUITY (DEFICIT)

For the nine months ended September 30,
2012

(Unaudited)



|                                       |  | Preferred Stock |           |  | Common Stock |   |        | Additional Paid-In |  |  | Accumulated |  |  | Total Shareholders’ |          
|-------------------------------------- |  | --------------- | --------- |  | ------------ | - | ------ | ------------------ |  |  | ----------- |  |  | ------------------- | ---------
|                                       |  | Shares          |           |  | Amount       |   |        | Shares             |  |  | Amount      |  |  | Capital             |          
|Balance, December 31, 2011             |  |                 | 3,585,000 |  |              | $ | 35,850 |                    |  |  | 108,041,084 |  |  | $                   | 1,080,411
|                                       |  |                 |           |  |              |   |        |                    |  |  |             |  |  |                     |          
|Stock based compensation – consultants |  |                 |           |  |              |   |        |                    |  |  |             |  |  |                     |          
|Stock based compensation – employees   |  |                 |           |  |              |   |        |                    |  |  |             |  |  |                     |          
|Common stock issued for services       |  |                 |           |  |              |   |        |                    |  |  | 50,000      |  |  |                     | 500      
|Conversion of convertible debt         |  |                 |           |  |              |   |        |                    |  |  | 28,149,163  |  |  |                     | 281,492  
|Net loss                               |  |                 |           |  |              |   |        |                    |  |  |             |  |  |                     |          
|Balance, September 30, 2012            |  |                 | 3,585,000 |  |              | $ | 35,850 |                    |  |  | 136,240,247 |  |  | $                   | 1,362,403



See accompanying notes to unaudited financial
statements.





5









SpectraScience, Inc.
and Subsidiary

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                         |  | Nine Months Ended  September 30, |           
|------------------------------------------------------------------------ |  | -------------------------------- | ----------
|                                                                         |  | 2012                             |           
|OPERATING ACTIVITIES:                                                    |  |                                  |           
|Net loss                                                                 |  | $                                | (9,545,389
|Adjustments to reconcile net loss to cash used in operating activities:  |  |                                  |           
|Depreciation and amortization                                            |  |                                  | 290,132   
|Amortization of derivative and warrant liabilities discount              |  |                                  | 2,252,549 
|Amortization of deferred debt issuance costs and original issue discount |  |                                  | 957,405   
|Change in fair value of derivative and warrant liabilities               |  |                                  | 3,265,264 
|Stock-based compensation employees                                       |  |                                  | 256,330   
|Stock-based compensation consultants                                     |  |                                  | 23,662    
|Amortization of prepaid financing costs                                  |  |                                  | -         
|Fair market value of common stock and warrants issued for services       |  |                                  | 8,500     
|Changes in operating assets and liabilities:                             |  |                                  |           
|Accounts receivable                                                      |  |                                  | (125,496  
|Inventory                                                                |  |                                  | 91,544    
|Prepaid expenses and other assets                                        |  |                                  | (95,536   
|Accounts payable                                                         |  |                                  | 32,306    
|Accrued expenses                                                         |  |                                  | 199,696   
|Net cash (used in) operating activities                                  |  |                                  | (2,389,033
|                                                                         |  |                                  |           
|INVESTING ACTIVITIES:                                                    |  |                                  |           
|Redemption of certificates of deposit                                    |  |                                  | -         
|Purchases of fixed assets                                                |  |                                  | (4,170    
|Net cash from (used in) investing activities                             |  |                                  | (4,170    
|                                                                         |  |                                  |           
|FINANCING ACTIVITIES:                                                    |  |                                  |           
|Proceeds from issuance of convertible notes payable                      |  |                                  | 2,688,000 
|Debt issuance costs                                                      |  |                                  | (480,002  
|Net cash provided by financing activities                                |  |                                  | 2,207,998 
|                                                                         |  |                                  |           
|Net decrease in cash and cash equivalents                                |  |                                  | (185,205  
|                                                                         |  |                                  |           
|CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                         |  |                                  | 250,723   
|                                                                         |  |                                  |           
|CASH AND CASH EQUIVALENTS AT END OF PERIOD                               |  | $                                | 65,518    
|                                                                         |  |                                  |           
|Convertible Debentures and accrued interest converted to common stock    |  | $                                | 1,612,948 



See accompanying notes to unaudited financial
statements.





6









SpectraScience, Inc.

Notes to Unaudited Condensed Financial
Statements

September 30, 2012



1.     Nature of Business and Basis
of Presentation



Description of Business



SpectraScience, Inc. was incorporated in the State of Minnesota
on May 4, 1983 as GV Medical, Inc. In October 1992, GV Medical discontinued its prior business, refocused its development efforts
and changed its name to SpectraScience, Inc. The “Company,” hereinafter, refers to SpectraScience, Inc. and its wholly-owned
subsidiary Luma Imaging Corp. (“LUMA”). Since 1996, the Company has primarily focused on developing the WavSTAT Optical
Biopsy System (the “WavSTAT System”).



The Company has developed and received the European CE mark
approval to market a proprietary, minimally invasive technology that optically illuminates tissue in real-time to distinguish between
normal, pre-cancerous or cancerous cells without the need to remove the subject cell tissue from the body to make such determinations.
The WavSTAT System operates by using cool, safe laser light to optically illuminate and analyze tissue, enabling the physician
to make an instant diagnosis during endoscopy when screening for cancer, and if warranted, to begin immediate treatment during
the same procedure. Beginning in December 2011, the WavSTAT 4 version of the product began to be sold in the European Union for
colon cancer detection. In June 2012 the Company entered into a distribution agreement with PENTAX Europe, GmbH, for the sale of
its systems internationally.



On November 6, 2007, the Company acquired the assets of LUMA
in an equity transaction accounted for as an acquisition of assets and now operates LUMA as a wholly-owned subsidiary of the Company.
LUMA had acquired the assets from a predecessor company that had developed and received FDA approval for a non-invasive diagnostic
imaging system that can detect cervical cancer precursors and which utilizes an underlying technology that is similar to that of
the WavSTAT System. The addition of the LUMA technology to the Company’s existing WavSTAT System technology provides the
Company with a broad suite of light-based intellectual property and know-how. During the fiscal year ended December 31, 2010, the
Company wrote off the remaining fair value of the LUMA inventory in order to focus on the continued development and marketing of
the WavSTAT System. The Company retained the intellectual property of LUMA for use in the development of future generations of
the WavSTAT System.



The transaction was accounted for as an acquisition of assets
that included intellectual property, inventory and equipment. The intellectual property consisted of a total of 34 issued U.S.
patents and 28 additional patent applications.



Basis of Presentation



The accompanying unaudited financial statements of the Company
have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial
information and with the instructions to Form 10-Q as they are prescribed for smaller reporting companies. Accordingly, they do
not include all of the information and footnotes required by accounting principles generally accepted in the United States of America
for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered
necessary to make the financial statements not misleading have been included. Operating results for the nine-month period ended
September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. These
statements should be read in conjunction with the financial statements and related notes, which are included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2011.



Liquidity and Capital Resources



Historically, the Company’s sources of cash have come
from the issuance and sales of equity securities, convertible debentures and interest income. The Company’s historical cash
outflows have been primarily used for operating activities including research, development, administrative and sales activities.
Fluctuations in the Company’s working capital due to timing differences of its cash receipts and cash disbursements also
impact its cash flow. The Company expects to incur significant additional operating losses through at least the end of 2013, as
it completes proof-of-concept trials, conducts outcome-based clinical studies and increases sales and marketing efforts to commercialize
the WavSTAT4 Systems in Europe. If the Company does not receive sufficient funding, the Company may be unable to continue as a
going concern. The Company may incur unknown expenses or may not be able to meet its revenue forecast, and one or more of these
circumstances would require the Company to seek additional capital. The Company may not be able to obtain equity capital or debt
funding on terms that are acceptable. Even if the Company receives additional funding, such proceeds may not be sufficient to allow
the Company to sustain operations until it becomes profitable and begins to generate positive cash flows from operations.





7







As of September 30, 2012, the Company had negative working capital
of approximately $2.7	 million and cash and cash equivalents of approximately $66,000. In December 2011, the Company entered
into an Engagement Agreement with Laidlaw & Company (UK) Ltd. (“Laidlaw”). Under the Engagement Agreement, Laidlaw
agreed to assist the Company in raising up to $20.0 million in capital over a two-year period from the date of the Engagement Agreement.
During the nine-month period ended September 30, 2012, the Company raised approximately $2.2 million under this agreement. However,
if the Company does not receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company
may not be able to find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if
the events defined in the Engagement Agreement occur as expected, such proceeds will be sufficient to allow the Company to sustain
operations until it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses
or may not be able to meet its revenue expectations which would require it to seek additional capital. In such event, the Company
may not be able to find capital or raise capital or debt on terms that are acceptable.





Non-cash Financing Activities



During the three-month period ended September 30, 2012, holders
of matured Convertible Debentures with a face value of approximately $1,466,000 voluntarily converted debentures into common stock.
At the time of conversion, the fair value of the debentures ($1,612,948) was reclassified from current liabilities to equity (common
stock and APIC).





The accompanying financial statements have been prepared on
a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.
The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts
and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.



2.     Summary of Significant Accounting
Policies



Revenue recognition



The Company recognizes revenues when persuasive evidence of
an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability
is reasonably assured. Revenue from the sale of the Company’s products is generally recognized when title and risk of loss
transfers to the customer, the terms of which are generally free on board shipping point. The Company uses customer purchase orders
to determine the existence of an arrangement. The Company uses shipping documents and third-party proof of delivery to verify that
title has transferred. The Company assesses whether the price is fixed or determinable based upon the terms of the agreement associated
with the transaction. To determine whether collection is probable, the Company assesses a number of factors, including past transaction
history with the customer and the creditworthiness of the customer.



Consolidation



The accompanying consolidated financial statements include the
accounts of SpectraScience, Inc. and its wholly-owned subsidiary LUMA. All significant intercompany balances and transactions have
been eliminated in consolidation.



Risks and Uncertainties



The Company operates in an industry that is subject to intense
competition, government regulation and rapid technological change. The Company's operations are subject to significant risk and
uncertainties, including financial, operational, technological, regulatory and other risks associated with a short history of product
sales, including the potential risk of business failure.



Use of Estimates



The Company prepares its consolidated financial statements in
conformity with accounting principles generally accepted in the United States of America, which requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and disclosures made in the accompanying notes to
the financial statements. Significant estimates made by management include, among others, realization of long-lived assets, assumptions
used to value stock options and warrants, assumptions used to value the common stock issued and the intellectual property acquired
in the LUMA acquisition and the realization of intangible assets. Actual results could differ from those estimates.



Inventory Valuation



The Company states its inventories at the lower of cost or market
value, determined on a specific cost basis. The Company provides inventory allowances when conditions indicate that the selling
price could be less than cost due to obsolescence and reductions in estimated future demand. The Company balances the need to maintain
strategic inventory levels with the risk of obsolescence due to changing technology and customer demand levels. Unfavorable changes
in market conditions may result in a need for additional inventory reserves that could adversely impact the Company’s gross
margins. Conversely, favorable changes in demand could result in higher gross margins when the Company sells products.





8







Valuation of Long-lived Assets



The Company’s long-lived assets consist of property and
equipment and intangible assets. Equipment is carried at cost and is depreciated over the estimated useful lives of the assets,
which are generally two to three years, and leasehold improvements are amortized over the lesser of the lease term or the estimated
useful lives of the improvements. The straight-line method is used for depreciation and amortization. Intangible assets consist
of patents, which are amortized using the straight-line method over the estimated useful lives of the patents. The Company does
not capitalize external legal costs and filing fees associated with obtaining patents on its new discoveries. Acquired intellectual
property is recorded at cost and is amortized over its estimated useful life. The Company believes the useful lives assigned to
these assets are reasonable. The Company assesses the recoverability of long-lived assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. These computations utilize judgments and assumptions inherent
in management’s estimate of future cash flows to determine recoverability of these assets. If management’s assumptions
about these assets were to change as a result of events or circumstances, the Company may be required to record an impairment loss.



Stock-Based Compensation



The Company accounts for stock-based compensation under the
provisions of FASB ASC Topic 718,  Compensation—Stock Compensation  (“ASC 718”), which
requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based
on estimated fair values on the grant date. The Company adopted ASC 718 on January 1, 2006. The Company estimates the fair value
of stock-based awards on the date of grant using the Black-Scholes-Merton option-pricing model (the “Black-Scholes Model”).
The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods
using the straight-line method. The Company estimates forfeitures at the time of grant and revises its estimate in subsequent periods
if actual forfeitures differ from those estimates.



The Company accounts for stock-based compensation awards to
non-employees in accordance with FASB ASC Topic 505-50, Equity-Based Payments to Non-Employees    (“ASC
505-50”). Under ASC 505-50, the Company determines the fair value of the warrants or stock-based compensation awards granted
as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably
measurable.



All issuances of stock options or other equity instruments to
employees and non-employees as the consideration for goods or services received by the Company are accounted for based on the fair
value of the equity instruments issued. Any stock options issued to non-employees are recorded in expense and additional paid-in
capital in shareholders’ equity over the applicable service periods using variable accounting through the vesting dates based
on the fair value of the options at the end of each reporting period.



As of September 30, 2012, the Company had one stock-based employee
compensation plan under which it makes grants, the 2011 Equity Incentive Plan (the “EIP”). The EIP provides for the
grant of incentive stock options (“ISOs”), nonqualified stock options (“NQSOs”) and restricted stock awards
to full-time employees (who may also be directors) and NQSOs and restricted stock awards to non-employee directors, consultants,
customers, vendors or providers of services. The exercise price of any ISO may not be less than the fair market value of the common
stock on the date of grant and the term shall not exceed ten years. The amount reserved under the 2011 EIP is 15,000,000 shares
of common stock.  At September 30, 2012, the Company had outstanding 21,041,667 options under the EIP and the Company’s
prior Amended 2001 Stock Plan representing approximately 18% of the Company’s outstanding shares (9,329,063 of which were
exercisable), with 6,453,333 available for future issuance under the 2011 EIP. Awards under the Company’s EIP generally vest
over four years.



The fair value of options granted were estimated at the date
of grant using a Black-Scholes Model which includes several variables including expected life, risk free interest rate, expected
stock price volatility, stock option exercise patterns and expected dividend yield. The Company also must estimate forfeitures
for employee stock options. These models and assumptions are complex and may change future expenses by increasing or decreasing
stock-based compensation expense. Management used the following weighted average assumptions to value stock options granted during
the nine months ended September 30, 2012 and 2011:



|                        |  | 2012    |      |  | 2011    | 
|----------------------- |  | ------- | ---- |  | ------- | 
|Expected life           |  | 5 Years |      |  | 5 Years | 
|Risk-free interest rate |  |         | .70% |  |         | 
|Expected volatility     |  |         | 101% |  |         | 
|Expected dividend yield |  |         | 0%   |  |         | 





9









Management believes estimated forfeitures for employee stock
options granted under the EIP would have a negligible effect on expenses because such forfeitures would be a very small percentage.
Stock option grants have been to a group of individuals that have a high desire to see the Company succeed and have aligned themselves
to that end.



The expected lives used in the calculations were selected by
management based on past experience, forward looking profit forecasts and estimates of what the trading price of the Company’s
stock might be at different future dates.



The risk-free interest rates used in the calculations are the
five-year U.S. Treasury rates as published on the date of the applicable stock option grant.



Volatility is a calculation based on fluctuations in the Company’s
stock price over a historical time period consistent with the estimated life of the option. Management computed and tested this
volatility calculation for reasonableness and found it to be acceptable based on a number of factors including the Company’s
current market capitalization, comparison to other similar companies in its area of interest, the current early revenue stage of
the Company and management’s estimate of the net present value of forward looking profits that has been compiled (for which
there is no assurance).



Information with respect to stock option activity is as follows:



|                                  |  |                             |            |   | Outstanding Options      | 
|--------------------------------- |  | --------------------------- | ---------- | - | ------------------------ | 
|                                  |  | Options Available For Grant |            |   | Plan Options Outstanding | 
|December 31, 2011                 |  |                             | 1,700,000  |   |                          | 
|Options granted                   |  |                             | (5,246,667 | ) |                          | 
|Options exercised                 |  |                             | -          |   |                          | 
|Options forfeited                 |  |                             | -          |   |                          | 
|Options expired under 2001 EIP    |  |                             | -          |   |                          | 
|Additional options authorized     |  |                             | 10,000,000 |   |                          | 
|Outstanding at September 30, 2012 |  |                             | 6,453,333  |   |                          | 
|Exercisable at September 30, 2012 |  |                             | -          |   |                          | 



There were no options exercised during the nine months ended
September 30, 2012 and 2011. At September 30, 2012, total unrecognized estimated employee compensation cost related to non-vested
stock options granted prior to that date is approximately $1,012,000, which we expect to be recognized over the next four years.



Inventories



Inventories consisted of the following at September 30, 2012
and December 31, 2011:



|               |  | September 30, 2012 |         |  | December 31, 2011 |  
|-------------- |  | ------------------ | ------- |  | ----------------- | -
|Raw materials  |  | $                  | 169,712 |  |                   | $
|Finished goods |  |                    | 106,582 |  |                   |  
|Totals         |  | $                  | 276,294 |  |                   | $





10









Earnings (Loss) Per Share



Basic earnings (loss) per share is computed by dividing net
income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period of
computation. Diluted earnings (loss) per share is computed similarly to basic earnings per share except that the denominator is
increased to include the number of additional common shares that would have been outstanding if the potential common shares had
been issued and only if the additional common shares would be dilutive. Basic and diluted loss per share are the same for the nine-month periods ended September 30, 2012 and 2011, since any additional common stock equivalents would be antidilutive. Potentially
dilutive shares of common stock that have been excluded from the calculation of the weighted average number of dilutive common
shares for the nine months ended September 30, 2012 include stock options to purchase 21,041,667 shares of common stock, warrants
to purchase 56,542,013 shares of common stock, convertible debt convertible into 20,269,100 shares of common stock and preferred
stock convertible into 3,585,000 shares of common stock.



The following table sets forth the computation of basic and diluted earnings per share and the additional
income related to the change in fair value of derivative securities for the three month period ending September 30, 2012:



|                                                                              |  | For the Nine Months Ended September 30, |             |   | For the Nine Months Ended September 30, |   |             | For the Three Months Ended September 30, |  |   | For the Three Months Ended September 30, |  
|----------------------------------------------------------------------------- |  | --------------------------------------- | ----------- | - | --------------------------------------- | - | ----------- | ---------------------------------------- |  | - | ---------------------------------------- | -
|                                                                              |  | 2012                                    |             |   | 2011                                    |   |             | 2012                                     |  |   | 2011                                     |  
|Numerator:                                                                    |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Net (loss) for basic earning per share                                        |  | $                                       | (9,545,389  | ) |                                         | $ | (3,004,256  | )                                        |  | $ | (865,480                                 | )
|Subtractions:                                                                 |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Change in fair value of derivative securities                                 |  |                                         | -           |   |                                         |   | -           |                                          |  |   | (1,374,700                               | )
|Net (loss) for diluted earnings per share                                     |  | $                                       | (9,545,389  | ) |                                         | $ | (3,004,256  | )                                        |  | $ | (2,240,180                               | )
|                                                                              |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Denominator:                                                                  |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Weighted average basic shares outstanding                                     |  |                                         | 111,078,252 |   |                                         |   | 108,033,806 |                                          |  |   | 117,152,589                              |  
|Assumed conversion of dilutive securities                                     |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Warrants                                                                      |  |                                         | -           |   |                                         |   | -           |                                          |  |   | 11,383,610                               |  
|Conversion feature - Convertible Debentures                                   |  |                                         | -           |   |                                         |   | -           |                                          |  |   | 41,021,402                               |  
|Potentially dilutive common shares                                            |  |                                         | -           |   |                                         |   | -           |                                          |  |   | 52,405,012                               |  
|                                                                              |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Denominator for diluted earnings per share - Adjusted weighted average shares |  |                                         | 111,078,252 |   |                                         |   | 108,033,806 |                                          |  |   | 184,838,302                              |  
|                                                                              |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|(Loss) per share                                                              |  |                                         |             |   |                                         |   |             |                                          |  |   |                                          |  
|Basic                                                                         |  | $                                       | (0.09       | ) |                                         | $ | (0.03       | )                                        |  | $ | (0.01                                    | )
|Diluted                                                                       |  | $                                       | (0.09       | ) |                                         | $ | (0.03       | )                                        |  | $ | (0.01                                    | )







3. Liabilities



Convertible Debentures



For the nine-month period ended September 30, 2012,
the Company issued Convertible Debentures (“Debentures”) at a face amount of $2,829,474. At September 30, 2012,
the unamortized discount of $318,324 consisted of a discount on the derivative liability of $141,902, discount on the
warrant liability of $155,615 and original issue discount of $20,807. The discount will be amortized over the remaining term
of the Debentures. The Debentures have an original term of six months, accrue interest at rates ranging from 16-20% per year,
carry an original issue discount of 5% and will convert into common stock at an initial conversion price ranging from $0.0573
to $0.099 per share at maturity. The Debentures were issued with detachable five-year cashless warrants
(“Holders Warrants”) that allow the holders to purchase one share of stock for each two shares available under
the converted Debentures at an exercise price ranging from $0.0745 to $0.1287 per share. In addition, the Company issued
five-year cashless warrants issued to the placement agent (“Agent Warrants”) equal to 10% of the total number of
shares issuable under the Debentures and Holders Warrants at an exercise price ranging from $0.0745 to $0.1287 per share. At
September 30, 2012, there were Debentures, Holders Warrants and Agent Warrants (collectively, the “Warrants”)
convertible or exercisable into 20,269,100, 22,929,627 and 6,878,888 shares of common stock, respectively. The conversion
price of the Debentures is subject to an adjustment feature in the event that the Company issues securities for less than the
conversion price of the Debentures. The Holders and Agent Warrants contain a provision under which the Warrants, under
certain circumstances, could be acquired for a presently undetermined consideration at a future date. This results in an
adjustment feature component for the Holders and Agent Warrants. The accounting for the adjustment features of the conversion
price and the warrant exercise price is described separately below under “Warrant Liability” and
“Derivative Liability”. Upon issuance of the Debentures the Company received net cash proceeds of $2,205,498, net
of $480,002 in transaction costs and $141,473 of original issue discount. On September 30, 2012, if converted, the value of
the Debentures would exceed their face value by approximately $1,272,000. For the nine-month period ended September 30, 2012,
Debentures with a face value of $1,466,316 and accrued interest of $146,632 were converted at a price of $0.0573 into
28,149,163 shares of common stock. At September 30, 2012, Debentures with a face value of $884,211 were in default and
accruing interest at a default rate of 20% per year.



Warrant Liability



The Company issued Debentures with Holders Warrants and Agent
Warrants that include a possible exercise adjustment feature in certain change of control transactions (referred to as “Derivative
Warrants”). Effective January 1, 2009, the accounting guidance regarding derivative warrants changed and required that these
warrants be recorded as a liability and measured at fair value recorded in earnings. The Company records the fair value of these
warrants in its statement of operations in the line “Change in fair value of derivative and warrant liabilities.” The
Company measures these warrants using a modified Black-Scholes option valuation model using similar assumptions to those described
under “Stock-Based Compensation.” For the nine-month period ended September 30, 2012, the Company recorded non-cash
expense related to these warrants of approximately $2,457,000. At September 30, 2012, there were exercisable warrants to purchase
29,808,515 shares of common stock subject to this price adjustment feature. The time period over which the Company will be required
to evaluate the fair value of these warrants is approximately five years. Upon issuance of the Debentures, the Company recorded
a Warrant Liability of $2,118,598 and an initial fair value non-cash expense of $380,334. For the nine-month period ended September
30, 2012, the Company recorded non-cash expense of $982,659 which represents the change in the fair value of the Warrant Liability
from inception to September 30, 2012, resulting in a Warrant Liability amount of $3,101,257.



The Company computes the fair value of the warrant liability
at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component
in the value of the warrant liability is the Company’s stock price, which is subject to significant fluctuation and is not
under the Company’s control. The resulting effect on the Company’s net loss is therefore subject to significant fluctuation
and will continue to be so until the Derivative Warrants expire (approximately five years from the date of issuance). Assuming
all other fair value inputs remain constant, the Company will record non-cash expense when its stock price increases and non-cash
income when its stock price decreases.



The assumptions used in determining fair value represent management’s
best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result,
if factors change, including changes in the market value of the Company’s common stock, the Company’s fair value estimates
could be materially different in the future.





11







Derivative Liability



During the nine-month period ended September 30, 2012, the Company issued convertible Debentures with
a conversion price that includes a possible exercise adjustment feature in the event that it issues securities for consideration
less than that offered with the convertible Debentures (referred to as “Derivative Liabilities”). The Company records
the fair value of the conversion feature in its statement of operations in the line “Change in fair value of derivative and
warrant liabilities.” The Company measures the conversion feature using a modified Black-Scholes option valuation model using
similar assumptions to those described under “Stock-Based Compensation.” For the nine-month period ended September
30, 2012, the Company recorded non-cash expense related to this conversion feature of approximately $3,061,000. At September 30,
2012, there were convertible shares to purchase 20,269,100 shares of common stock subject to this price adjustment feature. The
time period over which the Company will be required to evaluate the fair value of this conversion feature is the lesser of six
months or conversion. Upon issuance of the Debentures, the Company recorded a derivative liability of $1,733,394 and an initial
fair value non-cash expense of $432,685. For the nine-month period ended September 30, 2012, the Company recorded non-cash expense
of $1,469,587 which represents the change in the fair value of the Derivative Liability from inception to September 30, 2012. Convertible
Debentures with a face value of $1,466,315 converted into approximately 25,590,000 shares of Common Stock with an associated reclassification
of Derivative Liability of $1,747,509 to Additional Paid-In Capital (“APIC”). These changes result in a Derivative
Liability amount of $1,455,471 at September 30, 2012.





The Company computes the fair value of the derivative liability
at each reporting period and the change in the fair value is recorded as non-cash expense or non-cash income. The key component
in the value of the derivative liability is the Company’s stock price, which is subject to significant fluctuation and is
not under its control. The resulting effect on net loss is therefore subject to significant fluctuation and will continue to be
so until the Company’s Debentures, which the convertible feature is associated with, mature. Assuming all other fair value
inputs remain constant, the Company will record non-cash expense when its stock price increases and non-cash income when its stock
price decreases.



The assumptions used in determining fair value represent management’s
best estimates, but these estimates involve inherent uncertainties and the application of management’s judgment. As a result,
if factors change, including changes in the market value of the Company’s common stock, the Company’s fair value estimates
could be materially different in the future.



4. Shareholders’ Equity



Common Stock



In September 2012, holders of Convertible Debentures with a
face value of $1,466,318 converted their debentures into 25,590,150 shares of common stock. In addition, associated with these
debentures, the Company paid $146,632 in accrued interest by issuing 2,559,013 shares of common stock.



In July 2012, the Company issued 50,000 shares of restricted
common stock to a vendor for services. The fair value of the shares was determined to be $8,500, based upon the market value of
the stock on the date of issuance.



Stock Options



In September 2012, the Company granted
stock options to purchase 4,746,667 shares of common stock at an exercise price of $0.12 per share to six employees of the Company.
The options vest 25% one year from grant and 1/48 of the remaining grant amount monthly for the remaining three years.



5. Fair Value Measurements



Accounting guidance on fair value measurements and disclosures
defines fair value, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system, and
defines required disclosures. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer
a liability in an orderly transaction between market participants in the market in which the reporting entity transacts business.



The Company's balance sheet contains derivative and warrant
liabilities that are recorded at fair value on a recurring basis. The three-level valuation hierarchy for disclosure of fair value
is as follows:



Level 1: uses quoted market prices in active markets for identical
assets or liabilities.



Level 2: uses observable market-based inputs or unobservable
inputs that are corroborated by market data.



Level 3: uses unobservable inputs that are not corroborated
by market data.





12







The fair value of the Company’s recorded derivative and
warrant liabilities is determined based on unobservable inputs that are not corroborated by market data, which require a Level
3 classification. A modified Black Scholes option valuation model was used to determine the fair value with similar assumptions
to those described under “Stock-Based Compensation”. The Company records derivative and warrant liabilities on the
consolidated balance sheets at fair value with changes in fair value recorded in the consolidated statements of operations.



The following table presents the balances of liabilities measured
at fair value on a recurring basis by level as of September 30, 2012:





|                         |  | Fair Value Measurements Using |  
|------------------------ |  | ----------------------------- | -
|                         |  | Quoted Prices in              |  
|                         |  | Active Markets for            |  
|                         |  | Identical Assets              |  
|                         |  | (Level 1)                     |  
|As of September 30, 2012 |  |                               |  
|Derivative liability     |  | $                             | -
|Warrant liability        |  |                               | -
|Total                    |  | $                             | -



The following table presents changes in the liabilities with
significant unobservable inputs (Level 3) for the nine months ended September 30, 2012:



|                                                |  | Warrant   |           |   | Derivative |   |            | Total     | 
|----------------------------------------------- |  | --------- | --------- | - | ---------- | - | ---------- | --------- | 
|                                                |  | Liability |           |   | Liability  |   |            | Liability | 
|Balance, December 31, 2011                      |  | $         | -         |   |            | $ | -          |           | 
|Issuance of convertible debt and warrants       |  |           |           |   |            |   |            |           | 
|resulting in derivative and warrant liabilities |  |           | 1,888,415 |   |            |   | 1,573,319  |           | 
|Change in estimated fair value                  |  |           | 317,148   |   |            |   | 452,240    |           | 
|Balance, March 31, 2012                         |  |           | 2,205,563 |   |            |   | 2,025,559  |           | 
|Change in the estimated fair value              |  |           | 1,085,791 |   |            |   | 1,803,766  |           | 
|Balance, June 30, 2012                          |  |           | 3,291,354 |   |            |   | 3,829,325  |           | 
|Issuance of convertible debt and warrants       |  |           |           |   |            |   |            |           | 
|resulting in derivative and warrant liabilities |  |           | 230,183   |   |            |   | 160,074    |           | 
|Change in the estimated fair value              |  |           | (420,280  | ) |            |   | (786,419   | )         | 
|Reclassification of derivative liability to     |  |           |           |   |            |   |            |           | 
|APIC at conversion                              |  |           | -         |   |            |   | (1,747,509 | )         | 
|Balance, September 30, 2012                     |  | $         | 3,101,257 |   |            | $ | 1,455,471  |           | 



6. Contingencies



None



7. Subsequent Events



Common Stock



In October 2012, the Company issued 25,000 shares of restricted
common stock to a vendor for services. The fair value of the shares was determined to be $3,000 based upon the market value of
the stock on the date of issuance.



In November 2012, holders of Convertible Debentures with a face
value of $473,685 converted their Convertible Debentures into 8,266,740 shares of common stock. In addition, associated with these
Convertible Debentures, the Company paid $47,369 in accrued interest by issuing 826,674 shares of common stock.



Warrants



In October 2012, a holder of a cashless warrant to purchase
86,340 shares of restricted common stock exercised the warrant in a cashless transaction and was issued 14,870 shares of restricted
common stock.



In November 2012, the Company issued a five-year cashless warrant
to a vendor to purchase 300,000 shares of restricted common stock at an exercise price of $0.096 per share. Of the total Warrant
issued, the right to exercise 100,000 shares will be earned 10,000 shares monthly for 10 months. The remaining 200,000 underlying
shares will be earned upon the satisfaction of certain performance milestones. The fair value of the warrant at issuance and the
maximum non-cash expense potentially recognized in the future, utilizing the Black-Scholes option-pricing model, was determined
to be approximately $17,300.





Convertible Debentures







In October 2012, the Company entered into subscription agreements
with accredited investors to purchase an aggregate principal amount of $231,574 of Convertible Debentures initially convertible
into shares of common stock at a conversion price of $0.099, together with five-year warrants to purchase approximately 1,170,000
common shares at an exercise price equal to $0.1287 per share.





In November 2012, the Company entered into subscription agreements
with accredited investors to purchase an aggregate principal amount of $123,158 of Convertible Debentures initially convertible
into shares of common stock at a conversion price of $0.099, together with five-year warrants to purchase approximately 622,000
common shares at an exercise price equal to $0.1287 per share.









13







Item 2.     Management’s Discussion
and Analysis of Financial Condition and Results of Operations



Forward-Looking Statements



This quarterly report on Form 10-Q
(the “Report”) contains forward-looking statements that are not related to historical results, including,
without limitation, statements regarding our business strategy and objectives, near term operating goals, expectations
regarding the market for our products and beliefs with respect to opportunities and industry conditions in those markets,
beliefs about our products, product development, acquisition or licensing of complementary technologies and expectations with
respect to our products’ performance and acceptance, the results of our distribution agreement with PENTAX Europe GmbH,
our expectations regarding conversion of our Convertible Debentures, beliefs about the strengths of our intellectual property
portfolio, regulatory goals and developments, our agreement with Laidlaw and its effect on our future capital resources,
future financial position, expectations with respect to stock option expense recognition, future cash needs, the sufficiency
of our working capital and operating losses for the remainder of the current fiscal year, and involve risks and
uncertainties. Although we believe that the assumptions on which these forward-looking statements are based are reasonable,
there can be no assurance that such assumptions will prove to be accurate and actual results could differ materially from
those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but
are not limited to, changes in law or regulatory policies, unanticipated competition from other similar businesses, adverse
outcomes from litigation, unexpected employee departures or disruptions, adverse market and general economic factors and
other factors described in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Such
forward-looking statements are qualified in their entirety by the cautions and risk factors set forth in our Annual Report on
Form 10-K for the fiscal year ended December 31, 2011.



Business



SpectraScience, Inc. (the “Company,” “SpectraScience,”
“we,” “our,” or “us”) develops and manufactures innovative Laser Induced Fluorescence spectrophotometry
systems capable of determining whether tissue is normal, pre-cancerous or cancerous without removing tissue from the body. The
WavSTAT Optical Biopsy System (the “WavSTAT System”) is SpectraScience's first product to incorporate its proprietary
fluorescence technology for clinical use. The WavSTAT System carries the CE mark designation which allows for the sale and marketing
in the European Union for the diagnosis of cancer. The Company is developing light-based diagnostics for additional cancer indications
including inflammatory bowel disease and esophageal cancer. Once these additional applications are developed the Company plans
to self-certify for CE mark approval for sale in the European Union and then file an application with the FDA seeking permission
to begin marketing for that indication for use in the United States. The Company believes it has a strong intellectual property
portfolio that will allow it to continue to expand its WavSTAT cancer diagnosis platform to address the diagnosis of multiple cancers,
utilize additional proprietary bio-photonic techniques to improve the WavSTAT’s overall diagnostic performance and ultimately
allow for the detection of cancer and pre-cancer over a relatively large area of examined tissue.



Our principal executive offices are located at 11568 Sorrento
Valley Rd., Suite 11, San Diego, CA 92121. We can be reached by telephone at (858) 847-0200; by fax at (858) 847-0880; or by email
at info@spectrascience.com. We have a Web site at http://www.spectrascience.com. The information contained on our Web site shall
not be deemed to be a part of this Report.



Plan of Operation



During the past 12 months, SpectraScience spent a majority of
its time and significant resources redesigning and manufacturing its improved WavSTAT4 Optical Biopsy System. Improvements included
a redesign of the system to make it easier to use and the development of a new diagnostic algorithm that the Company believes is
more accurate and reliable. The WavSTAT4 completed production and qualified for sale in the European Union under the CE Mark in
December 2011.



Over the next 12 months, SpectraScience intends to:



| | · | Continue to market, sell and expand the geographic footprint of the WavSTAT4 Optical Biopsy System colon cancer diagnostic application in the European Union in conjunction with its distribution partnership with PENTAX Europe GmbH;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | Acquire or license complementary technologies for the development of future WavSTAT System diagnostic indications;
| | - | ------------------------------------------------------------------------------------------------------------------



| | · | Improve the diagnostic capability of the WavSTAT4 colon cancer application;
| | - | ---------------------------------------------------------------------------



| | · | Begin the design and planning for the next generation of multi-modal fluorescence and broadband spectroscopy systems at our facility in San Diego, California; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | Continue to expand and refine our intellectual property portfolio.
| | - | ------------------------------------------------------------------





14









Results of Operations



Three Months Ended September 30, 2012 and 2011



The Company recognized approximately $151,000 and $0 in revenue
for the three months ended September 30, 2012 and 2011, respectively. The revenue in the fiscal 2012 three-month period resulted
from the Company’s distribution agreement with PENTAX Europe, GmbH, signed in June 2012. As a result the Company recognized
gross profit of approximately $73,000 for the quarter ended September 30, 2012.



Total operating expenses decreased from approximately $1,193,000
to $880,000, a decrease of approximately $313,000 for the three-month period ended September 30, 2012 as compared to the three-month
period ended September 30, 2011. This overall decrease was comprised of approximate decreases in research and development expense
of $200,000, general and administration expense of $64,000 and sales and marketing expense of $49,000.



Research and development expenses for the three months ended
September 30, 2012 and 2011 were approximately $236,000 and $436,000 respectively. The approximate $200,000 decrease for the three
months ended September 30, 2012 compared to the three months ended September 30, 2011 was due to approximate decreases in engineering
development expense of $169,000, clinical studies expense of $30,000 and other expense of $1,000. The decrease in engineering development
expense reflected the increased expense in the prior period as a result of the re-engineering of the WavSTAT4 System. The decrease
in clinical studies was a result of no clinical studies in Europe in the three-month period ended September 30, 2012 as compared
to several clinical studies in the same period one year ago.



General and administrative expenses for the three months ended
September 30, 2012 and 2011 were approximately $537,000 and $601,000 respectively. The approximate $64,000 decrease for the three
months ended September 30, 2012 compared to the three months ended September 30, 2011 was due to approximate decreases in consulting
expense of $88,000, legal expense of $17,000, travel expense of $9,000 offset by approximate increases in investor relations expense
of $10,000, depreciation expense of $32,000 and all other expenses of $8,000. These expense decreases were a result of lower advisory
service fees paid to investment bankers in the three-month period ended September 30, 2012 as compared to the same period one-year
ago.



Sales and marketing expenses for the three months ended September
30, 2012 and 2011 were approximately $107,000 and $156,000, respectively. The decrease of approximately $49,000 was due to approximate
decreases of $33,000 in advertising expense, $11,000 in travel expense and $5,000 in all other expense. The decreases are generally
a result of higher trade-show collateral expenses in the prior three-month period ended September 30, 2011 due to the Company’s
direct participation in European trade shows and lower travel expenses due to the hiring of a European-based business development
executive to service international markets for the three-month period ended September 30, 2012.



As a result of the above, the approximate net operating loss
for the three months ended September 30, 2012 and 2011 was $807,000 and $1,193,000 respectively.  Of the net operating
loss for the quarter ended September 30, 2012, approximately $87,000 was comprised of non-cash stock option expense.



Non-operating expense increased approximately $62,000 as a result
of non-cash income and expense related to our convertible debt issuance comprised of approximate increases in amortization of derivative
and warrant liability discount of approximately $807,000, increased amortization of debt issuance costs and original issue discount
of approximately $353,000, increased interest expense of approximately $106,000 and increases in other non-operating expense of
approximately $3,000 offset by warrant and derivative liability income of $1,207,000.



As a result of the above, the approximate net loss decreased
by $325,000 for the three months ended September 30, 2012 and 2011 from approximately $1,190,000 to $865,000.  Of the
net loss for the quarter ended September 30, 2012, the Company recognized a non-cash benefit of approximately ($313,000).



Nine Months Ended September 30, 2012 and 2011



The Company recognized approximately $461,000 and $0 revenue
for the nine months ended September 30, 2012 and 2011, respectively. The revenue in the current nine-month period is a result of
the Company’s distribution agreement and sales to PENTAX Europe, GmbH, signed in June of 2012. As a result the Company recognized
gross profit of approximately $183,000 for the nine-month period ended September 30, 2012.



Total operating expenses decreased from approximately $3,010,000
to $2,991,000, a decrease of approximately $19,000 for the nine-month period ended September 30, 2012 as compared to the nine-month
period ended September 30, 2011. This overall decrease was comprised of approximate decreases in research and development expense
of $30,000 and sales and marketing expense of $63,000 offset by an approximate increase of $74,000 in general and administrative
expense.





15







Research and development expenses decreased approximately $30,000
for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. Overall research and development
expenses for the comparative periods were approximately $906,000 and $936,000, respectively. The decrease was comprised of approximate
decreases in clinical studies expense of $25,000, stock option expense of $22,000, consulting expense $22,000, engineering development
of $21,000 and all other expense of $17,000 offset by an approximate increase in payroll expense of $77,000. The decrease in engineering
development expense reflected the completion of the refinement of the WavSTAT4 System. Payroll expense increased due to bonus expense
and the hiring of an employee who was formerly a consultant in the nine-month period ended September 30, 2011 as compared to the
nine-month period ended September 30, 2012.



General and administrative expenses for the nine months ended
September 30, 2012 and 2011 were approximately $1,737,000 and $1,663,000, respectively. The approximate $74,000 increase for the
nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 was due to approximate increases in investor
relations expense of $86,000, depreciation expense of $79,000, payroll expense of $56,000, bad debt expense of $27,000, and other
expense of $1,000 offset by approximate decreases in stock compensation expense of $67,000, consulting expense of $49,000, legal
expense of $33,000 and financial amortization expense of $26,000. Investor relations expense increased because the Company retained
a new investor relations firm. Depreciation expense increased due to the classification of certain WavSTAT4 machines as demonstration
units. Payroll expense increased due to the payment of senior management bonuses and bad debt expense increased due to the Company’s
shift from small country-specific distributors to PENTAX Europe GmbH. Stock compensation expense decreased due to a comparative
reduction in stock option grants between the two comparative periods.



Sales and marketing expenses for the nine months ended September
30, 2012 and 2011 were approximately $348,000 and $411,000, respectively. The decrease of approximately $63,000 was due to approximate
decreases of $65,000 in recruiting expense, $33,000 in advertising expense, $18,000 in travel expense and $10,000 in other expense
offset by approximate increases of $53,000 in payroll expense and $10,000 in stock compensation expense. The decreases are generally
a result of the long recruitment time required to hire a European-based business development executive to service international
markets and an offset with the increased payroll cost of this executive.



As a result of the above, the approximate net operating loss
for the nine months ended September 30, 2012 and 2011 was $2,808,000 and $3,010,000, respectively.  Of the net operating
loss for the nine months ended September 30, 2012, approximately $280,000 was comprised of non-cash stock option expense.



Non-operating expense increased approximately $6,732,000 as
a result of non-cash expenses related to our convertible debt issuance comprised of approximate increases in warrant and derivative
liability expense of $3,265,000, increased amortization of debt discount of approximately $2,253,000, increased amortization of
debt issuance costs and original issue discount of approximately $958,000 and increased interest expense of approximately $259,000
offset by a decrease in other expense of $3,000.



As a result of the above, our net loss increased by approximately
$6,541,000 for the nine months ended September 30, 2012 and 2011 from approximately $3,004,000 to $9,545,000.  Of the
net loss for the nine months ended September 30, 2012, approximately $7,015,000 was comprised of non-cash expense.



Liquidity and Capital Resources



As of September 30, 2012, the Company had negative working capital
of approximately $2.7 million and cash and cash equivalents of approximately $66,000, compared to positive working capital of approximately
$171,000 and cash and cash equivalents of approximately $251,000 as of December 31, 2011. In December 2011, the Company entered
into an Engagement Agreement with Laidlaw & Company (UK) Ltd. Under the Engagement Agreement, Laidlaw agreed to assist the
Company in raising up to $20.0 million in capital over the next two years. During the nine-month period ended September 30, 2012,
the Company raised approximately $2.2 million, net of transaction costs, under this agreement. However, if the Company does not
receive additional funds in a timely manner, the Company could be in jeopardy as a going concern. The Company may not be able to
find alternative capital or raise capital or debt on terms that are acceptable. Management believes that if the events defined
in the Engagement Agreement occur as expected, such proceeds will be sufficient to allow the Company to sustain operations until
it attains profitability and positive cash flows from operations. However, the Company may incur unknown expenses or may not be
able to meet its revenue expectations which requiring it to seek additional capital. In such event, the Company may not be able
to find capital or raise capital or debt on terms that are acceptable.



Since December 31, 2011, the Company’s net working
capital deficit has increased from approximately ($171,000) to ($2,700,000). The primary cause of this deficit increase is a
result of the accounting treatment required for the Convertible Debentures issued through the nine-months ended September 30,
2012. The Company has paid principal and interest on the Convertible Debentures that have reached
maturity and been voluntarily converted by holders and interest on such Convertible Debentures by issuing shares of
common stock and plans to continue to do so in the future. At September 30, 2012, adjusting for the non-cash effect of
the Convertible Debentures on the Company’s net working capital deficit, the adjusted net working capital deficit
would have been approximately ($312,000).



The Company paid principal and interest owing on
Convertible Debentures that have been  voluntarily converted by holders by issuing shares of common stock. In the future, the
Company expects to continue to retire Convertible Debentures and to pay principal and interest owing by issuing common stock.
The holders of Convertible Debentures control the conversion of the Convertible Debentures and certain of the Convertible
Debentures were not converted at their maturity constituting a potential default on these remaining matured, but unconverted,
Convertible Debentures. The holders of these unconverted Convertible Debentures have the option to declare their Convertible
Debentures in default. In the event of such default, principal, accrued interest at a default rate of 20% per annum and other
related costs are immediately due and payable in cash.





16







During the three-month period ended September 30, 2012,
Convertible Debentures with a face value of approximately $2,350,000 held by a total of 44 investors matured. Of
these debentures, those with a face value of approximately $1,940,000 (held by 41 investors) were voluntarily converted as of
the date of this quarterly report. There remain matured, but outstanding Convertible Debentures with a face value of
approximately $411,000 held by three individual investors. None of these three investors have served the Company with notice
of default on the Convertible Debentures held by them.



The financial statements included elsewhere in this quarterly
report have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities
in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification
of assets or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as
a going concern.



Off-Balance Sheet Arrangements



We have no off-balance sheet arrangements.



Item 3. Quantitative and Qualitative Disclosures About
Market Risk



Not required



Item 4. Controls and Procedures



Evaluation of Disclosure Controls and Procedures



Under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this
Report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures are effective.



Changes in Internal Financial Controls



There was no change in the Company’s internal control
over financial reporting that occurred during the Company’s most recently completed quarter that has materially affected,
or is reasonably likely to materially affect, the Company’s internal control over financial reporting.





17









|PART II | OTHER INFORMATION
|------- | -----------------



|Item 1. | Legal Proceedings
|------- | -----------------



None



|Item 1A. | Risk Factors
|-------- | ------------



There have been no material changes in our risk factors
from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.



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



In July 2012, the Company issued
50,000 shares of restricted common stock to a vendor for services. The issuance of the shares was exempt from registration by virtue
of section 4(2) of the Securities Act as an issuance not involving a public offering.



During the quarter ended September
30, 2012, the Company issued and aggregate of 28,149,163 shares of common stock pursuant to the conversion by purchasers of 5%
Original Issue Discount Unsecured Convertible Debentures with a conversion price equal to $0.0573 per share. The issuance of the
shares was exempt from registration by virtue of Section 3(a)(9) of the Securities Act.



In September 2012, the Company
granted stock options to purchase 4,746,667 shares of common stock at an exercise price of $0.12 per share to six employees of
the Company. The options vest 25% one year from grant and 1/36 of the remaining grant amount for the remaining three years. The
issuance of the stock option was exempt from registration by virtue of Rule 701 promulgated under the Securities Act as offers
and sale of securities pursuant to certain compensatory benefit plans and contracts relating to compensation in compliance with
Rule 701.



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------



As of the date of this quarterly report there
are 5% Original Issue Discount Unsecured Convertible Debentures with a face value of approximately $411,000 held (at a default rate of 20% per annum) by
three individual Holders in default. As a result, the outstanding principal amount of these Debentures, plus accrued but
unpaid interest (at a default rate of 20% per annum), liquidated damages and other amounts owing (estimated to be approximately
$41,100) will become immediately due and payable in cash at the election of the Holders. As of the date of this quarterly
report, none of the Holders of these Debentures have elected to provide the Company with notice of default.



|Item 4. | Mine Safety Disclosures
|------- | -----------------------



None



|Item 5. | Other Information
|------- | -----------------





On
October 1,2012,theCompanyissued25,000 shares of restricted common stocktoa
vendor forservices.Theissuanceof theshareswas exemptfrom registration
byvirtue of Section 4(2) oftheSecurities
Act as anissuance
notinvolving apublicoffering.



On
November 6,2012,holdersof ConvertibleDebentureswith a face value of$473,685 convertedtheirConvertibleDebentures into8,266,740
shares ofcommonstock.Inaddition, associated with these ConvertibleDebentures,theCompanypaid$47,369inaccruedinterest
by issuing 826,674shares of common stock. Theissuanceoftheshareswasexempt fromregistration
byvirtue ofSection3(a)(9)
of the Securities Act.



On
October 24,2012, aholderof a cashless warrantto
purchase86,340 shares ofrestricted commonstock
exercisedthewarrantina cashlesstransactionand
wasissued 14,870
shares ofrestricted commonstock. Theissuanceoftheshareswas exempt fromregistrationby
virtue ofSection3(a)(9) ofthe
SecuritiesAct.



On
November 2, 2012,the Companyissueda five-yearcashlesswarranttoa vendortopurchase 300,000
shares ofrestrictedcommonstockat an exercisepriceof
$0.096 per share.The issuanceofthewarrant was exempt fromregistration byvirtue
of Section4(2)ofthe
SecuritiesAct asan issuance not involvingapublicoffering.







|Item 6. | Exhibits
|------- | --------



|3.1  | Amendment, dated July 13, 2012, to the Company’s Amended and Restated Articles of Incorporation incorporated by reference to the Company’s quarterly report on Form 10-Q for the quarter ended June 30, 2012.
|---- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                                                              
|4.1  | Form of Debenture issued by the Company to each subscriber in the Company’s Convertible Debenture Offering.                                                                                                  
|     |                                                                                                                                                                                                              
|4.2  | Form of Common Stock Purchase Warrant issued by the Company to each subscriber in the Company’s Convertible Debenture Offering.                                                                              
|     |                                                                                                                                                                                                              
|10.1 | Form of Subscription Agreement by and between the Company and each Subscriber for the Company’s Convertible Debenture Offering.                                                                              



|31.1 | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- | ---------------------------------------------------------------------------------------------------



|31.2 | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|---- | ---------------------------------------------------------------------------------------------------





18







|32.1 | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|---- | ---------------------------------------------------------------------------------------------------



|32.2 | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                               
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     |                                                                                                                                                                                                                                                                                                                                                                                                   
|101* | Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended September 30, 2012, formatted in XBRL; (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statement of Shareholders’ Equity, (iv) the Consolidated Statements of Cash Flows, and (v) the Notes to the Consolidated Financial Statements.







* To be furnished by amendment.





19







SIGNATURES



Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                        | SpectraScience, Inc.
        (Registrant)
|----------------------- | -----------------------------------------
|                        |                                          
|Date: November 14, 2012 |                                          
|                        |                                          
|                        |                                          
|                        |                                          
|                        |                                          
|Date: November 14, 2012 |                                          
|                        |                                          
|                        |                                          
|                        |                                          





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