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CBMX > SEC Filings for CBMX > Form 10-Q on 13-May-2013All Recent SEC Filings

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Form 10-Q for COMBIMATRIX CORP


13-May-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Statement

You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained in Part I, Item 1 of this report. The information contained in this Quarterly Report on Form 10-Q is not a complete description of our businesses or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the U.S. Securities and Exchange Commission, or "SEC," including our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 25, 2013.

This report contains forward-looking statements within the meaning of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact included in this report, are forward-looking statements. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives, and other forward-looking statements included in this report. Such statements may be identified by the use of forward-looking terminology such as "may," "will," "should," "would," "could," "expect," "believe," "estimate," "anticipate," "intend," "plan," "predict," "seek," "potential," "continue," "focus," "ongoing," or similar terms, variations of such terms or the negative of such terms, and include, but are not limited to, statements regarding projected results of operations, capital expenditures, earnings, management's future strategic plans, product development, litigation, regulatory matters, market acceptance and performance of our products and services, the success and effectiveness of our technologies, our ability to retain and hire key personnel, the competitive nature of and anticipated growth in our markets, market position of our products and services, marketing efforts and partnerships, liquidity and capital resources, our accounting estimates, and our assumptions and judgments. Such statements are based on management's current expectations, estimates and projections about our industry, management's beliefs, and certain assumptions made by us, all of which are subject to change. These forward looking statements are not guarantees of future results and are subject to a number of risks, uncertainties and assumptions that are difficult to predict and that could cause actual results to differ materially and adversely from those described in the forward-looking statements. The risks and uncertainties referred to above include, but are not limited to, our ability to consummate the Series C Second Closing; our stockholders' approval of the Series C Financing; our ability to obtain additional financing for working capital on acceptable terms and in a timely manner; our ability to successfully increase the volume of our existing tests, expand the number of tests offered by our laboratory, increase the number of customers and partners and improve reimbursement for our testing; our ability to regain and maintain compliance with Nasdaq's listing requirements; our ability to continue as a going concern; changes in consumer demand; our ability to attract and retain a qualified sales force and key technical personnel; our ability to successfully develop products; our ability to successfully introduce new technologies and services; rapid technological change in our markets; supply availability; the outcome of existing litigation; our ability to bill and obtain reimbursement for highly specialized tests; our ability to comply with regulations to which our business is subject; legislative, regulatory and competitive developments in markets in which we and our subsidiaries operate; our limited market capitalization; future economic conditions; other circumstances affecting anticipated revenues and costs; and other factors as more fully disclosed in our discussion of risk factors in Item 1A of Part II of this report and in the "Risk Factors" described in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 25, 2013. Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements. These forward-looking statements speak only as of the date of this report and we expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based, except as required by law.

General

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 microarray genetic testing, 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.

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.


Table of Contents

Overview

For the three months ended March 31, 2013, our operating activities included the recognition of $1.6 million of total revenues, which increased by $342,000 from the comparable period in 2012 due primarily to increased volumes of molecular diagnostic tests performed. Our net loss decreased over the comparable periods due partially to increased revenues and reduced operating expenses as a result of cost reduction efforts executed during the second quarter of 2012, but primarily due to a non-cash warrant derivative gain of $1.8 million that was recognized during the first quarter of 2013.

In addition, we completed financing activities in the first quarter of 2013, including a registered direct offering to an existing institutional investor of Series B convertible preferred stock, common stock and warrants to purchase common stock (the "Series B Financing"), resulting in net proceeds to us of $1.8 million. The exercise of certain warrants from our Series A convertible preferred stock financing executed during the fourth quarter of 2012 (the "Series A Warrants") resulted in additional proceeds of $993,000 through March 31, 2013, and additional proceeds of $402,000 in April 2013.

On May 3, 2013, we executed agreements to issue securities in a private placement transaction with certain accredited investors that, subject to stockholder approval, will result in gross proceeds to us totaling $2.4 million to be received in two tranches, with the first tranche having closed on May 6, 2013 and the second tranche expected to close in late June or early July 2013 following our annual stockholders' meeting. Such financing is through the sale of Series C convertible preferred stock (the "Series C Stock") with the first tranche having an initial conversion price of $3.05 per share of common stock, subject to future adjustments, and 125% warrant coverage at an exercise price of $3.77 per share. The Series C Stock also accrues an annual dividend of 6%, increasing by 1% per year that the Series C Stock remains outstanding but not to exceed 10%. Upon closing of the first tranche, we received gross proceeds of $1.2 million from the investors and, pending stockholder approval, expect to receive the remaining $1.2 million within five business days after our annual stockholders' meeting expected to occur in June 2013.

Critical Accounting Estimates

Our unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. Preparation of these statements requires management to make judgments and estimates. Some accounting policies have a significant impact on amounts reported in these financial statements. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 25, 2013, in the Notes to the Consolidated Financial Statements and the Critical Accounting Estimates sections. In addition, refer to Note 2 to the consolidated interim financial statements included in Part I, Item 1 of this report.

Comparison of the Results of Operations for the Three Months Ended March 31, 2013 and 2012

Revenues and Cost of Revenues (dollars in thousands):



                        Three Months Ended
                            March 31,             Change
                         2013         2012       $      %

Diagnostic services   $    1,586    $  1,244   $ 342    27%
Royalties                     25          25       -     0%
Cost of services            (937 )      (659 )  (278 ) (42% )


Table of Contents

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 test volumes were 1,718 for the three months ended March 31, 2013, compared to 1,377 for the comparable period in 2012, representing an increase of 25%, while diagnostic services revenues were $1.6 million for the three months ended March 31, 2013, compared to $1.2 million for the comparable period in 2012, representing an increase of 27%. The reason that diagnostic testing volumes have not increased by the same percentage as diagnostic services revenues is due to a shift in test mix during 2013 towards a higher concentration of microarray testing, particularly in the prenatal testing market. During 2012, cytogenetic tests in this market, including FISH and chromosome analysis, represented 61% of total tests performed, whereas in 2013, FISH and chromosome analysis represented 49% of total prenatal testing. These non-array tests are priced and reimbursed at lower rates than our array-based tests, which represented 39% of total tests performed in 2012 and 51% of total prenatal testing in 2013. As a result, our overall average revenue per test increased from $904 in 2012 to $923 in 2013. 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 three months ended March 31, 2013 and 2012, net positive revenue adjustments were $202,000 and $221,000, respectively.

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. We received the minimum contractual amount for the three months ended March 31, 2013 and 2012. It is uncertain whether in future periods, CA's revenues will increase or continue at 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. Increases in cost of services are due to increased volumes period-over-period. For the three months ended March 31, 2013 and 2012, non-cash stock compensation expenses were not significant.

Operating Expenses (dollars in thousands):



                               Three Months Ended
                                   March 31,             Change
                               2013         2012        $       %

Research and development     $     183    $     450   $ (267 ) (59% )
Sales and marketing                641          873     (232 ) (27% )
General and administrative       1,373        1,574     (201 ) (13% )

Research and Development. These expenses include labor (wages and benefits), non-cash stock compensation expenses and laboratory supply costs associated with investigating and validating new tests, costs to maintain and improve our existing suite of diagnostic tests offered and process improvement projects. 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. For the three months ended March 31, 2013, research and development expenses decreased from the comparable 2012 period due primarily to reduced headcount as well as from lower supply and materials costs incurred. For the three months ended March 31, 2013 and 2012, non-cash stock compensation expenses were not significant.

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 as well as non-cash stock compensation expenses. For the three months ended March 31, 2013, sales and marketing expenses decreased from the comparable 2012 period due primarily to reduced headcount, travel and marketing expenses primarily as a result of our cost reduction efforts executed near the end of the second quarter of 2012. For the three months ended March 31, 2013 and 2012, non-cash stock compensation expenses were not significant.


Table of Contents

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. For the three months ended March 31, 2013, general and administrative expenses decreased from the comparable 2012 period due primarily to reduced third-party billing fees and lower bad debt expenses, partially offset by increased salaries and benefits resulting from the hiring of our Chief Medical Officer during the second quarter of 2012. Included in general and administrative expenses are non-cash stock-based compensation expenses, which were $68,000 and $155,000 for the three months ended March 31, 2013 and 2012, respectively. The decreases were due primarily to prior stock option awards that were or became fully vested during recent periods, resulting in fewer option awards subject to vesting and related expenses during the current period as compared to the prior period. See Note 2 to our consolidated interim 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.

Other Non-Operating Items (dollars in thousands):



                             Three Months Ended
                                 March 31,              Change
                              2013         2012       $        %

Interest expense           $      (302 )  $    (6 ) $ (296 ) (4933% )

Warrant derivatives gain 1,837 - 1,837 -

Interest Expense. Prior to the fourth quarter of 2012, interest expense was entirely comprised of interest charges associated with certain capital leases for laboratory equipment, which were $21,000 and $6,000 for the three months ended March 31, 2013 and 2012, respectively. Increases are due to additional capital leases during 2012. In addition, $280,000 of interest expense in 2013 is related to the amortization of offering-related costs incurred during the fourth quarter of 2012. These costs were being amortized over the Series A Warrant exercise restriction period of six months from issuance, but due to a modification on February 22, 2013 to the Series A Warrants resulting in immediate exercisability, all of the unamortized offering related costs as of December 31, 2012 were charged to interest expense during the first quarter of 2013.

Warrant Derivatives Gain. This represents the net gain recognized from mark-to-market adjustments of the Series A Warrants to their estimated fair values as of March 31, 2013. There were no such activities during the first quarter of 2012. We valued the Series A Warrants using the Monte-Carlo simulation method using the following assumptions at March 31, 2013:
(i) closing stock price and Series A Warrant contractual exercise price;
(ii) term to expiration commensurate with the individual Series A Warrant terms ranging from 5.0 years to 5.2 years; (iii) historical volatilities commensurate with the term of the Series A Warrants ranging from 114.5% to 116.0%;
(iv) risk-free interest rates commensurate with the term of the Series A Warrants ranging from 0.7% to 0.8%; and (v) simulated anti-dilution impact assuming various probabilities that we will raise additional capital by issuing equity securities at prices above or below the current contractual Series A Warrant exercise prices during the Series A Warrant terms. The result of these valuation simulations was to value the remaining Series A Warrants held by Series A Investors at $2.6 million, which was $1.8 million below their fair value as of December 31, 2012. As a result, we recognized a $1.8 million non-operating, warrant derivative gain in our consolidated statement of operations for the period ended March 31, 2013. The Series A Warrants were valued as Level 3 liabilities under our policies for assessing fair value measurements. If the inputs such as volatility and probability of subsequent financings were to change, the concluded values could change significantly.

Inflation

Inflation has not had a significant impact on our business, results of operations or financial condition.


Table of Contents

Liquidity and Capital Resources

At March 31, 2013, cash and cash equivalents totaled $3.4 million, compared to $2.4 million at December 31, 2012. Cash is held primarily in general checking accounts as well as in money market mutual funds backed by U.S. government securities. Working capital at March 31, 2013 was $1.4 million, compared to a working capital deficit of $(1.4 million) at December 31, 2012. The change in working capital was due primarily to the impact of net cash flow activities as discussed below. The net change in cash and cash equivalents for the periods presented was comprised of the following (in thousands):

                                                     Three Months Ended
                                                         March 31,
                                                      2013         2012     Change
Net cash provided by (used in):
Operating activities                               $    (1,601 ) $ (1,625 ) $    24
Investing activities                                       (13 )      (17 )       4
Financing activities                                     2,647        (29 )   2,676
Increase (decrease) in cash and cash equivalents   $     1,033   $ (1,671 ) $ 2,704

Operating Activities. The decrease in net cash flows used in operating activities resulted primarily from lower cash reimbursement from customers, which was partially offset by decreased operating expenses described above.

Investing Activities. The decrease in net cash flows used in investing activities was due to a decrease in capital expenditures.

Financing Activities. The increase in net cash flows from financing activities was due primarily to the $1.8 million of net proceeds received from the Series B Financing coupled with $993,000 in proceeds from the exercise of certain Series A Warrants during the first quarter of 2013. There were no such financing activities during the first quarter of 2012.

Future Liquidity. We have a history of incurring net losses and net operating cash flow deficits. We are also deploying new technologies and continue to develop commercial services. We believe that our cash and cash equivalent balances at March 31, 2013, combined with: (i) $1.2 million of gross proceeds received on May 6, 2013 and $1.2 million of gross proceeds expected to be received from the recent Series C Financing described above; and (ii) $402,000 in proceeds from the exercise of certain Series A Warrants in April of 2013, will allow us to meet our cash requirements into the second quarter of 2014, assuming our stockholders approve the second tranche of the Series C Financing at our upcoming annual stockholders meeting. In the event the Series C Financing is not approved by stockholders and the second tranche closing does not occur, we believe we can meet our cash requirements into the first quarter of 2014.

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 assurance 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 stockholders. 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 Note 1 to the consolidated interim financial statements included elsewhere in this report for additional discussion of these matters.

Capital Requirements. We may also encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated. As a result, we may be required to seek additional funding through equity, debt or other external financing, and there can be no assurance that additional funding will be available on favorable terms, in a timely fashion or at all. At this time, we have no significant commitments for capital expenditures in 2013 or beyond. However, our long-term capital requirements could be substantial and the adequacy of available funds will depend upon many factors, including:

the costs of commercialization activities, including sales and marketing costs and capital equipment;

competing technological developments;

the creation and formation of strategic partnerships;

the costs associated with leasing and improving our Irvine, California facility; and

other factors that may not be within our control.


Table of Contents

Off-Balance Sheet Arrangements

As of March 31, 2013, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC. However, we have entered into an operating lease for our laboratory space and corporate offices, totaling approximately 12,200 square feet, expiring in January of 2014. We have no significant commitments for capital expenditures for the remainder of 2013 or beyond. We have executed twelve capital leases totaling $699,000 for certain laboratory and IT-related equipment, with lease payments continuing through 2017.

Recent Accounting Pronouncements

None that are expected to have a material impact to the Company's consolidated financial statements.

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