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CBMX > SEC Filings for CBMX > Form 10-K on 25-Mar-2013All Recent SEC Filings

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Annual Report


The following discussion should be read in conjunction with our consolidated financial statements included elsewhere in this report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors including those set forth under the heading "Risk Factors" elsewhere in this report.


We are a molecular diagnostics company that operates primarily in the field of genetic analysis and molecular diagnostics through our wholly owned subsidiary, CombiMatrix Molecular Diagnostics, Inc. ("CMDX"), located in Irvine, California. CMDX operates as a diagnostics reference laboratory providing DNA-based clinical diagnostic testing services to physicians, hospitals, clinics and other laboratories in two primary areas: (i) prenatal and postnatal developmental disorders; and (ii) hematology/oncology genomics. CMDX provides its services primarily through the use of array-comparative genomic hybridization ("aCGH"), which enables the analysis of genetic anomalies, as well as through other test offerings including fluorescent in-situ hybridization ("FISH") and G-Band Chromosome analysis. Our mission is to empower physicians to positively impact patient care through the delivery of innovative molecular diagnostics services.

Prior to 2010, we were primarily focused on developing proprietary DNA array-based tools and instruments for the genetic research community, under the brand formerly known as "CustomArray," as well as providing molecular diagnostics services through CMDX. On April 19, 2010, we announced a strategic and operational restructuring plan (the "Restructuring Plan") intended to significantly reduce operating costs, increase the focus on our diagnostic services business and transition senior management. As part of the Restructuring Plan, we closed our CustomArray business and facilities located in Mukilteo, Washington and relocated our corporate headquarters to Irvine, California. Since the restructuring, our primary focus has been on our diagnostics services business. Our goals include increasing utilization of our existing tests, expanding our diagnostic test menu, increasing and diversifying our client base, and improving reimbursement for our testing services.

As a result of executing the Restructuring Plan, the financial results of our CustomArray business have been classified as discontinued operations in the consolidated statements of operations for all periods presented. Unless otherwise noted, amounts and disclosures throughout this report relate to our continuing operations.

We also own a one-third minority interest in Leuchemix, Inc. ("Leuchemix"), a private drug development company focused on developing a series of compounds to address a number of oncology-related diseases.

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At December 31, 2012, we had cash and cash equivalents of $2.4 million. From January 1, 2013 through March 15, 2013, we have received net proceeds of $2.7 million from financing activities discussed further below. As a result, we anticipate that our cash and cash equivalent balances, inclusive of recent financing activities and coupled with anticipated cash flows from operations will be sufficient to meet our cash requirements into the fourth quarter of 2013. In order for us to continue as a going concern beyond this point and ultimately to achieve profitability, we will be required to obtain capital from external sources, increase revenues and reduce operating costs. However, there can be no assurances that our operations will become profitable or that external sources of financing, including the issuance of debt and/or equity securities, will be available at times and at terms acceptable to us, or at all. The issuance of additional equity or convertible debt securities will also cause dilution to our shareholders. If external financing sources are not available or are inadequate to fund our operations, we will be required to reduce operating costs, including research projects and personnel, which could jeopardize our future strategic initiatives and business plans. See the Liquidity and Capital Resources section below as well as Note 1 to our consolidated financial statements included elsewhere in this report for additional discussion of these matters.

Overview of Recent Business Activities

During 2012, our business activities were driven primarily by commercialization efforts for our suite of molecular diagnostic tests, expansion of our test menu and of our leadership team. For the year ended December 31, 2012, our operating activities included the recognition of $5.4 million of total revenues, which increased by $692,000 from 2011 due primarily to increased volumes of molecular diagnostic tests performed, increases in royalty revenues and from recognition of one-time revenues from providing clinical trials support services to one customer during the third quarter of 2012. In the area of molecular testing, our volumes from our prenatal testing services increased by 172% from 2011, and total molecular testing from all of our test offerings increased by 25%. Our net loss from operations decreased over the comparable period due to increased revenues and also from reduced operating expenses as a result of cost reduction efforts executed during the second quarter of 2012, which included the elimination of certain staff positions across all functional areas of the Company. Our net loss increased due primarily from charges recognized in 2012 relating to mark-to-market adjustments of our warrant derivative liabilities, which were issued as part of an equity financing discussed.

Also during 2012, we made significant changes to our executive management and leadership teams by hiring Richard Hockett, MD, as our Chief Medical Officer, who joined us on May 1, 2012, and by hiring Mark McDonough as Chief Commercial Officer, who joined us on August 23, 2012. During the first quarter of 2012, we named Richard Ding and Joseph Limber to our Board of Directors and, during the second quarter, appointed Dr. Ronald J. Wapner to our Scientific Advisory Board. On October 9, 2012, Mr. Limber resigned from our Board for personal reasons. During the fourth quarter of 2012, we named Jeremy Jones to our Board of Directors.

On October 1, 2012, we announced the execution of an agreement to issue securities in a private placement transaction to certain accredited investors ("Investors") that resulted in gross proceeds paid to us of $2.5 million, which was received in two tranches, with the first tranche having closed on October 1, 2012 and the second tranche having closed on December 6, 2012, following the approval by our stockholders at a special meeting held on November 29, 2012. The financing was through the sale of Series A convertible preferred stock and warrants to purchase common stock (the "Series A Financing") at 100% warrant coverage, meaning that the number of shares of common stock underlying the warrants was equal to the number of shares of common stock initially issuable from conversions of the Series A preferred stock. For the first tranche, the conversion price of the Series A preferred stock and the exercise price of the common stock warrants were $4.9112 and $9.50 per share of common stock, respectively, subject to future adjustments. For the second tranche, the conversion price of the Series A preferred stock

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and the exercise price of the common stock warrants were $1.9995 and $2.364 per share of common stock, respectively, also subject to future adjustments. As a result of closing the second tranche at a conversion price lower than the first tranche, the conversion price of the first tranche Series A preferred stock was reduced to $1.9995 and the number of shares of common stock issuable from conversion of the Series A Preferred stock was increased. In total, the $2.5 million of Series A preferred stock issued during the fourth quarter of 2012 was convertible into 1.25 million shares of common stock, along with warrants ("Series A Warrants") to purchase 938,770 shares of common stock. The preferred stock also accrued dividends at an annual rate of 6%. On February 26, 2013, we entered into an agreement with the Investors to modify the Series A Warrants such that they would become immediately exercisable as of February 22, 2013 (the "Modification Date"). Since the Modification Date through March 15, 2013, 329,820 shares of common stock have been issued from exercise of the Warrants, resulting in gross proceeds to the Company of $934,000.

On February 18, 2013, R. Judd Jessup informed our Board of Directors that he would retire as Chief Executive Officer effective March 15, 2013. Martin Felsenthal also resigned from our Board on the same date. Mark McDonough, our Chief Commercial Officer, became a director on February 28, 2013 and Chief Executive Officer on March 15, 2013. Richard Hockett, Jr., MD, our Chief Medical Officer, was also named to our Board of Directors on February 28, 2013. On March 12, 2013, Mark McGowan announced his resignation from our Board, and R. Judd Jessup was appointed Chairman of the Board on that date.

On March 19, 2013, we entered into a definitive securities purchase agreement with an existing institutional investor to purchase 130,000 shares of common stock at a price of $3.05 per share and approximately 1,610 units consisting of Series B 6% convertible preferred stock (the "Series B Preferred Stock") and warrants to purchase up to 275,000 shares of common stock at an exercise price of $3.49 per share (the "Series B Warrants") in a registered direct offering (the "Series B Offering") of securities off of our existing shelf registration statement on Form S-3 (File No. 333-176372). The Series B Offering closed on March 20, 2013 ("Closing"). The Series B Preferred Stock and Series B Warrants were sold in multiples of fixed combinations, with each fixed combination consisting of one share of Series B Preferred Stock and a Series B Warrant to purchase approximately 171 shares of common stock. Each fixed combination of Series B Preferred Stock and Series B Warrants were sold at a price of $1,000. The Series B Preferred Stock is convertible into an aggregate of 528,000 shares of common stock at an initial conversion price of $3.05 per share. The Series B Preferred Stock is not convertible into greater than 19.99% (when aggregated with the common shares purchased in the Offering) of our outstanding common stock unless and until stockholder approval is obtained. The Series B Warrants are not exercisable for six months from Closing, and the Series B Preferred Stock will accrue dividends at an annual rate of 6% beginning six months after Closing, assuming the Series B Preferred Stock has not been converted by that time. Upon closing of the Offering, we received proceeds of $1.76 million, net of placement agent fees and other related costs. Also as a result of the Offering, the exercise price of certain Series A Warrants automatically ratcheted down by their terms from their original exercise price of $9.50 per share to an adjusted exercise price of $3.05 per share, and the underlying shares exercisable was automatically increased from 213,945 shares to 666,365 shares.

Critical Accounting Policies

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. In preparing these financial statements, we make assumptions, judgments and estimates that can have a significant impact on amounts reported in our financial statements. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. On a regular basis we evaluate our assumptions, judgments and estimates and make changes accordingly.

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We believe that, of the significant accounting policies discussed in Note 2 to our consolidated financial statements, the following accounting policies require our most difficult, subjective or complex judgments:

revenue recognition and estimates for contractual allowances;

accounting for stock-based compensation;

accounting for derivative financial instruments;

fair value measurements; and

accounting for income taxes.

We discuss below the critical accounting assumptions, judgments and estimates associated with these policies. Historically, our assumptions, judgments and estimates relative to our critical accounting policies have not differed materially from actual results. For further information on our critical accounting policies, refer to Note 2 to our consolidated financial statements included elsewhere in this report.

Revenue Recognition

As described below, significant management judgments must be made and used in connection with the revenue recognized in any accounting period. Material differences may result in the amount and timing of revenue recognized or deferred for any period if management made different judgments.

In general, we recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been performed,
(iii) amounts are fixed or determinable and (iv) collectability of amounts is reasonably assured.

Service revenues from providing diagnostic tests are recognized when the testing process is complete and test results are reported to the ordering physician or clinic. These diagnostic services are billed to various payors, including commercial insurance companies, healthcare institutions, individuals and government payors including Medicare and Medicaid. We report revenues from contracted payors based on a contractual rate, or in the case of Medicare and Medicaid, published fee schedules for our tests. We report revenues from non-contracted payors based on the amount expected to be collected. The difference between the amount billed and the amount expected to be collected from non-contracted payors is recorded as a contractual allowance to arrive at net recognized revenues. The expected revenues from non-contracted payors are based on the historical collection experience of each payor or payor group, as appropriate. In each reporting period, we review our historical collection experience for non-contracted payors and adjust our expected revenues for current and subsequent periods accordingly. We also recognize additional revenue from actual cash payments that exceed amounts initially recognized, in the period the payments are received. Because a substantial portion of our revenues is from non-contracted third-party payors, it is likely that we will be required to make positive or negative adjustments to accounting estimates with respect to contractual allowances in the future, which may positively or adversely affect our results of operations. In all cases described above, we report revenues net of any applicable statutory taxes collected from customers, as applicable.

Accounting for Stock-Based Compensation

The compensation cost for all employee stock-based awards is measured at the grant date, based on the fair value of the award, and is recognized as an expense, on a straight-line basis, over the employee's requisite service period (generally the vesting period of the equity award) which is generally three to four years. The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model. Stock-based compensation expense is recognized only for those awards that are expected to vest using an estimated forfeiture rate. We estimate pre-vesting option forfeitures at the time of grant and reflect the impact of estimated pre-vesting option forfeitures in compensation expense recognized.

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Accounting for Derivative Financial Instruments

We evaluate financial instruments for freestanding or embedded derivatives. Derivative instruments that do not qualify for permanent equity classification are recorded as liabilities at fair value, with changes in value recognized as other income (expense) in the consolidated statements of operations in the period of change. Derivative warrant liabilities are categorized as either short-term or long-term based upon management's estimates as to when the derivative instrument may be realized. Management judgment is required in identifying derivative instruments and whether or not such instruments should be classified as liabilities or as a component of permanent equity based upon interpretations of existing accounting literature. Also, management judgment is required in determining the assumptions and valuation methods to be used for valuing the derivatives. If actual results differ from these estimates, the future impact on our consolidated financial position and results of operations could be significant.

     Fair Value Measurements

    We measure fair value as an exit price, representing the amount that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. As such, fair value is a market-based
measurement that is determined based on assumptions that market participants
would use in pricing an asset or liability. We utilize a three-tier fair value
hierarchy, which prioritizes the inputs used in measuring fair value as follows:

  Level 1:   Observable market inputs such as quoted prices in active markets;
            Observable market inputs, other than the quoted prices in active
  Level 2:   markets, that are observable either directly or indirectly; and
            Unobservable inputs where there is little or no market data, which
  Level 3:   require the reporting entity to develop its own assumptions

Accounting for Income Taxes

We recognize income taxes on an accrual basis based on tax positions taken or expected to be taken in our tax returns. A tax position is defined as a position in a previously filed tax return or a position expected to be taken in a future tax filing that is reflected in measuring current or deferred income tax assets and liabilities. Tax positions are recognized only when it is more likely than not (i.e., likelihood of greater than 50%), based on technical merits, that the position would be sustained upon examination by taxing authorities. Tax positions that meet the more likely than not threshold are measured using a probability-weighted approach as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement. Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. A valuation allowance is established to reduce deferred tax assets if all, or some portion, of such assets will more than likely not be realized. Should they occur, our policy is to classify interest and penalties related to tax positions as income tax expense. Since our inception, no such interest or penalties have been incurred, however.

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Comparison of the Results of Operations

Revenues and Cost of Revenues (dollars in thousands):

                                             For the Years Ended
                                                December 31,            Change
                                              2012          2011       $       %
         Diagnostic services                $    4,975    $  4,558   $ 417      9%
         Clinical trial support services           195           -     195       -

Royalties 180 100 80 80% Cost of services (2,702 ) (2,642 ) (60 ) (2% )

Diagnostic Services. Diagnostic services revenues are generated from providing DNA-based genomic testing services primarily in the areas of prenatal and postnatal development disorders in children and, to a lesser extent, in oncology. Total billable testing volumes were 5,782 for the year ended December 31, 2012, compared to 4,634 for 2011, representing an increase of 25%. The reason that diagnostic services revenues have not increased by the same percentage as diagnostic testing volumes is due to a change in mix during 2012 of the types of diagnostic services performed. Cytogenetic tests in the prenatal market, including FISH and chromosome analysis, are priced and reimbursed at lower rates than our array-based tests, which made up the majority of our testing volumes in 2011. As a result, our average revenue per test decreased from $984 in 2011 to $860 in 2012. In addition, decreases in oncology and pediatric testing volumes were offset by increases in prenatal testing, resulting in an overall increase in diagnostic services revenues year-over-year. Diagnostic services revenues also includes adjustments relating to our revenue recognition policy of periodically adjusting our estimate for contractual allowances for revenues from non-contracted payors as well as from receiving cash payments in excess of amounts previously recognized for services revenues. For the years ended December 31, 2012 and 2011, net positive revenue adjustments were $570,000 and $448,000, respectively.

Clinical Trial Support Services. In June of 2012, we entered into a materials transfer agreement with Affymetrix, Inc. in support of their clinical trial program. Under the terms of the agreement, we delivered over 300 anonymous patient samples during the third quarter. As a result, we fully satisfied our obligations to Affymetrix, which resulted in recognition of $195,000 of clinical trial support services revenues in 2012. There are no future performance obligations by either party and we do not expect to recognize additional revenues from this agreement in the future.

Royalties. In 2010, we entered into an exclusive licensing agreement with CustomArray, Inc. ("CA"), a private company located in Washington State, for certain of our patents and intellectual property developed as part of our prior microarray manufacturing business. This agreement requires CA to pay us royalties as a percentage of their gross revenues, not less than $25,000 per quarter. Beginning in the second quarter of 2012, CA's gross revenues exceeded the minimum thresholds stipulated in the licensing agreement, resulting in total royalties of $180,000 for 2012, compared to $100,000 in 2011. It is uncertain whether in future periods, CA's revenues will increase, continue at current levels or return to the minimum contractual amounts.

Cost of Services. Cost of services relating to our diagnostic tests performed include direct materials such as array and laboratory costs, direct laboratory labor (wages and benefits), allocation of administrative overhead and stock-compensation expenses. Due primarily to favorable pricing obtained on certain of our direct materials used in providing our services, the percentage changes from 2011 to 2012 are not proportional to the change in revenues during the same periods. For the years ended December 31, 2012 and 2011, non-cash stock compensation expenses were not significant. See Note 2 to our consolidated financial statements included elsewhere in this report for a detailed description of the amounts of non-cash stock compensation expense recognized for the periods presented.

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Operating Expenses (dollars in thousands):

                                          For the Years Ended
                                             December 31,             Change
                                           2012          2011       $        %
           Research and development      $    1,400     $ 1,366   $   34      2%
           Sales and marketing                2,596       2,715     (119 )   (4% )
           General and administrative         5,378       5,567     (189 )   (3% )

Research and Development. These expenses include labor and laboratory supply costs associated with investigating new tests, but primarily consist of development costs to maintain and improve our existing suite of diagnostic tests offered. Prior to launching a new test or modifying an existing test, appropriate clinical trials and extensive laboratory validations, consistent with the various regulations that govern our industry, must be performed. These costs are classified as research and development for all periods presented. The increase in research and development expenses was due primarily to higher laboratory supply costs from test validations of new cytogenetics and related tests launched in early 2012, as well as from higher headcount during the first half of 2012 compared to 2011, partially offset by lower headcount during the second half of 2012 as a result of cost reductions executed in May and June of 2012. In addition, research and development expenses include non-cash stock compensation charges, which were $7,000 and $48,000 for the years ended December 31, 2012 and 2011, respectively. The decrease in stock compensation charges was due primarily to prior stock option awards to our employees which became fully vested late in 2011. See Note 2 to our consolidated financial statements included elsewhere in this report for a detailed description of the amounts of non-cash stock compensation expense recognized for the periods presented.

Sales and Marketing. These expenses include salaries and wages associated with our sales force and marketing resources, sales commissions and other expenses associated with promotional and advertising efforts. The decrease in sales and marketing expenses was due primarily to fewer sales personnel in 2012 compared to 2011 as a result of the cost reductions executed in May and June of 2012. In addition, sales and marketing expenses include non-cash stock compensation charges, which were $4,000 and $43,000 for the years ended December 31, 2012 and 2011, respectively. The decrease in stock compensation charges was due primarily to prior stock option awards to our employees which became fully vested in 2011 and from fewer sales personnel with stock option awards continuing to vest. See Note 2 to our consolidated financial statements included elsewhere in this report for a detailed description of the amounts of non-cash stock compensation expense recognized for the periods presented.

General and Administrative. These expenses include compensation and benefit costs of our administrative staff, client billing and collections, information technology, executive management, human resources and accounting personnel, as well as facilities-related costs, insurance, legal, audit and other professional services. Excluding non-cash stock compensation expenses discussed below, general and administrative expenses were $5.0 million and $4.6 million for the years ended December 31, 2012 and 2011, respectively. General and administrative expenses increased due primarily to higher salaries and benefits costs associated with our Chief Medical Officer and from increased staff in our Billing department, increased recruitment expenses associated with new board . . .

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