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ILIU > SEC Filings for ILIU > Form 10-Q on 14-Aug-2013All Recent SEC Filings

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Form 10-Q for INTERLEUKIN GENETICS INC


14-Aug-2013

Quarterly Report


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

The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial statements and the notes thereto included elsewhere in this document.

General Overview and Trends

Interleukin Genetics, Inc. is a personalized health company that develops specific, health area focused, unique genetic tests. Our overall mission is to provide test products that can help individuals improve or maintain their health through preventive measures or lifestyle changes. Our vision is to use the science of applied genetics to empower individuals and physicians to better understand the set of actions and steps necessary to guide the best lifestyle and treatment options. We believe that the science of applied genetics can help companies provide improved services to their consumers, and assist in improving outcomes in drug development and use.

During the six months ended June 30, 2013, we continued to focus our resources on commercializing our PST® test following completion of the large validation study with the University of Michigan and Renaissance Health Services Corporation ("RHSC") and on the sales of our Inherent Health® brand of genetic tests and related programs. The objective of this study is to improve dental care by identifying and using certain risk factors to set preventative treatment regimens.

On February 25, 2013, we entered into a Preferred Participation Agreement with RHSC, for itself and on behalf of certain of its affiliates and subsidiaries.Pursuant to this agreement, affiliates of RHSC have agreed to reimburse us a fixed price for each PST® genetic test that we process for a customer of affiliates of RHSC. In addition, if during the term of the agreement we offer the PST® test to any other person or party for a lower price, such lower price shall then be applicable to tests processed for a customer of such affiliates of RHSC for the remainder of the term of the agreement. The pricing arrangement is subject to the satisfaction of certain milestones, including that
(1) within a specified timeframe, RHSC affiliates must develop and offer dental benefit plans for which a significant portion of such affiliate's clients are eligible that provides for use of the PST® test and reimbursement of the test at the agreed upon price (each such plan, hereinafter referred to as a "Reimbursed Dental Plan") and (2) prior to a specified date, RHSC affiliates shall have sold policies for Reimbursed Dental Plans for the year beginning January 1, 2014. We have agreed that for a one year period beginning on the date on which RHSC affiliates first offer a Reimbursed Dental Plan, we will make the PST® test available solely to RHSC affiliates and not to any other third party or person. This agreement has a term of three years beginning on February 25, 2013, but may be terminated earlier (1) upon the mutual written agreement of us and RHSC, (2) if either party becomes the subject of bankruptcy, insolvency, liquidation or other similar proceedings, or (3) in the event of an uncured breach of the Agreement by either party.

On June 10, 2013 we announced the online publication of the research study "Patient Stratification for Preventive Dental Care" in Journal of Dental Research. The study provides new insights into the prevention of periodontitis (gum disease) and the opportunity for significant advancement in the delivery of personalized, preventive dental care. Periodontitis affects an estimated 47% of the adult population.

Periodontitis initiation and progression is driven by two factors: bacterial plaque that initiates the disease and the body's inflammatory response to bacteria which, when overly aggressive, causes breakdown of the bone and tissue that support the teeth. This inflammatory response varies greatly within the population and is significantly impacted by individual genetic make-up. Genetic testing can identify patients who have an increased inflammatory response to oral bacteria which significantly increases risk of periodontitis and tooth loss. Smoking and diabetes also contribute significantly to the risk of periodontal disease. The study explored the influence of three key risk factors for periodontal disease-smoking, diabetes and genetics-on tooth loss given varied frequencies of preventive dental visits that included cleanings. By examining claims data from 5,117 patients without periodontitis throughout a 16 year period and conducting genetic testing, researchers determined that patients with genetic variations of the IL-1 genotype, or one or more other risk factors examined, were at significantly increased risk for tooth loss and therefore require more preventive dental care. The IL-1 genetic variation was the single most prevalent risk factor-nearly one in three Americans carry this genetic variation. This study demonstrates the important opportunity to provide more effective preventive oral care through the use of risk-based patient assessment that includes genetic testing.

Research was conducted under the direction of Dr. William Giannobile, Najjar endowed Professor of Dentistry and Biomedical Engineering, and Chair of the Department of Periodontics and Oral Medicine at the University of Michigan.

The timing of any revenues that we may receive under our agreement with RHSC is dependent upon the timing of the offering of Reimbursed Dental Plans, which timing is very uncertain at this time, and is contingent upon a number of factors, including RHSC's affiliates ability to develop Reimbursed Dental Plans and to develop a viable market for such plans. We do not expect to receive any significant revenues under this agreement until the first quarter of 2014 at the earliest, and the timing of any such revenues may be substantially later, and we may never receive significant revenues under this agreement.

Our Inherent Health®brand of genetic tests includes the first-of-its-kind test for weight management that identifies an individual's genetic tendencies for weight gain related to either fat or carbohydrates in the diet. The Inherent Health® brand also offers customers a full suite of affordable, easy-to-use and meaningful genetic tests in heart health, bone health and nutritional needs. In addition, we launched additional products under the name Wellness Select that allows our e-commerce customers to purchase any combination of our Inherent Health® genetic tests at a discounted price.

In September 2012, Access Business Group LLC ("ABG"), an affiliate of Alticor, a related party, placed a purchase order totaling $1.0 million consisting of weight management kits. The kits are included as part of a promotional bundle of products that Amway is now selling to their Individual Business Owners (IBOs). The total order has been shipped and $327,000 remains in accounts receivable from related party at June 30, 2013. Cash received from the order will remain in deferred revenue until the earlier of the tests being returned or being processed. We are now processing tests from the program in our laboratory. The program has an end date of December 31, 2013, and we expect to recognize revenue from the program throughout 2013.

Our research and development expenses are focused on our own development and commercialization efforts related primarily to our PST® and Osteoarthritis genetic tests. We are also focusing on seeking potential commercial partners to validate our technology within their specific business model as a collaboration with little or no cost to us. This is different than in prior years when our development focus was concentrated in research and development to bring new test configurations to market.

On May 17, 2013, we entered into a Common Stock Purchase Agreement (the "Purchase Agreement") with various accredited investors (the "Purchasers"), pursuant to which we sold securities to the Purchasers in a private placement transaction (the "Private Placement"). In the Private Placement, we sold an aggregate of 43,715,847 shares of our common stock at a price of $0.2745 per share for gross proceeds of $12,000,000. The Purchasers also received warrants to purchase up to an aggregate of 32,786,885 shares of common stock an exercise price of $0.2745 per share (the "Warrants"). The Warrants have a term of seven years from the date they become exercisable. Sixty-three percent of the shares issuable pursuant to the Warrants were exercisable immediately upon issuance, and the remaining 37% became exercisable following the Share Authorization Increase (as defined below), which occurred on August 9, 2013.

In addition, pursuant to the Purchase Agreement, each Purchaser has the right, at any time and from time to time following the date of shareholder approval of an amendment to our Certificate of Incorporation to increase the number of authorized shares of common stock from 150,000,000 shares to 300,000,000 shares, which occured on August 9, 2013 (the "Share Authorization Increase"), and on or before June 30, 2014 (the "Expiration Date"), to purchase at one or more subsequent closings its pro rata share of up to an aggregate of 18,214,936 additional shares of common stock at a purchase price of $0.2745 per share and warrants to purchase up to an aggregate of 13,661,201 shares of common stock at an exercise price of $0.2745 per share (the "Additional Investment"). If, prior to the Expiration Date, Purchasers have not purchased their entire pro rata share of the Additional Investment, Purchasers who have purchased their entire pro rata share of the Additional Investment, will be entitled to purchase the unsold portion of the Additional Investment.

Immediately prior to the closing of the Private Placement, and in accordance with the terms of the Purchase Agreement: (i) Pyxis Innovations Inc. ("Pyxis"), the sole holder of our outstanding Series A-1 Convertible Preferred Stock converted all 5,000,000 shares of outstanding Series A-1 stock into 28,160,200 shares of our common stock; (ii) Pyxis, the sole holder of our outstanding convertible debt, converted all of the principal amount of debt outstanding ($14,316,255) into 2,521,222 shares of our common stock; and (iii) Delta Dental Plan of Michigan, Inc. ("DDMI"), the sole holder of our outstanding Series B Convertible Preferred Stock converted all 500,000 outstanding shares of Series B stock into 10,928,961 shares of common stock.

In the genetic test business, competition is in flux and the markets and customer base are not well established. Adoption of new technologies by consumers requires substantial market development and customer education. Historically, we have focused on our relationship with our primary customer, Alticor, a significant direct marketing company, in order to assist us in developing the market for our products and educating our potential customers. Our challenge in 2013 and beyond will be to develop the market for our other personalized health products, in particular our PST® test. We continue to allocate considerable resources to commercialization of our PST® and Inherent Health® brands of genetic tests. Due to the early stage of these initiatives, we cannot predict with certainty fluctuations we may experience in our genetic test revenues or whether revenues derived from the Preferred Participation Agreement with RHSC and its affiliates and the Merchant Network and Channel Partner Agreement with Amway Global will ever be material or if material, will be sustained in future periods.

Three Months Ended June 30, 2013 and June 30, 2012

Total revenue for the three months ended June 30, 2013 was $852,000, compared to $799,000 for the three months ended June 30, 2012. The increase of $53,000, or 6.6%, is primarily attributable to increased testing revenue from genetic tests processed as a result of sales of our Inherent Health® Weight Management genetic test through the promotional product bundle program of ABG, an affiliate of Pyxis. Genetic testing revenue is derived from tests sold and processed, which is driven by consumer demand. Deferred revenue, which consists of genetic tests sold and not yet processed, increased $330,000 to $2.0 million at June 30, 2013 as compared to $1.6 million on December 31, 2012.

During the three months ended June 30, 2013, 24% of our sales revenue came through our Merchant Network and Channel Partner Agreement with Amway Global, compared to 63% during the three months ended June 30, 2012. Pursuant to this agreement, Amway Global sells our genetic tests through its e-commerce web site via a hyperlink to our e-commerce site.

Cost of revenue for the three months ended June 30, 2013 was $496,000 or 58.2% of revenue, compared to $393,000, or 49.2% of revenue, for the three months ended June 30, 2012. The increase in the cost of revenue as a percentage of revenue is primarily attributable to the higher laboratory costs associated with processing tests associated with the Amway product promotion bundle which have a lower selling price than those purchased through the Amway partner store.

Research and development expenses were $188,000 for the three months ended June 30, 2013, compared to $317,000 for the three months ended June 30, 2012. The decrease of $130,000, or 40.8% is primarily attributable to decreases in compensation, consulting and clinical trial costs. In the first quarter of 2013, our Chief Scientific Officer had fully transitioned to his role as Chief Executive Officer and, accordingly, related compensation costs were classified as part of selling, general and administrative expenses in the 2013 period whereas such costs had previously been classified as research and development expenses.

Selling, general and administrative expenses were $1.6 million for the three months ended June 30, 2013, compared to $1.2 million for the three months ended June 30, 2012. The increase of $0.4 million, or 33.8% is primarily attributable to increased consulting and compensation expenses related to marketing activities for our PST periodontal test, partially offset by lower corporate legal fees as well as lower sales commissions paid to Amway Global as part of our Merchant Channel and Partner Store Agreement.

Interest expense was $346,000 for the three months ended June 30, 2013, as compared to $115,000 for the three months ended June 30, 2012. The increase in interest expense of $232,000 is attributable to non cash interest associated with the fair value of the warrant liability partially offset by lower interest expense due to the conversion of all outstanding convertible debt to common stock on May 17, 2013.

Six Months Ended June 30, 2013 and June 30, 2012

Total revenue was $1.3 million for the six months ended June 30, 2013, as compared to $1.5 million for the six months ended June 30, 2012. The decrease of $0.2 million, or 9.3%, is primarily attributable to increased testing revenue from genetic tests processed as a result of sales of our Inherent Health® Weight Management genetic test through the promotional product bundle program of Access Business Group, LLC, an affiliate of Pyxis, offset by lower revenue recognized from sales through our Merchant Network and Channel Partner Agreement with Amway Global and, to a lesser extent in 2012 only, revenue recognized in 2012 as part of our PST validation study with the University of Michigan and RHSC.

During the six months ended June 30, 2013, 38% of our sales revenue came through our Merchant Network and Channel Partner Agreement with Amway Global compared to 64% during the six months ended June 30, 2012.

Cost of revenue for the six months ended June 30, 2013 was $880,000 or 65.7% of revenue, compared to $769,000, or 52.1% of revenue, for the six months ended June 30, 2012. The increase in the cost of revenue as a percentage of revenue is primarily attributable to the higher laboratory costs associated with processing tests associated with the Amway product promotion bundle which have a lower selling price than those purchased through the Amway partner store.

Research and development expenses were $348,000 for the six months ended June 30, 2013, compared to $764,000 for the six months ended June 30, 2012. The decrease of $416,000 or 54.4%, in research and development expenses is primarily attributable to decreased compensation, consulting and clinical study costs. In the first quarter of 2013, our Chief Scientific Officer had fully transitioned to his role as Chief Executive Officer and, accordingly, related compensation costs were classified as part of selling, general and administrative expenses in the 2013 period whereas such costs had previously been classified as research and development expenses.

Selling, general and administrative expenses were $2.6 million for the six months ended June 30, 2013, compared to $2.3 million for the six months ended June 30, 2012. The increase of $263,000, or 11.4%, is primarily attributable to increased consulting and compensation expenses related to marketing activities for our PST periodontal test, partially offset by lower corporate legal fees as well as lower sales commissions paid to Amway Global as part of our Merchant Channel and Partner Store Agreement.

Interest expense was $461,000 for the six months ended June 30, 2013, as compared to $220,000 for the six months ended June 30, 2012. The increase in interest expense of $242,000 is attributable to non cash interest associated with the fair value of the warrant liability partially offset by lower interest expense due to the conversion of all outstanding convertible debt to common stock on May 17, 2013.

Liquidity and Capital Resources

As of June 30, 2013, we had cash and cash equivalents of $10.8 million and no outstanding debt.

Cash used in operations was $1.5 million for the six months ended June 30, 2013, as compared to $2.2 million for the six months ended June 30, 2012. Cash used in operations is primarily impacted by operating results and changes in working capital, particularly the timing of the collection of related party receivables, inventory levels, receipt of orders and the timing of payments to suppliers. In the six months ended June 30, 2013, approximately $1.1 million was received as payment for weight management kits ordered as part of Amway's promotional product bundle incorporating our weight management genetic test. Deferred revenue, which consists of cash received from genetic test sales increased by $330,000 to $2.0 million during the six months ended June 30, 2013.

Cash used in investing activities was $10,247 for the six months ended June 30, 2013, compared to $5,000 for the six months ended June 30, 2012. These amounts represent capital additions. We believe that based on current and projected volumes, our laboratory equipment is sufficient to process genetic tests. We expect additional capital purchases may be needed in the foreseeable future to automate some of our laboratory process as we start to process samples related to our PST® test.

Cash provided by financing activities was $11.1 million for the six months ended June 30, 2013, compared to $4.3 million for the six months ended June 30, 2012. On May 17, 2013, we entered into a Common Stock Purchase Agreement with various accredited investors, pursuant to which we sold an aggregate of 43,715,847 shares of our common stock, at a price of $0.2745 per share for net cash proceeds of $11.1 million. On April 13, 2012, we received $1.3 million in proceeds from the issuance of a note payable under our credit facility with Pyxis. On June 29, 2012, we completed a financing with DDMI, pursuant to which DDMI purchased 500,000 shares of Series B Convertible Preferred Stock for gross proceeds of $3,000,000. All costs associated with this transaction were paid in the third quarter of 2012. We received $12,839 from stock purchases through the employee stock purchase plan during the six months ending June 30, 2013 compared to $8,810 for the six months ended June 30, 2012.

The amount of cash we generate from operations is currently not sufficient to continue to fund operations and grow our business. We expect that our current and anticipated financial resources, including the proceeds from the May 2013 private placement will be adequate to maintain our current and planned operations at least through the next twelve months. We may need significant additional capital to fund our continued operations, to facilitate the commercial launch of our PST® genetic test, continued research and development efforts, obtaining and protecting patents and administrative expenses. We believe our success depends on our ability to have sufficient capital and liquidity to fund operations at least until we begin to receive significant revenues under the Preferred Participation Agreement with RHSC and its affiliates. The timing of any revenues that we may receive under this agreement is dependent upon the timing of the offering of Reimbursed Dental Plans by RHSC affiliates, which timing is uncertain at this time, and is contingent upon a number of factors, including RHSC's affiliates' ability to develop reimbursed Dental Plans and to develop a viable market for such plans. We do not expect to receive any significant revenues under this agreement until the first quarter of 2014 at the earliest, and the timing of such revenues may be substantially later, and we may never receive significant revenues under this agreement.

Until such time, if ever, that we generate revenues sufficient to fund operations, we may fund our operations by issuing common stock, debt or other securities in one or more public or private offerings, as market conditions permit, or through the incurrence of debt from commercial lenders. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our existing stockholders will be diluted, and the terms may include liquidation or other preferences that adversely affect the rights of our stockholders. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring debt, making capital expenditures or declaring dividends. There can be no assurance that additional funds will be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available to us on a timely basis, we may be required to delay, limit, reduce or cease activities or operations or enter into licenses or other arrangements with third parties on terms that may be unfavorable to us or sell, license or relinquish rights to develop or commercialize our products, technologies or intellectual property.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements. The preparation of these financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires us to (i) make judgments, assumptions and estimates that affect the reported amounts of assets, liabilities, revenue and expenses; and (ii) disclose contingent assets and liabilities. A critical accounting estimate is an assumption that could have a material effect on our financial statements if another, also reasonable, amount were used or a change in the estimates is reasonably likely from period to period. We base our accounting estimates on historical experience and other factors that we consider reasonable under the circumstances. However, actual results may differ from these estimates. To the extent there are material differences between our estimates and the actual results, our future financial condition and results of operations will be affected. Our most critical accounting policies and estimates upon which our financial condition depends, and which involve the most complex or subjective decisions or assessments are set forth in Note 4 to our financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. There have been no significant changes in our accounting policies or changes from the methodology applied by management for critical accounting estimates previously disclosed in our most recent Annual Report on Form 10-K.

Recent Accounting Pronouncements

Please see the discussion of "Recent Accounting Pronouncements" in Note 4, Significant Accounting Policies contained in the Notes to Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012. No new updates or other guidance issued to date by the FASB in 2013 are expected to have a material impact on our financial statements.

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