The accompanying notes are an integral part
of these financial statements.
The accompanying notes are an integral part
of these financial statements.
The accompanying notes are an
integral part of these financial statements.
The accompanying notes are an integral part
of these financial statements.
NOTES TO CONDENSED FINANCIAL STATEMENTS
September 30, 2016
(UNAUDITED)
Note 1—Basis of Presentation
Interleukin Genetics, Inc. (“the Company”)
develops genetic tests for sale into the emerging personalized health market and performs testing services that can help individuals
improve and maintain their health through preventive or therapeutic measures. The Company’s principal operations and markets
are located in the United States.
The accompanying condensed
financial statements include the accounts of the Company as of September 30, 2016 and December 31, 2015 and for the three and nine
months ended September 30, 2016 and September 30, 2015.
The financial statements
have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for
interim financial reporting. Accordingly, they do not include all of the information and notes required by generally accepted accounting
principles for complete financial statements. These unaudited condensed financial statements, which in the opinion of management
reflect all adjustments (including normal recurring adjustments) necessary for a fair presentation, should be read in conjunction
with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2015. Operating results are not necessarily indicative of the results that may be expected for any future interim
period or for the entire 2016 fiscal year.
For information regarding
our critical accounting policies and estimates, please refer to “Management’s Discussion and Analysis of Financial
Condition and Results of Operations – Critical Accounting Policies and Estimates” contained in our Annual Report on
Form 10-K for the year ended December 31, 2015 and Note 3 to our condensed financial statements contained herein.
Note 2—Operating Matters and Liquidity
The Company has experienced
net operating losses since its inception through September 30, 2016. The Company had net losses of $7.9 million and $6.3 million
for the years ended December 31, 2015 and 2014, respectively, and $5.6 million for the nine months ended September 30, 2016, contributing
to an accumulated deficit of $134.6 million as of September 30, 2016.
The Company continues
to take steps to reduce genetic test processing costs. Cost savings are primarily achieved through test process improvements. Management
believes that the current laboratory space is adequate to process high volumes of genetic tests.
On December 23, 2014,
the Company entered into a Securities Purchase Agreement (the “2014 Purchase Agreement”) with various accredited investors
(the “2014 Investors”), pursuant to which the Company sold to the 2014 Investors in a private placement transaction
(the “December 2014 Private Placement”) an aggregate of 50,099,700 shares of common stock at a price of $0.1003 per
share for gross proceeds of approximately $5.025 million. The 2014 Investors also received warrants to purchase up to an aggregate
of 50,099,700 shares of common stock an exercise price of $0.1003 per share (the “2014 Warrants”). The 2014 Warrants
vested immediately, are all currently exercisable and have a term of seven years.
On December
23, 2014, the Company entered into a Venture Loan and Security Agreement (the “Loan Agreement”) with
Horizon Technology Finance Corporation (the “Lender”) under which the Company borrowed $5.0 million. The loan
originally bore interest at a floating rate equal to the One Month LIBOR Rate (with a floor of 0.50%) plus 8.50%. The loan
was to be repaid in forty-five (45) monthly payments consisting of fifteen (15) monthly payments of only interest followed by
thirty (30) equal monthly payments of principal and interest. In addition, at the end of the repayment term (or at early
termination of the loan) a final payment equal to 4.5% of the loan would have been due and payable. The Company’s
obligations under the Loan Agreement were secured by a first priority security interest in substantially all of its assets
other than its intellectual property. The Company had also agreed not to pledge or otherwise encumber its intellectual
property assets, subject to certain exceptions. In connection with the Loan Agreement, the Company issued to the Lender and
its affiliates warrants to purchase a total of 2,492,523 shares of common stock at an exercise price of $0.1003 per share,
which the Company refers to herein as the 2014 Lender Warrants. The 2014 Lender Warrants vested immediately, are all
currently exercisable and have a term of ten (10) years.
On August 25,
2016, the Company and the Lender entered into the First Amendment of Venture Loan and Security Agreement and an Amended and
Restated Secured Promissory Note (collectively referred to herein as the “2016 Debt Restructuring”), which was
effective as of August 1, 2016, pursuant to which the principal payments due from August 2016 through December 2016 will be
reduced to 33% of the principal payments due for these periods under the Loan Agreement. Principal payments may also be
reduced in future periods upon the achievement of certain milestones by the Company. In consideration of these changes, (i)
the Company paid the Lender an amendment fee of $25,000 and reimbursed the Lender’s legal expenses in the amount of
$5,000, (ii) the Company granted the Lender a first priority security interest in substantially all of its assets, including
its intellectual property, (iii) the interest rate of the loan has been increased to 11.00% plus the amount by which the one
month LIBOR Rate exceeds 0.50%, and (iv) the final payment was increased from 4.5% of the loan, or $225,000, to 6.5% of the
loan, or $325,000. At September 30, 2016, the interest rate was 11.03% per annum. In connection with the 2016 Debt
Restructuring, the Company also issued to the Lender an additional warrant to purchase up to 5,169,577 shares of the
Company’s common stock at an exercise price of $0.0994 per share (the “2016 Lender Warrant”). The 2016
Lender Warrant vested immediately, is currently exercisable and has a term of ten (10) years. If the milestones required
to further reduce the principal payments are achieved, the Lender shall be entitled to additional warrants.
On July 29, 2016,
the Company entered into a Securities Purchase Agreement (the “2016 Purchase Agreement”) with various accredited
investors (the “2016 Investors”), pursuant to which the Company sold to the 2016 Investors in a private placement
transaction (the “2016 Private Placement”) an aggregate of 56,262,571 shares of common stock at a price of
$0.0994 per share for gross proceeds of approximately $5.6 million. The 2016 Investors also received warrants to purchase up
to an aggregate of 56,262,571 shares of common stock at an exercise price of $0.0994 per share (the “2016
Warrants”). The 2016 Warrants vested immediately, are all currently exercisable and have a term of seven years.
The
Company’s financial statements have been prepared assuming that it will continue as a going concern which contemplates
the realization of assets and satisfaction of liabilities in the normal course of business. The financial statements do
not include any adjustments that might result from the outcome of this uncertain realization. The Company expects to
incur additional losses in 2016 and beyond, accordingly, is dependent on financings and potential revenue to fund its
operations and support the market adoption of the ILUSTRA
™
I
nflammation
Management Program (the “ILUSTRA Program”), which includes the ILUSTRA Genetic Risk Test (the “ILUSTRA
Test”, formerly referred to as the PerioPredict
®
Genetic Risk Test). The timing of any revenues that the
Company may receive from the ILUSTRA Program is uncertain at this time, and is contingent upon a number of factors, including
the Company’s ability to attract employer and insurance carriers as customers directly, to consummate arrangements
with additional partners to promote the ILUSTRA Program, our partners’ ability to attract customers for the ILUSTRA
Program, and the timing of utilization of the ILUSTRA Program by customers, among other possible variables. The Company
expects that its current cash and cash equivalents sufficient to support the Company’s operations into the second
quarter of 2017.
The ability of the
Company to realize the carrying value of its fixed assets and intangible assets is especially dependent on management’s ability
to successfully execute on its plan. The Company needs to generate additional funds in order to meet its financial obligations.
If it is unsuccessful in doing so, the Company may not be able to realize the carrying value of its fixed assets and intangible
assets.
Note 3—Summary of Significant
Accounting Policies
Management Estimates
The preparation of
financial statements in conformity with accounting principles generally accepted in the United States of America requires management
to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets
and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reported
periods. Actual results could differ from those estimates. The Company’s most critical accounting policies are more fully
discussed in these notes to the financial statements.
Revenue Recognition
Revenue from genetic
testing services is recognized when there is persuasive evidence of an arrangement, service has been rendered, the sales price
is determinable and collectability is reasonably assured. Service is deemed to be rendered when the results have been reported
to the individual who ordered the test. For the nine months ended September 30, 2016, the Company recognized $881,000 of revenue
associated with genetic testing compared to $922,000 for the nine months ended September 30, 2015. To the extent that tests have
been prepaid but results have not yet been reported, recognition of all related revenue is deferred. As of September 30, 2016 and
December 31, 2015, the Company had deferred revenue of $2.5 million and $3.2 million, respectively. Included in deferred revenue
at September 30, 2016 is $2.4 million for kits that are still outstanding one year or longer after initial kit sale, of which $0.15
million was sold directly to consumers (credit card payments) and $2.27 million was sold to distributors as a promotional bundle.
In 2012 and 2013, Access Business Group LLC (“ABG”), an affiliate of Alticor, Inc., a related party (“Alticor”),
placed purchase orders totaling approximately $3.3 million for Weight Management test kits. The kits were included as part of a
promotional bundle of products that ABG sold to their Individual Business Owners (IBOs).
For
the three and nine months ended September 30, 2016, the Company recognized $465,000 and $1.4 million in Other revenue,
respectively,
compared to $47,000 and $154,000 for the three and nine months ended September 30, 2015,
respectively.
Of the $1.4 million of Other revenue recognized for the nine months ended September 30, 2016, $1.2 million was related to contracted
research revenue and $160,000 was related to royalties received related to our license agreement with ABG. Of the $154,000 of Other
revenue recognized for the nine months ended September 30, 2015, $5,000 was related to contracted research revenue and $149,000
was related to royalties received related to our license agreement with ABG. Revenue from contracted research projects is recognized
when the deliverables for which the Company is obligated have been provided to the customer who contracted the project.
The Company recognizes
breakage revenue related to genetic test kits utilizing the remote method. Under the remote method, breakage revenue should be
recognized when the likelihood of the customer exercising rights of redemption becomes remote. The term remote requires statistical
analysis of customer redemption patterns for all tests sold and returned. The Company analyzed redemption patterns from 2009 through
2015 and determined the period of time after which the likelihood of test redemption was remote was three years after the sale
of a genetic test kit. Included in genetic test revenue in the three and nine months ended September 30, 2016 is $41,000 and $171,000,
respectively, of breakage revenue related to unredeemed genetic test kits sold in the three and nine months ended September 30,
2013, respectively, compared to genetic test revenue in the three and nine months ended September 30, 2015 of $39,000 and $167,000,
respectively, related to unredeemed genetic test kits sold in the three and nine months ended September 30, 2012, respectively.
The Company expects to continue to recognize breakage revenue and the corresponding deferred cost of goods on a quarterly basis
based on the historical analysis.
Sales Commission
On October 26, 2009,
the Company entered into a Merchant Network and Channel Partner Agreement with Amway Corp., d/b/a/ Amway Global (“Amway Global”),
a subsidiary of Alticor Inc. Pursuant to this Agreement, Amway Global sells the Company’s Inherent Health
®
brand of genetic tests through its e-commerce website via a hyperlink to our e-commerce site. The Company accounts for sales commissions
due to Amway Global under the Merchant Network and Channel Partner Agreement in accordance with SEC Staff Accounting Bulletin (“SAB”)
104. Commissions are recorded as an expense at the time they become due, which is at the point of sale. The cost of commissions
was $37,000 and $70,000 for the three months ended September 30, 2016 and 2015, respectively, and $189,000 and $239,000 for the
nine months ended September 30, 2016 and 2015, respectively..
Accounts Receivable
Accounts receivable
is stated at estimated net realizable value, which is generally the invoiced amount less any estimated discount related to payment
terms. The Company offers its commercial genetic test customers a 2% cash discount if payment is made by bank wire transfer within
10 days of the invoice date. No accounts receivable reserve is required at September 30, 2016 as all accounts receivable are
expected to be collected.
Inventory
Inventory is carried
at lower of cost (first-in, first-out method) or market and no inventory reserve was deemed necessary at December 31, 2015 or September
30, 2016. As the Company does not manufacture any products, no overhead costs are included in inventory. Inventory is stored at
a fulfillment provider.
Inventory consisted
of the following:
|
|
September 30, 2016
|
|
|
December 31, 2015
|
|
Raw materials
|
|
$
|
61,239
|
|
|
$
|
112,372
|
|
Finished goods
|
|
|
16,902
|
|
|
|
12,211
|
|
Total inventory, net
|
|
$
|
78,141
|
|
|
$
|
124,583
|
|
Stock-Based Compensation
The Company accounts
for stock-based compensation expense in accordance with FASB ASC 718,
Compensation – Stock Compensation
. The
standard addresses all forms of share-based payment (SBP) awards, including shares issued under employee stock purchase plans,
stock options, restricted stock and stock appreciation rights. We expense SBP awards within compensation cost for SBP transactions
measured at fair value. Compensation cost for the portion of awards for which the requisite service has not been rendered that
are outstanding as of the effective date shall be recognized as the requisite service is rendered on or after the effective date.
The compensation cost for that portion of awards shall be based on the grant-date fair value of those awards as calculated under
the Black-Scholes option pricing model. Common stock purchased pursuant to our employee stock purchase plan will be expensed based
upon the fair market value in excess of purchase price.
Income Taxes
The Company accounts
for income taxes in accordance with FASB ASC 740,
Income Taxes
, which requires the recognition of taxes payable or
refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been
recognized in the financial statements or tax returns. The measurement of current and deferred tax liabilities and assets is based
on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. The Company records
a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized.
Significant management
judgment is required in determining the Company’s provision (benefit) for income taxes, its deferred tax assets and liabilities
and any valuation allowance recorded against deferred tax assets. The Company has recorded a full valuation allowance against its
deferred tax assets of approximately $35.6 million as of September 30, 2016, due to uncertainties related to its ability to utilize
these assets. The valuation allowance is based on management’s estimates of taxable income by jurisdiction in which the Company
operates and the period over which the deferred tax assets will be recoverable. In the event that actual results differ from these
estimates or management adjusts these estimates in future periods, the Company may need to adjust its valuation allowance, which
could materially impact its financial position and results of operations.
As a result of the
Company’s change in its capital structure during the quarters ended June 30, 2013, December 31, 2014 and September 30, 2016
the Company may have undergone IRC section 382 ownership changes which would limit its ability to realize the benefit of its tax
attributes (i.e., federal/state net operating losses and research and development credits) during their respective carry forward
periods. The Company has not performed an analysis to determine the extent of such limitations, if any.
The Company reviews
its recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected
to be taken in a tax return. The Company reviews all material tax positions for all years open to statute to determine whether
it is more likely than not that the positions taken would be sustained based on the technical merits of those positions. The Company
did not recognize any adjustments for uncertain tax positions as of and during the nine months ended September 30, 2016.
Research and Development
Research and development
costs are expensed as incurred.
Basic and Diluted Net Loss per Common
Share
The Company applies the provisions of FASB
ASC 260,
Earnings per Share
, which establishes standards for computing and presenting earnings per share. Basic and
diluted net loss per share was determined by dividing net loss applicable to common stockholders by the weighted average number
of shares of common stock outstanding during the period. Diluted net loss per share is the same as basic net loss per share for
all the periods presented, as the effect of the potential common stock equivalents is anti-dilutive due to the loss in each period.
Potential common stock equivalents excluded from the calculation of diluted net loss per share are as follows:
|
|
As of September 30,
|
|
|
|
2016
|
|
|
2015
|
|
Options outstanding
|
|
|
21,934,214
|
|
|
|
22,258,659
|
|
Warrants outstanding
|
|
|
149,733,227
|
|
|
|
88,301,079
|
|
Total
|
|
|
171,667,441
|
|
|
|
110,559,738
|
|
Fair Value of Financial Instruments
The Company, using
available market information, has determined the estimated fair values of financial instruments. The stated values of cash and
cash equivalents, accounts receivable and accounts payable approximate fair value due to the short term nature of these instruments.
The fair value of warrants is calculated using the Black-Scholes pricing model.
Cash and Cash Equivalents
The Company maintains
its cash and cash equivalents with a domestic financial institution that the Company believes to be of high credit standing. The
Company believes that, as of September 30, 2016, its concentration of credit risk related to cash and cash equivalents was not
significant. Cash and cash equivalents are available on demand and are generally in excess of FDIC insurance limits.
Fixed Assets
Fixed assets are stated at cost, less accumulated
depreciation and amortization. Depreciation and amortization are provided using the straight-line method over estimated useful
lives of three to five years. Leasehold improvements are amortized over the shorter of the estimated useful life of the asset or
the remaining term of the lease.
Segment Reporting
As of September 30,
2016 and 2015, the Company has one segment, the genetic test business. The Company develops genetic tests for sale into the emerging
personalized health market and performs testing services that can help individuals improve and maintain their health through preventive
measures. The Company’s principal operations and markets are located in the United States.
Recent Accounting Pronouncements
FASB ASC 606 ASU 2014-09 - Revenue from
contracts with customers.
In May 2014, the FASB
issued amended guidance on contracts with customers to transfer goods or services or contracts for the transfer of nonfinancial
assets, unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). The guidance
requires an entity to recognize revenue on contracts with customers to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The guidance requires that an entity depict the consideration by applying the following five steps:
|
·
|
Identify the contract(s) with a customer.
|
|
·
|
Identify the performance obligations in the contract.
|
|
·
|
Determine the transaction price.
|
|
·
|
Allocate the transaction price to the performance obligations in the contract.
|
|
·
|
Recognize revenue when (or as) the entity satisfies a performance obligation.
|
The amendments in this
ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting
period. Early application is not permitted. This amendment is to be either retrospectively adopted to each prior reporting period
presented or retrospectively with the cumulative effect of initially applying this ASU recognized at the date of initial application.
In April, 2015 the
FASB voted to defer the required implementation date of ASU 2014-09 to December 2017. Public companies may elect to adopt the standard
along the original timeline. The Company is evaluating the impact of the adoption of this guidance to determine whether or not
it has a material impact on its financial statements.
FASB ASC 606 ASU 2014-15 - Presentation of Financial Statements—Going
Concern (Subtopic 205-40); Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.
In August 2014, the
FASB issued ASU No. 2014-15, which applies should a company be facing probable liquidation within one year of the issuance of the
financial statements, but is not actually in liquidation at the time of issuance. The applicable basis for presentation remains
as a going concern, but if liquidation within one year is probable, then certain disclosures must be included in the financial
statement presentation. ASU 2014-15 is effective for annual and interim periods beginning after December 15, 2016, with early
adoption permitted. The Company is evaluating the impact of ASU 2014-15 on our financial disclosures, but is not electing early
adoption at this time.
FASB ASU 2016-02 - Leases (Topic 842).
In February 2016, the FASB issued ASU No.
2016-02, “Leases” (Topic 842). The updated standard aims to increase transparency and comparability among organizations
by requiring lessees to recognize lease assets and lease liabilities on the balance sheet and requiring disclosure of key information
about leasing arrangements. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods
within those fiscal years. The Company is currently evaluating the impact of ASU 2016-02 on its consolidated financial statements.
FASB ASU No. 2016-09, - Compensation - Stock Compensation
(Topic 718): Improvements to Employee Share-Based Payment Accounting.
In March 2016,
the FASB issued ASU No. 2016-09. The standard 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 forfeitures. ASU 2016-09 is effective
for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted.
The
Company is currently evaluating the impact of ASU 2016-09 on its consolidated financial statements.
Note 4—Related Party Transactions
Since March 2003, the
Company has maintained a broad strategic alliance with several affiliates of the Alticor Inc. family of companies, a related party.
The alliance initially included an equity investment, a multi-year research and development agreement, a licensing agreement with
royalties on marketed products, the deferment of outstanding loan repayment and the refinancing of bridge financing obligations.
On October 26, 2009,
the Company entered into a Merchant Network and Channel Partner Agreement with Amway Corp., d/b/a/ Amway Global (“Amway Global”),
a subsidiary of Alticor. Pursuant to this Agreement, Amway Global sells the Company’s Inherent Health brand of genetic tests
through its e-commerce website via a hyperlink to the Company’s e-commerce site. The Company paid Amway Global $37,000 and
$70,000 in commissions for the three months ended September 30, 2016 and 2015, respectively, and $189,000 and $239,000 in commissions
for the nine months ended September 30, 2016 and 2015, respectively, representing a percentage of net sales to their customers.
The Company expenses commissions owed to Amway Global in the month of sale to the customer.
In
2012 and 2013, Access Business Group LLC (“ABG”), an affiliate of Alticor placed purchase orders totaling approximately
$3.3 million consisting of the Company’s Weight Management test kits. The kits are included as part of a promotional bundle
of products that Amway sells to their Individual Business Owners (IBOs). Of the $3.3 million in orders, $1.5 million was received
for the 2013 program and $1.8 million for the 2014 program. As a component of the 2013 promotional program, and not reflective
of actual product expiry, the kits were required to be redeemed by December 31, 2013. In February 2014, the Company removed the
redemption date requirement for the 2013 promotional program, for which ABG paid the Company $519,000 as a retrospective increase
in the product purchase price. All cash received related to the 2013 promotional program, including the $519,000, will be treated
as deferred revenue until kits are returned for processing or the breakage analysis determines the probability of eventual redemption
is remote
.
In October 2014, the Company received
$250,000 as a retrospective increase in the product purchase price for unsold kits as consideration for extending the required
redemption date of the 2014 promotional program to December 31, 2017. All cash received for these kits will be treated as deferred
revenue until specific kits are returned for processing or on the final allowed redemption date of December 31, 2017.
On September 21, 2012,
the Company entered into a License Agreement (the “License Agreement”) with Access Business Group International LLC
(“ABGI”), an affiliate of Alticor. Pursuant to the License Agreement, the Company has granted ABGI and its affiliates
a non-exclusive license to use the technology related to the Company’s Weight Management genetic test and to sell the Weight
Management test in Europe, Russia and South Africa (the “Territories”). ABGI, or a laboratory designated by ABGI, will
be responsible for processing the tests, and the Company will receive a royalty for each test sold, which royalty will increase
if certain pending patent applications are issued. The License Agreement has an initial term of five years from the date of first
commercial sale of the Weight Management test under the agreement which was in June 2013. Thereafter, the term will automatically
renew for additional one-year periods unless at least 60 days prior notice is delivered by either party. During the three and nine
months ended September 30, 2016, $47,000 and $153,000, respectively, related to license fees was earned, compared to $39,000 and
$142,000, respectively, for the three and nine months ended September 30, 2015.
In connection with
the execution of the License Agreement, the Company and ABGI also entered into a Professional Services Agreement (the “PSA”)
pursuant to which the Company has agreed to provide services to ABGI in connection with its sale and processing of the tests within
the Territories. No fees were earned in the three and nine months ended September 30, 2016 or September 30, 2015.
For the three months
ended September 30, 2016 and 2015, approximately 24% and 45%, respectively, of the Company’s revenue came from sales through
the Merchant Network and Channel Partner Agreement with Amway Global, and 3% and 14%, respectively, of revenue came from sales
through ABG’s promotional product bundle program. For the nine months ended September 30, 2016 and 2015, approximately 23%
and 49%, respectively, of the Company’s revenue came from sales through our Merchant Network and Channel Partner Agreement
with Amway Global, and 4% and 15%, respectively, of revenue came from sales through ABG’s promotional product bundle program.
On February 25, 2013, the Company entered into a Preferred Participation
Agreement with Renaissance Health Services Corporation (“RHSC”), for itself and on behalf of certain of its affiliates
and subsidiaries. This agreement was amended and restated on November 1, 2013. RHSC is a related party through its affiliation
with Delta Dental of Michigan, Inc. (“DDMI”), a stockholder of the Company.
Pursuant to this agreement,
as amended, affiliates of RHSC agreed to reimburse the Company a fixed price for each ILUSTRA Test that the Company processed for
a customer of affiliates of RHSC. This amended agreement had a term of three years beginning February 25, 2013and terminated on
February 25, 2016. A revised agreement with substantially similar terms was executed in April 2016.
Note
5—Debt Instruments
Venture Loan and Security Agreement
On December
23, 2014, the Company entered into a Venture Loan and Security Agreement (the “Loan Agreement”) with
Horizon Technology Finance Corporation (the “Lender”) under which the Company borrowed $5.0 million. The loan
bore interest at a floating rate equal to the One Month LIBOR Rate (with a floor of 0.50%) plus 8.50%. In the event that the
One Month LIBOR Rate, as reported in the Wall Street Journal, exceeds 0.50%, the interest rate would have been adjusted by
an amount equal to the difference between such rates at the end of that particular month. The loan was to be repaid
in forty-five (45) monthly payments consisting of fifteen (15) monthly payments of only interest followed by thirty (30)
equal monthly payments of principal and interest (the “Payment Terms”). In addition, at the end of the repayment
term (or at early termination of the loan) a final payment equal to 4.5% of the loan would have been due and payable.
The Company’s obligations under the Loan Agreement were secured by a first priority security interest in substantially
all of its assets other than its intellectual property. The Company had also agreed not to pledge or otherwise encumber
its intellectual property assets, subject to certain exceptions. In connection with the Loan Agreement, the Company issued to
the Lender and its affiliates warrants to purchase a total of 2,492,523 shares of common stock at an exercise price of
$0.1003 per share, which the Company refers to herein as the 2014 Lender Warrants. The 2014 Lender Warrants vested
immediately, are all currently exercisable and have a term of ten (10) years.
On August 25,
2016, the Company and the Lender entered into the First Amendment of Venture Loan and Security Agreement and an Amended and
Restated Secured Promissory Note (collectively referred to herein as the “2016 Debt Restructuring”), which was
effective as of August 1, 2016, pursuant to which the principal payments due from August 2016 through December 2016 will be
reduced to 33% of the principal payments due for these periods under the Loan Agreement. Principal payments may also be
reduced in future periods upon the achievement of certain milestones by the Company. In consideration of these changes, (i)
the Company paid the Lender an amendment fee of $25,000 and reimbursed the Lender’s legal expenses in the amount of
$5,000, (ii) the Company granted the Lender a first priority security interest in substantially all of its assets, including
its intellectual property, (iii) the interest rate of the loan has been increased to 11.00% plus the amount by which the one
month LIBOR Rate exceeds 0.50%, and (iv) the final payment was increased from 4.5% of the loan, or $225,000, to 6.5% of the
loan, or $325,000. At September 30, 2016, the interest rate was 11.03% per annum. In connection with the 2016 Debt
Restructuring, the Company also issued to the Lender a warrant to purchase up to 5,169,577 shares of the
Company’s common stock at an exercise price of $0.0994 per share (the “2016 Lender Warrant”). The 2016
Lender Warrant vested immediately, is currently exercisable and has a term of ten (10) years. If the milestones required to
further reduce the principal payments are achieved, the Lender shall be entitled to additional warrants.
The Company recorded
a discount on the loan comprised of (i) $89,000 in cash fees paid to the Lender related to the Loan Agreement, (ii) $261,000 as
the intrinsic value of the 2014 Lender Warrants, (iii) $30,000 in cash fees paid to the Lender related to the 2016 Debt Restructuring
and (iv) $504,000 as the intrinsic value of the 2016 Lender Warrants. The discount on the loan is amortized over the term of the
loan in the Company’s Condensed Statements of Operations. As of September 30, 2016, the unamortized discount associated with
the loan was $661,000. The amended final non-principal payment of $325,000 will be accrued as additional interest expense, using
the effective interest method, over the term of the loan. Cash interest expense for the three and nine months ended September 30,
2016 was $115,000 and $339,000, respectively, and $115,000 and $341,000, respectively, for the three and nine months ended September
30, 2015. Non-cash interest expense was $109,000 and $185,000 for the three and nine months ended September 30, 2016 and $38,000
and $115,000 for the three and nine months ended September 30, 2015.
Note 6—Commitments and contingencies
Operating Lease
The Company leases
its office and laboratory space under a non-cancelable operating lease which is scheduled to expire on March 31, 2017. The lease
agreement includes an initial base rent beginning in March 2014 with an escalation of 2.06% of the base rent in year two and another
2.06% increase in year three.
Rent expense was $85,000
and $96,000 for the three months ended September 30, 2016 and 2015, respectively, and $257,000 and $268,000, respectively, for
the nine months ended September 30, 2016 and 2015.
Off-Balance Sheet Arrangements
The Company has no
off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on its financial
condition, results of operations or cash flows.
Employment Agreements
On May 19, 2016, the Company entered into
an employment agreement with Stephan Toutain for the position of Chief Commercial Officer beginning on August 15, 2016 (the “Start
Date”). The agreement provides for a minimum annual base salary of $315,000 and he is eligible for a bonus of 30% of his
base salary pursuant to the Company’s bonus plan. The agreement also provides that Mr. Toutain will be granted options to
purchase shares of the Company’s common stock equal to 1% of the Company’s fully diluted shares of the Company as of
the Start Date, which equals 3,738,933 options, at an exercise price equal to fair market value of the Company’s common stock
on the grant date of the option. The option will vest as to 25% of the shares on the first anniversary of the Start Date, and as
to an additional 2.083% of the shares monthly thereafter. Mr. Toutain’s agreement is terminable at will by the Company or
Mr. Toutain. If the Company terminates Mr. Toutain without cause, the Company will pay Mr. Toutain, in addition to any accrued,
but unpaid compensation prior to termination, an amount equal to six months of his base salary in effect at the time of the termination.
Note 7—Capital Stock
Authorized Preferred and Common Stock
As of September 30,
2016, the Company has 6,000,000 shares of preferred stock, par value $0.001 authorized and 450,000,000 shares of common stock,
par value $0.001 authorized. As of September 30, 2016 the Company has 229,331,060 shares of common stock outstanding and the following
shares of common stock are reserved for issuance:
|
|
Reserved
for issuance
|
|
|
Strike
Price
|
|
|
Expiry
|
|
|
|
|
|
|
|
|
|
Shares reserved under outstanding stock options and options available for grant
|
|
|
52,092,463
|
|
|
|
|
|
|
|
Rights associated with Employee Stock Purchase Plan
|
|
|
120,121
|
|
|
|
|
|
|
|
Warrants to purchase common stock associated with the 2016 Debt Restructuring
|
|
|
5,169,577
|
|
|
$
|
0.0994
|
|
|
Aug 1, 2026
|
Warrants to purchase common stock associated with July 2016 private placement
|
|
|
56,262,571
|
|
|
$
|
0.0994
|
|
|
Jul 29, 2023
|
Warrants to purchase common stock associated with December 2014 private placement
|
|
|
50,189,431
|
|
|
$
|
0.1003
|
|
|
Dec 23, 2021
|
Warrants to purchase common stock associated with December 2014 venture loan and security agreement
|
|
|
2,492,523
|
|
|
$
|
0.1003
|
|
|
Dec 23, 2024
|
Warrants to purchase common stock associated with September 2014 consulting agreement with Danforth Advisors
|
|
|
100,000
|
|
|
$
|
0.2500
|
|
|
Sep 8, 2024
|
Outstanding warrants issued in May 2013, vesting August 2013
|
|
|
14,426,230
|
|
|
$
|
0.2745
|
|
|
Aug 9, 2020
|
Outstanding warrants issued in May 2013, vesting May 2013
|
|
|
20,655,737
|
|
|
$
|
0.2745
|
|
|
May 17, 2020
|
Outstanding warrants issued in June 2012
|
|
|
437,158
|
|
|
$
|
0.2745
|
|
|
Jun 29, 2017
|
Total common shares reserved for issuance at September 30, 2016
|
|
|
201,945,811
|
|
|
|
|
|
|
|
Total common shares issued and outstanding at September 30, 2016
|
|
|
229,331,060
|
|
|
|
|
|
|
|
Total common shares outstanding and reserved for issuance at September 30, 2016
|
|
|
431,276,871
|
|
|
|
|
|
|
|
On May 17, 2013, the
Company entered into a Common Stock Purchase Agreement (the “2013 Purchase Agreement”) with various accredited investors
(the “2013 Investors”), pursuant to which the Company sold securities to the 2013 Investors in a private placement
transaction (the “May 2013 Private Placement”). In the May 2013 Private Placement, the Company sold an aggregate of
43,715,847 shares of its common stock at a price of $0.2745 per share for gross proceeds of $12,000,000. The 2013 Investors also
received warrants to purchase up to an aggregate of 32,786,885 shares of common stock at an exercise price of $0.2745 per share
(the “2013 Warrants”). The 2013 Warrants were immediately exercisable as to 63% of the shares issuable thereunder.
The remaining 37% of the shares issuable under the 2013 Warrants were to become exercisable upon an increase in the number of authorized
shares of common stock. On August 9, 2013, the Company’s shareholders’ approved an amendment to the Company’s
Certificate of Incorporation to increase the number of authorized shares of common stock from 150,000,000 to 300,000,000 shares,
which provided for adequate authorized shares for all potential common stock equivalents issued pursuant to the May 2013 Private
Placement. The 2013 Warrants are all currently exercisable and have a term of seven years from the date they became exercisable.
For its services in
this transaction, the placement agent received cash compensation in the amount of approximately $780,000 and the placement agent
and an affiliate received warrants to purchase an aggregate of 2,295,082 shares of common stock, at an exercise price of $0.2745
per share (the “2013 Placement Agent Warrants”). The 2013 Placement Agent Warrants became exercisable on August 9,
2013, following shareholder approval of an increase in the Company’s authorized shares of common stock and expire August
9, 2020. The cash compensation and the fair value of the warrants were recorded as issuance costs resulting in a reduction to shareholders’
equity.
In connection with
the May 2013 Private Placement, all preferred stockholders converted their shares of Preferred Stock to common stock resulting
in the issuance of 39,089,161 shares of common stock (the “2013 Preferred Conversion”) and $14,316,255 in principal
amount of outstanding convertible debt held by a related party was converted into 2,521,222 shares of common stock (the “2013
Debt Conversion”).
In September 2014, the
Company issued warrants to the Company’s financial consultant, Danforth Advisors, to purchase up to 100,000
shares of common stock at a price of $0.25 per share. The warrants have a ten (10) year term and vested on a monthly basis over
two years. These warrants have fully vested as of September 30, 2016. The fair value of the warrants at issuance was recorded as
equity totaling $24,000 and was fully amortized as of September 30, 2016. The non-cash compensation expense for the three and nine
months ended September 30, 2016 and September 30, 2015 was $3,000 and $9,000 respectively.
On December 23, 2014,
the Company entered into a Securities Purchase Agreement (the “2014 Purchase Agreement”) with various accredited
investors (the “2014 Investors”), pursuant to which it sold to the 2014 Investors in a private placement
transaction (the “December 2014 Private Placement”) an aggregate of 50,099,700 shares of common stock at a price
of $0.1003 per share for gross proceeds of approximately $5.025 million. The 2014 Investors also received warrants to
purchase up to an aggregate of 50,099,700 shares of common stock an exercise price of $0.1003 per share (the “2014
Warrants”). The 2014 Warrants vested immediately, are all currently exercisable and have a term of seven years.
For services related to
this transaction, the placement agent and legal counsel received an aggregate of $218,000 in cash fees and the placement agent
received warrants to purchase an aggregate of 89,731 shares of common stock (“2014 Placement Agent Warrants”). The
cash fees and the fair value of the 2014 Placement Agent Warrants were recorded as equity issuance costs resulting in a reduction
to shareholders’ equity.
The 2014 Warrants and the
2014 Placement Agent Warrants were recorded as equity at fair value on the date of issuance. On the closing date of the December
2014 Private Placement, the fair value of the 2014 Warrants was $5.2 million, and the fair value of the 2014 Placement Agent Warrants
was $9,000.
On July 29, 2016, the
Company entered into a Securities Purchase Agreement (the “2016 Purchase Agreement”) with various accredited
investors (the “2016 Investors”), pursuant to which the Company sold to the 2016 Investors in a private placement
transaction (the “2016 Private Placement”) an aggregate of 56,262,571 shares of common stock at a price of
$0.0994 per share for gross proceeds of approximately $5.6 million. The 2016 Investors also received warrants to purchase up
to an aggregate of 56,262,571 shares of common stock at an exercise price of $0.0994 per share (the “2016
Warrants”). The 2016 Warrants vested immediately, are all currently exercisable and have a term of seven years.
For services related to
this transaction, legal counsel received $62,000 in cash fees.
The fair value of the 2016
Warrants at issuance was $6.5 million. Fair value of the 2016 Warrants was calculated using the following inputs in a Black-Scholes
model:
|
|
July 29, 2016
|
|
Risk-free interest rate
|
|
|
1.52
|
%
|
Expected life
|
|
|
7 years
|
|
Expected volatility
|
|
|
147.03
|
%
|
Dividend yield
|
|
|
0
|
%
|
Venture Loan and Security Agreement
On December 23,
2014, the Company entered into the Loan Agreement with the Lender under which the Company has borrowed $5.0 million. In
connection with the Loan Agreement, the Company issued to the Lender and its affiliates 2014 Lender Warrants to purchase a
total of 2,492,523 shares of common stock at an exercise price of $0.1003 per share. The 2014 Lender Warrants vested
immediately, are all currently exercisable and have a term of ten (10) years. The fair value of the 2014 Lender Warrants at
issuance was $261,000
On August 25,
2016, the Company and Horizon agreed to the 2016 Debt Restructuring, which was effective as of August 1, 2016, pursuant to
which the principal payments due from August 2016 through December 2016 will be reduced to 33% of the principal payments due
for these periods under the Loan Agreement. In connection with the 2016 Debt Restructuring, the Company issued to the Lender
a warrant to purchase up to 5,169,577 shares of the Company’s common stock at an exercise price of $0.0994 per share
(the “2016 Lender Warrant”). The 2016 Lender Warrant vested immediately, is currently exercisable and has a term
of ten (10) years. If the milestones required to further reduce the principal payments are achieved, the Lender shall be
entitled to additional warrants.
The 2014 Lender Warrants
and 2016 Lender Warrants were recorded as equity at fair value on the date of issuance. Fair value of the 2014 Lender Warrants
and 2016 Lender Warrants was calculated using the Black-Scholes model. Fair value of the 2016 Lender Warrants was calculated using
the following inputs in a Black-Scholes model:
|
|
August 1, 2016
|
|
Risk-free interest rate
|
|
|
1.78
|
%
|
Expected life
|
|
|
10 years
|
|
Expected volatility
|
|
|
138.81
|
%
|
Dividend yield
|
|
|
0
|
%
|
The fair value of the 2016
Lender Warrants at issuance was $504,000. Cash interest paid during the three and nine months ended September 30, 2016 totaled
$68,000 and $292,000, respectively, compared to $115,000 and $353,000, respectively, for the same periods in 2015. Non-cash interest
related to debt discounts was $109,000 and $185,000 for the three and nine months ended September 30, 2016, respectively, and $38,000
and $115,000 for the three and nine months ended September 30, 2015, respectively. The debt discount balance was $661,000 as of
September 30, 2016.
Note 8—Stock-Based Compensation Arrangements
Total stock-based compensation
is as follows:
|
|
Three Months Ended September 30,
|
|
|
Nine Months Ended September 30,
|
|
|
|
2016
|
|
|
2015
|
|
|
2016
|
|
|
2015
|
|
Stock option grants beginning of period
|
|
$
|
212,451
|
|
|
$
|
251,374
|
|
|
$
|
637,438
|
|
|
$
|
491,197
|
|
Stock-based arrangements during the period:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock option grants
|
|
|
-
|
|
|
|
92
|
|
|
|
3,367
|
|
|
|
157,463
|
|
Restricted stock issued:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee stock purchase plan
|
|
|
747
|
|
|
|
1,088
|
|
|
|
1,921
|
|
|
|
3,129
|
|
|
|
$
|
213,198
|
|
|
$
|
252,554
|
|
|
$
|
642,726
|
|
|
$
|
651,789
|
|
Stock option and restricted stock grants
The following table details stock option activity:
|
|
Nine
Months Ended
September 30, 2016
|
|
|
Nine
Months Ended
September 30, 2015
|
|
|
|
Shares
|
|
|
Weighted Avg
Exercise
Price
|
|
|
Shares
|
|
|
Weighted Avg
Exercise
Price
|
|
Outstanding, beginning of period
|
|
|
21,657,776
|
|
|
$
|
0.21
|
|
|
|
4,523,900
|
|
|
$
|
0.39
|
|
Stock options granted
|
|
|
1,185,400
|
|
|
|
0.05
|
|
|
|
17,793,027
|
|
|
|
0.17
|
|
Stock options exercised
|
|
|
1,316
|
|
|
|
0.05
|
|
|
|
—
|
|
|
|
0.00
|
|
Restricted stock exercised
|
|
|
—
|
|
|
|
0.00
|
|
|
|
—
|
|
|
|
0.00
|
|
Canceled/Expired
|
|
|
(907,646
|
)
|
|
|
0.33
|
|
|
|
(58,268
|
)
|
|
|
0.28
|
|
Outstanding, end of period
|
|
|
21,934,214
|
|
|
$
|
0.20
|
|
|
|
22,258,659
|
|
|
$
|
0.22
|
|
Exercisable, end of period
|
|
|
9,463,671
|
|
|
$
|
0.245
|
|
|
|
3,067,959
|
|
|
$
|
0.34
|
|
As of September 30, 2016
and 2015, there was approximately $1.7 million and $2.7 million, respectively, of total unrecognized compensation related to non-vested
share-based compensation arrangements granted under the Company’s stock plans.
Restricted Stock Awards
At September 30, 2016 and
2015, there were no outstanding restricted stock awards.
Stock Option Grants
On August 9, 2013, the
Company’s shareholders’ approved the 2013 Employee, Director and Consultant Equity Incentive Plan (the “2013
Plan”). The 2013 Plan allows for the issuance of up to 8,860,000 additional shares of the Company’s common stock pursuant
to awards granted under the 2013 Plan. Additionally, the 2013 Plan allows for the issuance of up to a maximum of 2,435,500 additional
shares of the Company’s common stock, pursuant to the cancellation, forfeiture, or expiry, of awards granted under the 2004
Employee, Director and Consultant Stock Plan and terminated on or after the 2013 Plan approval on August 9, 2013. On July 21, 2015,
the Company’s stockholders approved an amendment to the 2013 Plan to increase the number of shares of common stock available
for issuance thereunder by 30,000,000 shares. During the nine month period ended September 30, 2016, the Company granted 1,185,400
stock options under the 2013 Plan. At September 30, 2016, the Company had an aggregate of 30,158,249 shares of common stock available
for grant under the 2013 Plan.
Per his employment agreement,
Mark Carbeau was entitled to receive a grant of options to purchase shares of the Company’s common stock equal to 5% of the
number of shares of the Company’s stock issued in the 2016 Private Placement, assuming the conversion of all convertible
securities issued in the 2016 Private Placement, which equals 5,626,257 shares, at a per share exercise price equal to the fair
market value of the Company’s common stock on the date of the grant. Pursuant to the terms of the 2013 Plan, the Company
cannot issue options or other grants for more than 5,000,000 shares to any one person in a calendar year. Consequently, on October
20, 2016, the Company granted Mr. Carbeau options to purchase 5,000,000 shares of the Company’s common stock at an exercise
price of $0.17544 per share and expects to grant the remaining options to which Mr. Carbeau is entitled in 2017. These options
will vest as to 25% of the shares on July 29, 2017 and as to an additional 2.083% of the shares on the last day of each successive
month thereafter, provided that Mr. Carbeau remains employed by Company on the vesting date. See Note 10 – Subsequent Events.
Per
his employment agreement, Stephan Toutain was entitled to receive a grant of options to purchase shares of the Company’s
common stock equal to 1% of the Company’s fully diluted shares as of his start date at an exercise price equal to fair market
value of the Company’s common stock on the grant date of the option. Consequently, on October 20, 2016, the Company granted
Mr. Toutain options to purchase 3,738,933 shares of the Company’s common stock at an exercise price of $0.17544 per share.
These options will vest as to 25% of the shares on August 15, 2017, and as to an additional 2.083% of the shares monthly thereafter.
See Note 10 – Subsequent Events.
It is the Company’s
policy to grant stock options with an exercise price equal to the fair market value of the Company’s common stock at the
grant date, and stock options to employees generally vest over four years based upon continuous service. Historically, the majority
of the Company’s stock options have been granted in connection with the employee’s start date with the Company. In
addition, the Company may grant stock options in recognition of promotion and/or performance.
Employee Stock Purchase Plan
Purchases made under the
Company’s Employee Stock Purchase Plan are deemed to be compensatory because employees may purchase stock at a price equal
to 85% of the fair market value of the Company’s common stock on either the first day or the last day of a calendar quarter,
whichever is lower. During the nine months ended September 30, 2016 and 2015, employees purchased 179,952 and 157,705 shares, respectively,
of common stock at a weighted-average purchase price of $0.06 and $0.11, respectively, while the weighted-average market value
was $0.08 and $0.13 per share, respectively, resulting in compensation expense of $1,921 and $3,129, respectively.
Note 9—Industry Risk and Concentration
The Company develops genetic
risk assessment tests and performs research for its own benefit. As of September 30, 2016, the Company sells five genetic risk
assessment tests. Commercial success of the Company’s genetic risk assessment tests will depend on their success at being
deemed to be scientifically credible and cost-effective by consumers and the marketing success of the Company and its collaborative
partners.
Research in the field of
disease predisposing genes and genetic markers is intense and highly competitive. The Company has many competitors in the United
States and abroad that have considerably greater financial, technical, marketing, and other resources available. If the Company
does not discover disease predisposing genes or genetic markers and develop risk assessment tests and launch such services or products
before its competitors, then the potential for significant revenues may be reduced or eliminated.
During the nine months
ended September 30, 2016 and 2015, approximately 24% and 45%, respectively, of the Company’s revenue came from sales through
the Merchant Network and Channel Partner Agreement with Amway Global, and 3% and 14%, respectively, of the Company’s revenue
came from sales through ABG’s promotional product bundle program. During the nine months ended September 30, 2016 and 2015,
approximately 23% and 49%, respectively, of the Company’s revenue came from sales through the Merchant Network and Channel
Partner Agreement with Amway Global, and 4% and 15%, respectively, of the Company’s revenue came from sales through ABG’s
promotional product bundle program.
Note 10—Subsequent Events
Per his employment agreement,
on October 20, 2016 Mark Carbeau was granted options to purchase 5,000,000 shares of the Company’s common stock at an exercise
price of $0.17544 per share. The options will vest as to 25% of the shares on July 29, 2017 and as to an additional 2.083% of the
shares on the last day of each successive month thereafter, provided that he remains employed by Company on the vesting date.
Per his employment agreement,
on October 20, 2016 Stephan Toutain was granted options to purchase 3,738,933 shares of the Company’s common stock at an
exercise price of $0.17544 per share. The options will vest as to 25% of the shares on August 15, 2017, and as to an additional
2.083% of the shares on the last day of each successive month thereafter, provided that he remains employed by Company on the vesting
date.