This prospectus supplement supplements the
prospectus dated September 27, 2016, relating to the offering and resale by the selling stockholders of up to 122,585,504 shares
of our common stock. We will not receive any proceeds from the sale of these shares by the selling stockholders.
This prospectus supplement incorporates
into our prospectus the information contained in the attached Quarterly Report on Form 10-Q, which was filed with the Securities
and Exchange Commission on November 14, 2016.
You should read this prospectus supplement
in conjunction with the prospectus, including any supplements and amendments thereto. This prospectus supplement is qualified by
reference to the prospectus except to the extent that the information in this prospectus supplement supersedes the information
contained in the prospectus.
This prospectus supplement is not complete
without, and may not be delivered or utilized except in connection with, the prospectus, including any supplements and amendments
thereto.
Our common stock is traded on the OTCQB
under the symbol “ILIU”. On November 11, 2016, the closing sale price of our common stock on the OTCQB was $0.11 per
share.
Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.
See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act. (Check one):
As of November
11, 2016, there were 229,381,059 shares of Common Stock, $0.001 par value per share, outstanding.
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.
Item 2. Management’s Discussion
and Analysis of Financial Condition and Results of Operations
The following discussion
of our financial condition and results of operations should be read in conjunction with the unaudited condensed financial statements
and the notes thereto included elsewhere in this document.
General Overview and Trends
Interleukin Genetics, Inc.
develops and markets proprietary genetic tests for chronic diseases and health-related conditions. Our products provide information
that is not otherwise available to empower individuals and their healthcare providers to manage their health and wellness through
genetics-based insights and actionable guidance. We leverage our research, intellectual property, and genetic test development
expertise in inflammation and metabolism to identify an individual’s risk for severe and progressive chronic inflammatory
diseases, thereby enabling personalized healthcare. We market our tests through healthcare professionals, partnerships with health
and wellness companies, and other distribution channels. We have patents covering the use of specific patterns of gene variations
for a number of common chronic diseases. Our lead products are our proprietary ILUSTRA Program, which identifies individuals with
an increased risk for severe and progressive periodontitis due to a life-long genetic predisposition to over-produce Interleukin-1
(IL-1), a key mediator of inflammation, and seeks to improve outcomes and lower healthcare costs through improved management of
inflammation, and our Inherent Health line of genetic tests.
During the nine months
ended September 30, 2016, our principal focus has been on commercializing our ILUSTRA Program. The ILUSTRA Program serves
as a central component to an enhanced benefit design or wellness initiative directed to lower medical costs through disease avoidance
and reduced disease progression and complications. The program includes a genetic risk test that identifies individuals at high
risk for elevated systemic inflammation, enabling a risk stratification framework to personalize care interventions and patient
outreach. The program creates value through early identification of risk, elevated professional surveillance for disease detection,
and enhanced patient engagement and compliance.
We
market the ILUSTRA Program to large employers, who are typically self-insured, and to insurance carriers. Our employer customers
see value in the potential reduction of medical costs associated with the highly prevalent inflammatory diseases that our program
can provide. Within the insurance carrier segment, we place particular emphasis on carriers with dental-medical integration (DMI)
products, either in place or in development, and integrated delivery networks (IDNs), as these customers are best positioned to
realize value from the potential reduction of medical costs associated with the highly prevalent inflammatory diseases
that
our program can provide.
We
pursue these customers through our internal team and through consultants and other third parties, including channel partners, primarily
benefits consulting firms, who may be helpful to identify, and facilitate initial interactions with, potential customers. We had
established two such relationships by September 30, 2016, with Employee Benefit Consulting Group LLC (EBCG), a firm with expertise
in the U.S. insurance market and strong relationships with employers, insurance carriers, and health and wellness providers, and
with Comprehensive Benefit Administrators (“CBA”), which has included the ILUSTRA Program as part of its Freedom Dental
Plan that CBA promotes to their customers. In July, we signed an agreement with
Amway,
a leading direct selling company, to provide the ILUSTRA Program to Amway’s employees as part of an enhanced employee benefits
plan.
The timing of any revenues
that we may receive from our marketing efforts is very uncertain at this time and is dependent on a number of variables, many of
which we may have a limited ability to influence. We may never receive significant revenues for the ILUSTRA Program.
We process test samples
in our CLIA-certified genetic testing laboratory, which must hold certain licenses, certifications, and permits to conduct our
business. Laboratories that perform testing on human specimens for the purpose of providing information for the diagnosis, prevention
or treatment of disease or assessment of health are subject to the Clinical Laboratory Improvement Amendments of 1988 (CLIA). CLIA
requires such a laboratory to be certified by the federal government and mandates compliance with various operational, personnel,
facilities, administration, quality and proficiency testing requirements intended to ensure that testing services are accurate,
reliable and timely. Requirements for testing under CLIA vary based on the level of complexity of the testing performed. Laboratories
performing high complexity tests, such as genetic tests, must comply with more stringent requirements than laboratories performing
moderate or waived testing. Our laboratory was most recently inspected in September 2015 and no deficiencies or other issues were
noted, and our CLIA license was renewed.
On April 5, 2016, we announced
the results of discussions with the U.S. Food and Drug Administration (FDA) in response to an Untitled Letter issued by the FDA
on November 4, 2015 and a meeting on February 3, 2016 with personnel within FDA’s Office of In Vitro Diagnostics and Radiological
Health (OIR) to discuss Interleukin’s written response to OIR with respect to the Untitled Letter. OIR personnel confirmed
that the ILUSTRA Test is a laboratory developed test (LDT) currently subject to FDA enforcement discretion and may continue to
be marketed without prior marketing authorization at this time. Our Bone Health and Heart Health tests, which are part of the Inherent
Health line of tests, will be transitioned from a direct-to-consumer (DTC) distribution channel to a distribution model under which
a licensed healthcare provider orders tests and oversees any resulting change in care. These two tests were available through Interleukin
Genetics’ DTC retail channels until May 22, 2016, at which time they were no longer available unless requested by an authorized
healthcare provider.
Our Inherent Health
brand
of genetic tests includes the first-of-its-kind test for weight management that identifies an individual’s genetic tendencies
for weight gain related to either fat or carbohydrates in the diet. The Inherent Health brand also offers customers a full
suite of affordable, easy-to-use and meaningful genetic tests in heart health, bone health and nutritional needs. In addition,
we launched additional products under the name Wellness Select that allows our e-commerce customers to purchase any combination
of our Inherent Health genetic tests at a discounted price.
We market our Inherent
Health brand of genetic assessment tests primarily through our commercial relationships with Alticor Inc. affiliated companies.
Alticor is a related party. On October 26, 2009, we 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 our Inherent
Health brand of genetic tests through its e-commerce website via a hyperlink to our e-commerce site. In the three months ended
September 30, 2016 and 2015, revenues from this agreement accounted for approximately 24% and 45% of our revenues, respectively.
In the nine months ended September 30, 2016 and 2015, revenues from this agreement accounted for approximately 23% and 49% of our
revenues, respectively.
In 2012 and 2013, Access
Business Group LLC (ABG), an affiliate of Alticor, placed purchase orders totaling approximately $3.3 million consisting of Weight
Management kits. Of the $3.3 million in orders received in 2013, $1.8 million was related to the 2014 program and $1.5 million
was related to the 2013 program. Cash for the kits purchased for the 2013 program was received in the first quarter of 2013 and
cash for the kits purchased for the 2014 program was received by December 31, 2013. As a component of the 2013 promotional program,
and not reflective of actual product expiry, the kits were required to be redeemed before December 31, 2013. In February 2014,
we removed the redemption date requirement for the 2013 promotional program, for which ABG paid us $519,000 as a retrospective
increase in the product purchase price. Cash related to the 2013 promotional program, including the $519,000, will be treated as
deferred revenue until kits are redeemed or the breakage analysis determines the probability of eventual redemption is remote.
In October 2014, we 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. Cash received for these kits will
be treated as deferred revenue until kits are redeemed for processing or on the final allowed redemption date of December 31, 2017.
For the three months ended September 30, 2016 and 2015, approximately 3% and 14%, respectively, of our revenue came from sales
through ABG’s promotional product bundle program. For the nine months ended September 30, 2016 and 2015, approximately 4%
and 15%, respectively, of our revenue came from sales through ABG’s promotional product bundle program.
On September 21, 2012,
we entered into a License Agreement with ABGI, an affiliate of Alticor. Pursuant to this License Agreement, we granted ABGI and
its affiliates a non-exclusive license to use the technology related to our Weight Management genetic test and to sell the Weight
Management test in Europe, Russia and South Africa. ABGI, or a laboratory designated by ABGI, is responsible for processing the
tests, and we receive a royalty for each test sold. 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. 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 same period
in 2015.
Our research and development
expenses are focused on our own development and commercialization efforts related primarily to our ILUSTRA Program and cardiovascular
disease genetic tests. We are also focusing on seeking potential commercial partners to validate our technology within their specific
business model as a collaboration with little or no cost to us. This is different than in prior years when our development focus
was concentrated in research and development to bring new test configurations to market.
We recognize revenue from
genetic testing services 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. To the extent that tests have been prepaid but results have not yet been reported, recognition of all related
revenue is deferred. During the fourth quarter of 2013, we concluded that sufficient historical customer genetic test redemption
patterns existed to determine the period of time after which the likelihood of test redemption was remote for Inherent Health tests
purchased. Based on our analysis of the redemption data, we estimate that period of time to be three years after the sale of a
genetic test kit. Prior to making this determination, revenue was recognized only on test kits returned and processed. Beginning
in the fourth quarter of 2013, we began to recognize breakage revenue related to genetic tests 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.
We analyzed redemption patterns from 2009 through 2015. 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 from the three and
nine months ended September 30, 2013, respectively, compared to $39,000 and $167,000 in the same periods in 2015, of breakage revenue
related to unredeemed genetic test kits from the three and nine months ended September 30, 2012, respectively. We expect to continue
to recognize breakage revenue and the corresponding deferred cost of goods as well as analyze the data on a quarterly basis based
on the historical analysis.
In the genetic test business,
competition is in flux and the markets and customer base are not well established. Adoption of new technologies by customers requires
substantial market development and customer education. Historically, we have focused on our relationship with our primary customer,
Alticor, a significant direct marketing company, in order to assist us in developing the market for our products and educating
our potential customers. Our challenge in the remainder 2016 and beyond will be to develop the market for our personalized health
products, in particular our ILUSTRA Program, and we will allocate considerable resources to commercialization of the ILUSTRA Program.
Due to the early stage of this initiative, we cannot predict with certainty fluctuations we may experience in our genetic test
revenues or whether such revenues will ever be material, or if material, will be sustained in future periods.
Results of Operations
Three Months Ended September 30, 2016 and 2015
Total revenue was $734,000
for the three months ended September 30, 2016
compared to $296,000 for the three months ended September 30, 2015.
The change in total revenue is primarily attributable to contracted research projects recognized in Other revenue.
During the three months
ended September 30, 2016, 24% of our sales revenue came through our Merchant Network and Channel Partner Agreement with Amway Global,
compared to 45% during the three months ended September 30, 2015. During the same periods, 3% and 14%, respectively, of our revenue
came from sales through ABG’s promotional product bundle program.
Cost of revenue for the
three months ended September 30, 2016, was $443,000, or 60% of total revenue, compared to $323,000, or 109% of total revenue, for
the three months ended September 30, 2015. The decrease in the cost of revenue as a percentage of revenue in the three months ended
September 30, 2016 is primarily attributable to the fixed laboratory costs being applied to higher revenue in the period, which
was due to contracted research projects.
Research and development
expenses were $418,000 for the three months ended September 30, 2016, compared to $412,000 for the three months ended September
30, 2015.
Selling, general and administrative
expenses were $1.7 million for the three months ended September 30, 2016, compared to $1.4 million for the three months ended September
30, 2015. The 19% increase is primarily attributable to recruiting fees and compensation related to new staff in sales and marketing
and higher consulting costs partially offset by lower commissions related to our Merchant Network and Channel Partner Agreement
with Amway Global and lower accounting fees.
Interest expense was $154,000
for the three months ended September 30, 2016, compared to $153,000 for the three months ended September 30, 2015. The interest
expense is entirely related to the Loan Agreement with Horizon Technology Finance Corporation (the “Lender”) entered
into on December 23, 2014, as restructured in August 2016.
Nine Months Ended September 30, 2016 and 2015
Total revenue was $2.3
million for the nine months ended September 30, 2016
compared to $1.1 million for the nine months ended September
30, 2015. The change in total revenue is largely attributable to contracted research projects, partially offset by a decrease in
kits returned for processing related to ABG’s promotional product bundle.
During the nine
months ended September 30, 2016, 23% of our sales revenue came through our Merchant Network and Channel Partner Agreement
with Amway Global, compared to 49% during the nine months ended September 30, 2015. During the same periods, 4% and 15%,
respectively, of our revenue came from sales through ABG’s promotional product bundle program.
Cost of revenue for the
nine months ended September 30, 2016, was $1.3 million, or 58% of total revenue, compared to 986,000, or 92% of total
revenue, for the nine months ended September 30, 2015. The decrease in the cost of revenue as a percentage of revenue in the
nine months ended September 30, 2016 is primarily attributable to the fixed laboratory costs being applied to higher revenue
in the period, which was due to contracted research projects.
Research and development
expenses were $1.4 million for the nine months ended September 30, 2016, compared to $979,000 for the nine months ended September
30, 2015. The 38% increase of $371,000 is primarily attributable to expenses related to Dr. Kornman moving back to the R&D
department in April 2015 as President and Chief Scientific Officer from his previous position as CEO. While he served as CEO, expenses
generated by Dr. Kornman were recorded as selling, general and administrative expenses. The increase in research and development
expenses was also partially due to increased compensation expense related to annual salary increases for existing staff and our
patient engagement study.
Selling, general and administrative
expenses were $4.7 million for the nine months ended September 30, 2016, compared to $4.6 million for the nine months ended September
30, 2015. The 2% increase is primarily attributable to higher legal and consulting expenses partially offset by lower recruiting
and patent fees as well as lower commissions related to our Merchant Network and Channel Partner Agreement with Amway Global.
Interest expense was $454,000
for the nine months ended September 30, 2016, compared to $456,000 for the nine months ended September 30, 2015. The interest expense
is entirely related to our venture loan and security agreement with the Lender entered into on December 23, 2014, as restructured
in August 2016.
Liquidity and Capital Resources
As of September 30, 2016,
we had cash and cash equivalents of $4.3 million.
On July 29, 2016, we
entered into a Securities Purchase Agreement (the “2016 Purchase Agreement”) with various accredited investors
(the “2016 Investors”), pursuant to which we 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 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.
On August 25, 2016, we and the Lender
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. Principal payments may also be reduced in future periods if we achieve certain milestones. In consideration of
these changes, (i) we paid the Lender an amendment fee of $25,000 and reimbursed the Lender’s legal expenses in the
amount of $5,000, (ii) we granted the Lender a first priority security interest in substantially all of our assets, including
our 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, we also issued to the Lender a warrant to purchase up to 5,169,577 shares of our 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 and is initially exercisable for up to 5,169,577 shares. If the
milestones required to further reduce the principal payments are achieved, the Lender shall be entitled to
additional warrants.
Cash
used in operations was $5.1 million for the nine months ended September 30, 2016 and $5.2 million for the nine months ended September
30, 2015. Cash used in operations is primarily impacted by operating results and changes in working capital, particularly the timing
of the collection of related party receivables, inventory levels, receipt of orders and the timing of payments to suppliers.
Cash used in investing
activities was $55,000 for the nine months ended September 30, 2016, compared to $41,000 for the nine months ended September 30,
2015. The majority of the $55,000 in 2016 relates to the cost of creating our new product website. The majority of the $41,000
in 2015 relates to the purchase of new computer equipment.
Cash provided by financing
activities was $4.8 million for the nine months ended September 30, 2016, compared to cash provided by financing activities of
$10,000 for the nine months ended September 30, 2015. In July 2016 the Company received approximately $5.5 million, net of expenses,
from the 2016 Private Placement. This was partially offset by $722,000 in principal payments related to our venture loan and security
agreement with the Lender entered into on December 23, 2014, as restructured in August 2016.The Company received $10,000 from stock
purchases through the employee stock purchase plan during the nine months ended September 30, 2016 compared to $17,000 for the
nine months ended September 30, 2015. The $17,000 received through the employee stock purchase plan for the nine months ended September
30, 2015 was offset by $7,100 in additional fees related to the December 2014 Private Placement.
The amount of cash we
generate from operations is currently not sufficient to continue to fund operations and grow our business. We expect our
current cash and cash equivalents to be sufficient to support operations into the second quarter of 2017. We believe our
success depends on our ability to generate significant revenues for the ILUSTRA Program. The timing of any revenues that we
may receive for the ILUSTRA Program is uncertain at this time, and is contingent upon a number of factors, including our
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. We do not expect to receive
any material revenues from the ILUSTRA Program until the first half of 2017, at the earliest, and the timing of any such
revenues may be substantially later. We may never receive significant revenues from the ILUSTRA Program.
Until such time, if ever,
that we generate revenues sufficient to fund operations, we may fund our operations by issuing common stock, debt or other securities
in one or more public or private offerings, as market conditions permit, or through the incurrence of debt from commercial lenders.
However, no assurance can be given at this time as to whether we will be able to achieve these objectives. To the extent that we
raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our existing stockholders
will be diluted, and the terms may include liquidation or other preferences that adversely affect the rights of our stockholders.
Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific
actions, such as incurring debt, making capital expenditures or declaring dividends. There can be no assurance that additional
funds will be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available to
us on a timely basis, we may be required to delay, limit, reduce or cease activities or operations or enter into licenses or other
arrangements with third parties on terms that may be unfavorable to us or sell, license or relinquish rights to develop or commercialize
our products, technologies or intellectual property, or seek protection under U.S. bankruptcy laws. The financial statements do
not include any adjustment relating to the recoverability and classification of recorded asset amounts or the amounts and classification
of liabilities that might be necessary should we be unable to continue as a going concern.
Critical Accounting Policies and Estimates
Our discussion and analysis
of our financial condition and results of operations are based upon our financial statements. The preparation of these financial
statements and related disclosures in conformity with accounting principles generally accepted in the United States of America
requires us to (i) make judgments, assumptions and estimates that affect the reported amounts of assets, liabilities, revenue and
expenses; and (ii) disclose contingent assets and liabilities. A critical accounting estimate is an assumption that could have
a material effect on our financial statements if another, also reasonable, amount were used or a change in the estimates is reasonably
likely from period to period. We base our accounting estimates on historical experience and other factors that we consider reasonable
under the circumstances. However, actual results may differ from these estimates. To the extent there are material differences
between our estimates and the actual results, our future financial condition and results of operations will be affected. Our most
critical accounting policies and estimates upon which our financial condition depends, and which involve the most complex or subjective
decisions or assessments are set forth in Note 3 to our financial statements included in our Annual Report on Form 10-K for the
year ended December 31, 2015. There have been no significant changes in our accounting policies or changes from the methodology
applied by management for critical accounting estimates previously disclosed in our most recent Annual Report on Form 10-K.
Recent Accounting Pronouncements
Please see the discussion
of “Recent Accounting Pronouncements” in Note 3, “Summary of Significant Accounting Policies” contained
in the Notes to Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2015
and Note 3, “Summary of Significant Accounting Policies” contained in the Notes to unaudited Condensed Financial Statements
included in this Quarterly Report on Form 10-Q.
Item 3.
Quantitative and Qualitative
Disclosures about Market Risk
As a smaller reporting
company, we have elected scaled disclosure reporting obligations and therefore are not required to provide the information required
by this Item 3.
Item 4.
Controls and Procedures
(a)
Evaluation
of Disclosure Controls and Procedures.
Our principal executive officer and principal financial officer, after evaluating
the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) as of
the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, our disclosure
controls and procedures were adequate and effective to ensure that information required to be disclosed by us in the reports that
we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in
the SEC’s rules and forms, and is accumulated and communicated to our management, including our principal executive and principal
financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
(b)
Changes in Internal Control Over
Financial Reporting.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f))
occurred during the quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect,
our internal control over financial reporting.