NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
OVERVIEW AND BACKGROUND
CombiMatrix
Corporation (the “Company,” “we,” “us” and “our”) was originally incorporated
in October 1995 as a California corporation and later reincorporated as a Delaware corporation in September 2000. In December
2002, we merged with, and became a wholly owned subsidiary of Acacia Research Corporation (“Acacia”). In August 2007,
we split-off from Acacia and became publicly traded on The NASDAQ Stock Market. As a result of the split-off, we ceased to be
a subsidiary of, or affiliated with, Acacia.
Description
of the Company
We
are a family health-focused clinical molecular diagnostic laboratory specializing in pre-implantation genetic screening, prenatal
diagnosis, miscarriage analysis, and pediatric developmental disorders. We strive to provide best-in-class clinical laboratory
support to healthcare professionals, allowing them to maximize the clinical utility of their patients’ test results and
to optimize patient care. Our testing focuses on advanced technologies, including single nucleotide polymorphism (“SNP”)
chromosomal microarray analysis, next generation sequencing, fluorescent in situ hybridization and high resolution karyotyping.
Our approach to testing is to offer sophisticated technology along with high-quality clinical support to our ordering physicians
and their patients. Our laboratory facilities and corporate headquarters are located in Irvine, California.
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.
Basis
of Presentation
The
accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, certain
information and notes required by generally accepted accounting principles in annual financial statements have been omitted or
condensed. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements
and notes thereto for the year ended December 31, 2016, as reported by us in our Annual Report on Form 10-K filed with the Securities
and Exchange Commission (the “SEC”) on March 3, 2017. The year-end consolidated balance sheet data was derived from
audited financial statements but does not include all disclosures required by accounting principles generally accepted in the
United States of America. The consolidated financial statements include all adjustments of a normal recurring nature which, in
the opinion of management, are necessary for a fair statement of our financial position as of September 30, 2017, and results
of operations and cash flows for the interim periods presented. The results of operations for the three and nine months ended
September 30, 2017 are not necessarily indicative of the results to be expected for the entire year.
Going
Concern Analysis
We
have a history of incurring net losses and net operating cash flow deficits. We also incur expenses from deploying new technologies
and from continuing to develop new and improving existing commercial diagnostic testing services and related technologies. As
a result, these conditions raise substantial doubt regarding our ability to continue as a going concern beyond twelve months from
the date of this filing. As of September 30, 2017, we had cash, cash equivalents and short-term investments of $2.4 million. Also,
the combination of continued revenue and cash reimbursement growth we have experienced over the past several quarters, coupled
with improved gross margins and cost containment of expenses leads management to believe that it is probable that our cash resources
will be sufficient to meet our cash requirements for current operations through and beyond the first quarter of 2018, when we
anticipate achieving cash flow break-even status (excluding merger-related expenses). If necessary, management also believes that
it is probable that external sources of debt and/or equity financing could be obtained based on management’s history of
being able to raise capital coupled with current favorable market conditions. As a result of both management’s plans and
current favorable trends in improving cash flow, we believe the initial conditions which raised substantial doubt regarding our
ability to continue as a going concern have been alleviated. Therefore, the accompanying consolidated financial statements have
been prepared assuming that we will continue as a going concern. 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 on terms acceptable to us, or at all.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The
consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability
and classification of assets or the amounts and classification of liabilities that may result from the matters discussed herein.
While we believe in the viability of our strategy to generate sufficient revenue and cash reimbursement, control costs and our
ability to raise additional funds if necessary, there can be no assurances to that effect. Our ability to continue as a going
concern is dependent upon our ability to further implement our business plan, generate sufficient revenues and cash reimbursement
and to control operating expenses.
Risks
Our
business operations are also subject to certain risks and uncertainties, including:
|
●
|
market
acceptance of our services;
|
|
|
|
|
●
|
technological
advances that may make our services obsolete or less competitive;
|
|
|
|
|
●
|
increases
in operating costs, including costs for supplies, personnel and equipment;
|
|
|
|
|
●
|
variability
in third-party reimbursement of our tests;
|
|
|
|
|
●
|
the
availability and cost of capital; and
|
|
|
|
|
●
|
governmental
regulation that may restrict our business.
|
Our
services are concentrated in a highly competitive market that is characterized by rapid technological advances, frequent changes
in customer requirements and evolving regulatory requirements and industry standards. Failure to anticipate or respond adequately
to technological advances, changes in customer requirements, changes in regulatory requirements or industry standards, or any
significant delays in the development or introduction of planned services, could have a material adverse effect on our business
and operating results.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use
of Estimates.
The preparation of financial statements in conformity with generally accepted accounting principles (“GAAP”)
in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets
and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Principles
of Consolidation
. The accompanying consolidated
financial statements include the accounts of the Company and our wholly owned and majority-owned subsidiaries. Investments for
which we possess the power to direct or cause the direction of the management and policies, either through majority ownership
or other means, are accounted for under the consolidation method. Material intercompany transactions and balances have been eliminated
in consolidation. Investments in companies in which we maintain an ownership interest of 20% to 50% or exercise significant influence
over operating and financial policies are accounted for under the equity method. The cost method is used where we maintain ownership
interests of less than 20% and do not exercise significant influence over the investee.
Revenue
Recognition
. 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.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
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 third-party commercial insurance
companies, healthcare institutions, government payors including various state Medicaid programs, and individuals. We report revenues
from contracted payors based on a contractual rate, or in the case of state Medicaid contracts, published fee schedules for our
tests. We report revenues from non-contracted payors based on the amounts expected to be collected. The differences between the
amounts billed and the amounts expected to be collected from non-contracted payors are recorded as contractual allowances 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, and also take into account recent collection trends. 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 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. No single customer exceeded 10% of revenues for any
of the periods presented.
Cash
Equivalents and Short-Term Investments.
We consider all highly liquid investments purchased with original maturities of three
months or less when purchased to be cash equivalents. Short-term investments consist of fixed income investments with maturities
between three and 12 months and other highly liquid investments that can be readily purchased or sold using established markets.
These investments are classified as available-for-sale and are reported at fair value on our consolidated balance sheet. Unrealized
holding gains and losses are reported within comprehensive loss in the consolidated statements of comprehensive loss. Fair value
is based on available market information including quoted market prices, broker or dealer quotations or other observable inputs.
If a decline in the fair value of a short-term investment below our cost basis is determined to be other than temporary, such
investment is written down to its estimated fair value as a new cost basis and the amount of the write-down is included in earnings
as an impairment charge. To-date, no permanent impairment charges have been realized or recorded.
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;
|
|
|
|
|
|
●
|
Level
2:
|
Observable
market inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
|
|
|
|
|
|
●
|
Level
3:
|
Unobservable
inputs where there is little or no market data, which require the reporting entity to develop its own assumptions.
|
We
classify our cash equivalents within the fair value hierarchy as Level 1 as these assets are valued using quoted prices in active
markets for identical assets at the measurement date. We classify short-term investments within the fair value hierarchy as Level
2, primarily utilizing broker quotes in a non-active market for valuation of these investments. Financial instruments that contain
valuation inputs that are not readily determinable from active markets or from similar securities trading in active markets, such
as derivative financial instruments, are classified within the fair value hierarchy as Level 3.
Impairment
of Long-Lived Assets
. Long-lived assets and intangible assets are reviewed for potential impairment when events or changes
in circumstances indicate the carrying amount of an asset may not be recoverable. In the event the sum of the expected undiscounted
future cash flows resulting from the use of the asset is less than the carrying amount of the asset, an impairment loss equal
to the excess of the asset’s carrying value over its fair value is recorded. If an asset is determined to be impaired, the
loss is measured based on quoted market prices in active markets, if available. If quoted market prices are not available, the
estimate of fair value is based on various valuation techniques, including a discounted value of estimated future cash flows.
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 liabilities are categorized
as either short-term or long-term based upon management’s estimates as to when the derivative instrument may be realized
or based upon the holder’s ability to realize the instrument.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Concentration
of Credit Risks
. Cash and cash equivalents
are invested in deposits with certain financial institutions and may, at times, exceed federally insured limits. We have not experienced
any significant losses on our deposits of cash and cash equivalents. We do not believe that we are exposed to significant credit
risk on cash and cash equivalents or on our short-term investments. Accounts receivable from Insurance Carrier A of $601,000,
Carrier B of $497,000 and Carrier C of $459,000 each exceeded 10% of our total accounts receivable balance as of September 30,
2017. Accounts receivable from Insurance Carrier B of $441,000 exceeded 10% of our total accounts receivable balance as of December
31, 2016.
Substantially
all of the components and raw materials used in providing our testing services, including array slides and reagents, are currently
provided to us from a limited number of sources or in some cases from a single source. Although we believe that alternative sources
for those components and raw materials are available, any supply interruption in a sole-sourced component or raw material might
result in up to a several-month production delay and materially harm our ability to provide testing services until a new source
of supply, if any, could be located and qualified.
Accounts
Receivable and Allowance for Doubtful Accounts.
For our contracted third-party payors, governmental payors or direct-bill
customers, accounts receivable are stated at principal amounts and are primarily comprised of amounts contractually due from customers
for services performed. For our non-contracted customers, accounts receivable are stated at amounts expected to be collected based
on historical collection experience with the third-party payor. The payment realization cycle for certain governmental and commercial
insurance payors can be lengthy, involving denial, appeal and adjudication processes, and is subject to periodic adjustments that
may be significant. Accounts receivable are periodically written off when identified as uncollectible after appropriate collection
efforts have been exhausted. Such write-offs increase the contractual allowances (which reduce revenues) for those accounts in
the period of adjustment. Collection of governmental, private health insurer, and client receivables are generally a function
of providing complete and correct billing information to the insurers and clients within the filing deadlines required by each
payor.
Collection
of receivables due from patients and private-pay clients is generally subject to increased credit risk due to credit-worthiness
or inability to pay. For these customers, an allowance for doubtful accounts is recorded for estimated uncollectible amounts,
and involves significant assumptions and judgments. Specifically, the allowance for doubtful accounts is adjusted periodically
and is principally based upon specific identification of past due or disputed accounts. We also review the age of receivables
to assess our allowance at each period end. Additions to the allowance for doubtful accounts are charged to bad debt expense as
a component of general and administrative expenses in the consolidated statements of operations.
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 four years. The fair value of each stock option award is estimated
on the date of grant using a Black-Scholes option valuation model. The fair value of each restricted stock unit (“RSU”)
award is based on the number of shares granted and the closing price of our common stock as reported on The NASDAQ Capital Market
on the date of grant.
In
March 2016, the Financial Accounting Standards Board (“FASB”) issued guidance regarding employee share-based payment
accounting. The guidance is intended to simplify several areas of accounting for share-based compensation arrangements, including
the income tax impact, classification on the statement of cash flows and provides the choice for companies to estimate forfeitures
during the vesting period of an award or recognize forfeitures at the time an award is canceled and forfeited. The standard became
effective and was implemented by us on January 1, 2017. We elected to change our policy regarding forfeitures to recognize when
an award is canceled and forfeited rather than estimating forfeitures up front. The impact from implementing this policy was to
reduce retained earnings and increase additional paid-in capital by $57,000.
Stock-based
compensation expense for all periods presented attributable to our functional expense categories from stock option and RSU awards
vesting during the periods presented were as follows (in thousands):
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of services
|
|
$
|
9
|
|
|
$
|
14
|
|
|
$
|
27
|
|
|
$
|
34
|
|
Research and development
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Sales and marketing
|
|
|
16
|
|
|
|
19
|
|
|
|
50
|
|
|
|
63
|
|
General and administrative
|
|
|
137
|
|
|
|
153
|
|
|
|
431
|
|
|
|
494
|
|
Total non-cash stock compensation
|
|
$
|
162
|
|
|
$
|
186
|
|
|
$
|
508
|
|
|
$
|
591
|
|
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Net
Loss Per Share
. Basic and diluted net loss
per share has been computed by dividing the net loss by the weighted average number of common shares issued and outstanding during
the periods presented. Options and warrants to purchase common stock as well as preferred stock convertible into shares of common
stock are anti-dilutive and therefore are not included in the determination of the diluted net loss per share. The following table
reflects the excluded dilutive securities:
|
|
Three Months Ended
|
|
|
Nine Months Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Common stock options
|
|
|
62,697
|
|
|
|
66,687
|
|
|
|
62,697
|
|
|
|
66,687
|
|
Restricted stock units
|
|
|
98,049
|
|
|
|
59,000
|
|
|
|
98,049
|
|
|
|
59,000
|
|
Common stock warrants
|
|
|
2,578,455
|
|
|
|
2,701,754
|
|
|
|
2,578,455
|
|
|
|
2,701,754
|
|
Series F preferred stock convertible into common stock
|
|
|
3,582
|
|
|
|
436,662
|
|
|
|
3,582
|
|
|
|
436,662
|
|
Excluded potentially dilutive securities
|
|
|
2,742,783
|
|
|
|
3,264,103
|
|
|
|
2,742,783
|
|
|
|
3,264,103
|
|
Segments.
We have determined that we operate in one segment for financial reporting purposes.
Recent
Accounting Pronouncements.
In July 2017, the FASB issued an accounting standards update regarding earnings per share, distinguishing
liabilities from equity and derivatives and hedging. Part 1 of the update addresses the complexity of accounting for certain financial
instruments with down-round features, such as anti-dilution provisions of common stock warrant contracts that can require liability
classification and subsequent mark-to-market accounting for these securities. As a result of this update, a down-round feature
no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock, which
means that derivative accounting treatment and liability classification are no longer required. The amendment requires the effect
of a down round feature to be treated as a dividend and as a reduction of income available to common shareholders when computing
basic earnings per share when the feature is triggered. In addition, convertible instruments with embedded conversion options
that have down-round features are now subject to the specialized guidance for contingent beneficial conversion features, including
related EPS guidance. Part II of the update addresses certain content that is pending or deferred and has no accounting effect.
The amendments in Part I of the update are effective for all public entities for the first interim and annual reporting periods
beginning after December 15, 2018, with early adoption permitted. We do not expect the adoption of this update to have a material
impact on our consolidated financial statements.
In
February 2016, the FASB issued a new accounting standard regarding leases, which requires lessees to recognize on their balance
sheets a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for
all leases with terms greater than 12 months. The standard also requires qualitative and quantitative disclosures designed to
assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective
transition approach, which includes a number of optional practical expedients that entities may elect to apply. The standard is
effective for us beginning January 1, 2019, and we are currently evaluating the impact that this standard will have on our consolidated
financial statements.
In
May 2014, the FASB issued new accounting guidance regarding revenue recognition from contracts with customers, which when effective
will supersede existing revenue recognition requirements and will eliminate most industry-specific guidance from GAAP. The core
principle of the new guidance is to require an entity to recognize as revenue the amount that reflects the consideration to which
it expects to be entitled in exchange for goods or services as it transfers control to its customers. The new guidance requires
additional qualitative and quantitative disclosures about the nature, amount, timing and uncertainty of revenue and cash flows
arising from contracts with customers. An entity can apply the new guidance retrospectively to each prior reporting period presented
(i.e., the full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized
at the date of initial application in retained earnings. As originally issued, the new revenue recognition standard would be effective
for us beginning January 1, 2017. However, in 2015, the FASB voted to defer the effective date of the new guidance for one year.
We have nearly completed our detailed assessment of the impact that this guidance will have on our consolidated financial statements,
with additional analysis currently ongoing. Based on our current assessment, we expect the majority of the amounts that have historically
been recognized as bad debt expense, primarily related to patient responsibility, will be reflected as a reduction of the transaction
price originally recognized and therefore as a reduction in revenue. We will adopt the new guidance beginning January 2018.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
3.
CASH AND SHORT-TERM INVESTMENTS
As
of September 30, 2017, we held $2.4 million in cash, cash equivalents and short-term investments, which are reported at fair value.
Cash, cash equivalents and short-term investments consisted of the following as of September 30, 2017 and December 31, 2016 (in
thousands):
|
|
As of September 30, 2017
|
|
|
As of December 31, 2016
|
|
|
|
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
|
|
Unrealized
|
|
|
Fair
|
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
Cost
|
|
|
Gains
|
|
|
Losses
|
|
|
Value
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and money market securities
|
|
$
|
2,382
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,382
|
|
|
$
|
2,727
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,727
|
|
Commercial paper
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
500
|
|
|
|
-
|
|
|
|
-
|
|
|
|
500
|
|
Certificates of deposit
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
500
|
|
|
|
-
|
|
|
|
-
|
|
|
|
500
|
|
|
|
$
|
2,382
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,382
|
|
|
$
|
3,727
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,727
|
|
There
were no realized gains or losses for the periods ended September 30, 2017 or 2016.
4.
FAIR VALUE MEASUREMENTS
The
following table summarizes, for each major category of financial assets measured on a recurring basis, the respective fair value
at September 30, 2017 and December 31, 2016 and the classification by level of input within the fair value hierarchy defined above
(in thousands):
|
|
|
|
|
Fair Value Measurements
|
|
September 30, 2017
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$
|
1,346
|
|
|
$
|
1,346
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Short-term investments
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Cash equivalents
|
|
$
|
1,346
|
|
|
$
|
1,346
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
Fair Value Measurements
|
|
December 31, 2016
|
|
Total
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents
|
|
$
|
1,735
|
|
|
$
|
1,735
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Short-term investments
|
|
|
1,000
|
|
|
|
-
|
|
|
|
1,000
|
|
|
|
-
|
|
Cash equivalents
|
|
$
|
2,735
|
|
|
$
|
1,735
|
|
|
$
|
1,000
|
|
|
$
|
-
|
|
The
carrying amounts of accounts receivable, accounts payable, accrued expenses, capital leases and the secured promissory note approximate
fair value due primarily to the short-term nature of these financial instruments.
5.
STOCKHOLDERS’ EQUITY
Series
A through E Convertible Preferred Stock and Warrant Financings
Between
2012 and 2015, we executed several financing transactions whereby we issued convertible preferred stock and warrants to purchase
common stock to investors. As of December 31, 2016, none of the Series A through E convertible preferred stock remained outstanding.
For as long as the Series A warrants remain unexercised through their expiration date, except under certain permitted circumstances,
we may not issue, or enter into any agreement to issue, common stock or common stock equivalents at a price per share below the
$73.65 exercise price of the Series A warrants, unless waivers from the Series A investors are obtained. Until the time that less
than 7.5% of the Series B, C and E warrants remain unexercised through their expiration date, except under certain permitted circumstances,
we may not issue, or enter into any agreement to issue, common stock or common stock equivalents at prices per share below the
$29.55, $29.55 and $32.51 exercise prices of the Series B, C and E warrants, respectively, unless waivers from the Series B, C
and E investors are obtained. In addition, until there are no longer Series A, C and E warrants outstanding, we may not sell any
variable rate securities except for certain exempt issuances.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Series
E Modifications
On
February 4, 2016, we entered into a Series E 6% Convertible Preferred Stock Repurchase Agreement (the “Repurchase Agreement”)
with the Series E Investors. Pursuant to the terms of the Repurchase Agreement, we agreed to pay each Series E Investor $300 per
share of Series E Preferred Stock, or approximately $656,000, in consideration for the right to repurchase the Series E Investor’s
Series E Preferred Stock at a price per share of $1,000 (the “Repurchase Price”), which was the original price per
share paid by the Series E Investors for their Series E Preferred Stock in February 2015. We recognized the $656,000 payment as
a deemed dividend paid to the Series E investors.
Immediately
following the closing of our Series F public offering discussed below, we paid $2.2 million to the Series E Investors to repurchase
all of the outstanding Series E Preferred Stock, in accordance with the terms of the Repurchase Agreement. Since almost none of
the Series E Preferred Stock had converted by the time we repurchased the Series E Preferred Stock, the original $890,000 beneficial
conversion feature that we recognized as a deemed dividend in 2015 was reversed as a return of capital from the Series E Preferred
stockholders to the common stockholders.
Series
F Convertible Preferred Stock and Warrants Financing
On
March 24, 2016 (the “Series F Closing”), we closed an underwritten public offering (the “Series F Offering”)
and issued 8,000 immediately separable units of securities to investors, with each unit consisting of: (i) one share of Series
F convertible preferred stock (“Series F Preferred Stock”) convertible into shares of our common stock equal to 1,000
divided by the conversion price of $3.87, which was 75% of the consolidated closing bid price of our common stock on The NASDAQ
Capital Market on March 18, 2016, the date we executed the underwriting agreement (“UA date”); and (ii) 258.397875
warrants, each to purchase one share of our common stock at an exercise price per share equal to $5.17 (“Series F Warrants”),
which was 100% of the consolidated closing bid price of our common stock on The NASDAQ Capital Market on the UA date. The Series
F Preferred Stock, the Series F Warrants, and the shares of common stock underlying the Series F Preferred Stock and Series F
Warrants were registered on Form S-1, which was declared effective by the SEC on March 18, 2016. The Series F Preferred Stock
was immediately convertible and the Series F Warrants were immediately exercisable for shares of common stock and have a term
of five years. The Series F Warrants are exercisable for cash or, solely in the absence of an effective registration statement
or prospectus, by cashless exercise. In total, there were 2,067,183 shares of common stock issuable upon conversion of the Series
F Preferred Stock and up to 2,067,183 shares of common stock issuable upon exercise of the Series F Warrants. The units were sold
for a purchase price equal to $1,000 per unit, resulting in gross proceeds received by us of $8.0 million. Total offering-related
costs paid through December 31, 2016 were $1.1 million, resulting in net proceeds recognized of $6.9 million. Given that the effective
conversion price of the Series F Preferred Stock was below the closing market price of our common stock at the time of the Series
F Closing, we recognized a beneficial conversion feature in the amount of $1.9 million. Since the Series F Preferred Stock was
immediately convertible into common stock, the beneficial conversion feature was treated as a deemed dividend charged to retained
earnings at closing. Also, from the time of the Series F Closing through September 30, 2017, 7,986 shares of the Series F Preferred
Stock have converted into 2,063,601 shares of common stock, leaving 14 shares of Series F Preferred Stock (representing 3,582
shares of common stock) unconverted.
The
Series F Preferred Stock is non-voting (except to the extent required by law and except for certain consent rights relating to
amending the certificate of incorporation or bylaws, and the like), but ranks senior to our common stock with respect to distributions
upon our dissolution, liquidation or winding-up. Until the volume weighted average price of our common stock on NASDAQ exceeds
200% of the conversion price of the Series F Preferred Stock for any 20 of 30 consecutive trading days, and the daily dollar trading
volume during such period exceeds $200,000 per trading day, the Series F Preferred Stock is subject to full ratchet price based
anti-dilution protection, subject to certain limitations. Also, the Company can force holders of Series F Preferred Stock to convert
into our common stock if the volume-weighted average price of our common stock exceeds 200% of the Series F Preferred Stock conversion
price for any 20 of 30 consecutive trading days, and the daily dollar trading volume during such period exceeds $200,000 per trading
day, subject to certain other conditions. The Series F investors have agreed to be subject to a blocker that would prevent each
of their respective common stock ownership at any given time from exceeding 4.99% of our outstanding common stock (which may be
increased on 61 days’ notice, but not above 9.99%).
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
The
Series F Warrants have a 5-year term and have a cashless exercise provision in the event there is no effective registration statement
covering the common stock issuable upon exercise of the Series F Warrants. The Series F Warrants are not subject to price based
anti-dilution protection. The Series F Warrants are listed on The NASDAQ Capital Market under the trading symbol “CBMXW.”
For the nine months ended September 30, 2017, 210 Series F Warrants have been exercised, generating gross proceeds to the Company
of $1,086. Subsequent to September 30, 2017 through November 3, 2017, 4,900 Series F Warrants were exercised, generating gross
proceeds of $25,333.
Depending
on the circumstances, upon a change in control constituting a “Fundamental Transaction” (as defined in the Series
F Warrants), the holders of Series F Preferred Stock may be entitled to a 30% premium and the holders of Series F Warrants may
have the right to require either that the Company purchase the Series F Warrants for an amount in cash that is determined in accordance
with a formula set forth in the Series F Warrants or that the successor assumes and replaces the Series F Warrants with substantially
equivalent warrants of the successor.
Common
Stock Purchase Warrants Repurchase Agreement
On
July 11, 2016, we entered into a Common Stock Purchase Warrants Repurchase Agreement (the “Warrants Repurchase Agreement”)
with the holders (the “Holders”) of our outstanding common stock purchase warrants issued in October 2012, March 2013,
May 2013, June 2013, June 2014, February 2015 and April 2015 (collectively, the “Warrants”) in connection with our
Series A, Series B, Series C and Series E financings. Pursuant to the terms of the Warrants Repurchase Agreement, we have agreed
to repurchase such Warrants from each Holder upon execution of a “Fundamental Transaction” (as defined in such Warrants)
at various negotiated prices per Warrant share as set forth in the Warrants Repurchase Agreement. The Warrants Repurchase Agreement
obligates us to repurchase half of such Warrants upon the announcement of a Fundamental Transaction. On July 31, 2017, we announced
that we entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”) with Invitae Corporation
(“Invitae”) and Coronado Merger Sub, Inc., a wholly owned subsidiary of Invitae (“Merger Sub”), pursuant
to which Invitae plans to acquire us in an all-stock transaction in which Merger Sub will merge with and into us (the “Merger”).
The Merger is considered a Fundamental Transaction under the Warrants Repurchase Agreement and, as a result of entering into and
announcing the Merger Agreement, and pursuant to the terms of the Warrants Repurchase Agreement, we repurchased one-half of such
outstanding Warrants on August 3, 2017, for approximately $230,000 of cash consideration. Under the terms of the Warrants Repurchase
Agreement, we will be obligated to repurchase the remaining one-half of such Warrants for an additional $230,000 within three
business days of any closing of the Merger. However, under the terms of the Merger Agreement, we are required to repurchase the
remaining one-half of such Warrants at or prior to the closing of the Merger. In addition, upon any closing of the Merger, all
Securities Purchase Agreements and Registration Rights Agreements associated with the original issuances of such Warrants will
be terminated and the various restrictions set forth therein will no longer be of any force or effect. In the event that we do
not close the Merger or any other Fundamental Transaction, for whatever reason, then the remaining one-half of such Warrants will
remain issued and outstanding. See Note 7 below.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
Warrants
Outstanding
warrants to purchase common stock are as follows:
|
|
Shares of Common Stock
Issuable from Warrants
Outstanding as of
|
|
|
|
|
|
|
|
|
|
September 30,
|
|
|
December 31,
|
|
|
Exercise
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
Price
|
|
|
Expiration
|
|
Equity-classified warrants:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 2016
|
|
|
2,066,966
|
|
|
|
2,067,176
|
|
|
$
|
5.17
|
|
|
|
March 2021
|
|
April 2015
|
|
|
50,430
|
|
|
|
100,847
|
|
|
$
|
16.50
|
|
|
|
August 2020
|
|
April 2015
|
|
|
920
|
|
|
|
1,831
|
|
|
$
|
32.51
|
|
|
|
August 2020
|
|
February 2015
|
|
|
23,342
|
|
|
|
46,676
|
|
|
$
|
16.50
|
|
|
|
August 2020
|
|
June 2014
|
|
|
847
|
|
|
|
1,690
|
|
|
$
|
30.90
|
|
|
|
April 2018
|
|
December 2013
|
|
|
388,365
|
|
|
|
388,365
|
|
|
$
|
46.80
|
|
|
|
December 2018
|
|
June 2013
|
|
|
16,395
|
|
|
|
32,788
|
|
|
$
|
29.55
|
|
|
|
June 2019
|
|
May 2013
|
|
|
16,395
|
|
|
|
32,788
|
|
|
$
|
29.55
|
|
|
|
May 2019
|
|
March 2013
|
|
|
9,167
|
|
|
|
18,334
|
|
|
$
|
29.55
|
|
|
|
March 2019
|
|
October 2012
|
|
|
5,628
|
|
|
|
11,252
|
|
|
$
|
29.55
|
|
|
|
September 2018
|
|
Total
|
|
|
2,578,455
|
|
|
|
2,701,747
|
|
|
|
|
|
|
|
|
|
6.
COMMITMENTS AND CONTINGENCIES
Executive
Severance
We
provide certain severance benefits such that if any of our executive officers is terminated for other than cause, death or disability,
the executive will receive payments equal to three months’ base salary plus medical and dental benefits. In addition, we
have implemented a Restated Executive Change of Control Severance Plan (as amended, the “Severance Plan”) that affects
certain of our senior management-level employees who are classified as “Section 16 Officers” of the Company. Pursuant
to the Severance Plan, if a participating employee is involuntarily terminated (other than for death, disability or for cause)
or resigns for “good reason” (as defined in the Severance Plan) during the two-year period following a “change
of control” (as defined in the Severance Plan) of the Company, then, subject to execution of a release of claims against
the Company, the employee will be entitled to receive: (i) one-half times annual base salary (one times annual base salary for
the Chief Executive Officer); (ii) immediate vesting of outstanding compensatory equity awards; and (iii) payment of COBRA premiums
for the participating employee and eligible dependents for a pre-determined period of time. Payment of benefits under the Severance
Plan will be limited by provisions contained in Section 409A of the U.S. Internal Revenue Code. The Severance Plan is administered
by a plan administrator, which initially is the Compensation Committee of the Board of Directors. In order to participate in the
Severance Plan, an eligible employee must waive any prior retention or severance agreements. The Severance Plan automatically
renews annually unless terminated upon 12 months prior written notice. We expect that our Chief Executive Officer and Chief Financial
Officer will receive benefits under the Severance Plan as a result of any consummation of the Merger.
Also,
our Board of Directors and Compensation Committee have adopted a Transaction Bonus Plan (the “Transaction Bonus Plan”),
which provides for certain bonus payments to be made, upon any consummation of a qualifying change of control transaction (as
defined in the Transaction Bonus Plan) such as the Merger, to certain participants as shall be determined from time to time by
the Compensation Committee of our Board of Directors. The aggregate value of the bonuses payable under the Transaction Bonus Plan
shall be the greater of (i) $1,000,000 or (ii) ten percent of the net proceeds received in connection with a qualifying change
of control transaction such as the Merger, and the percentage of such bonus pool awarded to each eligible participant shall be
determined from time to time by our Compensation Committee.
Litigation
In
2002, we entered into a settlement agreement with Nanogen, Inc. (“Nanogen”) to settle all pending litigation between
the parties. Pursuant to the terms of the settlement agreement, we agreed to make quarterly payments to Nanogen equal to 12.5%
of total sales of products developed by us and our affiliates based on the patents that had been in dispute in the litigation,
up to an annual maximum amount of $1.5 million. The minimum quarterly payments under the settlement agreement are $25,000 per
quarter until the patents expire in 2018. Royalty expenses recognized under the agreement were $25,000 and $75,000 for both of
the three and nine months ended September 30, 2017 and 2016, respectively, and are included in patent amortization and royalties
in the accompanying consolidated statements of operations.
COMBIMATRIX
CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(Unaudited)
From
time to time, we are subject to other claims and legal actions that arise in the ordinary course of business. We believe that
the ultimate liability with respect to these claims and legal actions, if any, will not have a material effect on our financial
position, results of operations or cash flows. Any legal costs resulting from claims or legal actions are expensed as incurred.
7.
PROPOSED MERGER WITH INVITAE CORPORATION
On
July 31, 2017, we entered into the Merger Agreement with Invitae, pursuant to which Invitae plans to acquire us through an all-stock
Merger. The Merger is subject to certain closing conditions, as set forth in the Merger Agreement, including, among others, obtaining
certain regulatory approvals, approval from our stockholders and at least 90% participation in a Series F Warrant exchange offer
being conducted by Invitae in connection with the Merger. Any Series F warrants that are exercised prior to expiration of the
warrant exchange offer (including exercises contingent solely upon closing of the Merger) will be counted by Invitae towards the
90% threshold of participation.
The
Merger Agreement contains certain termination rights for both us and Invitae, including, among others, if the Merger is not consummated
on or before January 31, 2018 (unless due to the terminating party’s action or failure to act or SEC delay) or if the approval
of our stockholders is not obtained. If the Merger Agreement is terminated by either us or Invitae as a result of a breach by
the other party of any of such other party’s representations, warranties or covenants, or because the occurrence of a material
adverse effect applicable to such other party was the sole failed condition to closing, or if the Merger Agreement is terminated
by Invitae as a result of the failure of our stockholders to approve the Merger Agreement or as a result of an adverse change
in the recommendation of our board of directors, then the defaulting party will be obligated to reimburse the other party’s
third party expenses up to a maximum of $400,000. The Merger Agreement further provides that, upon termination of the Merger Agreement
under specified circumstances, including, among others, termination of the Merger Agreement as a result of an adverse change in
the recommendation of our board of directors after receiving a bona fide alternative acquisition proposal or termination of the
Merger Agreement as a result of our stockholders not approving the Merger Agreement following disclosure of a bona fide acquisition
proposal after which we are sold within 12 months, we may be required to pay to Invitae a termination fee of up to $1.4 million
(net of any expense reimbursement previously paid).
The
foregoing description of the Merger Agreement is not a complete description of all of the parties’ rights and obligations
under the Merger Agreement and is qualified in its entirety by reference to the Merger Agreement, which was filed as Exhibit 2.1
to our Current Report on Form 8-K filed with the SEC on July 31, 2017.
On
September 13, 2017, Invitae filed certain registration statements with the SEC in order to register securities to be issued in
the Merger and the Series F Warrant exchange offer, as amended on September 28, 2017. These registration statements were declared
effective by the SEC on October 5, 2017. On October 23, 2017, we filed a proxy statement and solicitation materials regarding
the Special Meeting of CombiMatrix Stockholders to be held on November 10, 2017 at 1:00 PM Pacific time in Newport Beach, California.
The primary purpose of this meeting is for our stockholders to vote on the approval of the Merger and related proposals. The Series
F Warrant exchange offer by Invitae is currently ongoing and will expire at 12:00 midnight, New York City time, on November 13,
2017 (one minute after 11:59 p.m., New York City time, on November 13, 2017) unless extended. Assuming that our stockholders representing
a majority of our issued and outstanding common stock as of September 26, 2017 vote in favor of the Merger and assuming other
closing conditions are met, we anticipate closing of the Merger to occur during the fourth quarter of 2017.