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Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For The Quarterly Period Ended September 30, 2009

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                      TO            

 

Commission File Number 001-33523

 

COMBIMATRIX CORPORATION

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

47-0899439

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

6500 Harbour Heights Pkwy., Suite 303,

 

 

Mukilteo, WA

 

98275

(Address of Principal Executive Offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:  (425) 493-2000

 

 

(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

 

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):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer o

(Do not check if a smaller reporting company)

 

Smaller reporting company x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

 

As of November 9, 2009, 7,571,886 shares of CombiMatrix Corporation common stock were issued and outstanding.

 

 

 



Table of Contents

 

COMBIMATRIX CORPORATION

Table of Contents

 

 Part I. Financial Information

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 2009 (Unaudited) and December 31, 2008

3

 

 

 

 

Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008 (Unaudited)

4

 

 

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008 (Unaudited)

5

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

24

 

 

 

Item 4T.

Controls and Procedures

24

 

 

 

Part II. Other Information

 

 

 

 

Item 1.

Legal Proceedings

25

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

25

 

 

 

Item 5.

Other Information

25

 

 

 

Item 6.

Exhibits

26

 

 

 

Signatures

 

27

 

 

 

Exhibit Index

 

28

 

2



Table of Contents

 

COMBIMATRIX CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands)

 

 

 

September 30,

 

December 31,

 

 

 

2009

 

2008

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

7,905

 

$

7,579

 

Available-for-sale investments

 

 

1,526

 

Accounts receivable, net of allowance for doubtful accounts of $655 and $378

 

681

 

916

 

Inventory

 

773

 

725

 

Prepaid expenses and other assets

 

346

 

219

 

Total current assets

 

9,705

 

10,965

 

 

 

 

 

 

 

Property and equipment, net

 

516

 

743

 

Investments in unconsolidated subsidiaries

 

299

 

938

 

Patents and licenses, net

 

4,099

 

4,970

 

Goodwill

 

16,918

 

16,918

 

Total assets

 

$

31,537

 

$

34,534

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable, accrued expenses and other

 

$

1,992

 

$

2,130

 

Credit line borrowings

 

 

820

 

Current portion of deferred revenues

 

306

 

418

 

Total current liabilities

 

2,298

 

3,368

 

 

 

 

 

 

 

Deferred revenues, net of current portion

 

25

 

125

 

Capital lease obligation, net of current portion

 

33

 

43

 

Secured convertible debenture

 

7,271

 

6,483

 

Other liabilities

 

848

 

469

 

Total liabilities

 

10,475

 

10,488

 

 

 

 

 

 

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

Preferred stock; $0.001 par value; 5,000,000 shares authorized; none issued and outstanding

 

 

 

Common stock; $0.001 par value; 25,000,000 shares authorized; 7,539,313 and 6,288,033 shares issued and outstanding

 

8

 

6

 

Additional paid-in capital

 

54,728

 

43,650

 

Accumulated net losses

 

(33,674

)

(19,610

)

Total shareholders’ equity

 

21,062

 

24,046

 

Total liabilities and shareholders’ equity

 

$

31,537

 

$

34,534

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

3



Table of Contents

 

COMBIMATRIX CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share information)

(Unaudited)

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Government contracts

 

$

133

 

$

343

 

$

949

 

$

2,380

 

Products

 

250

 

158

 

807

 

1,356

 

Services

 

524

 

448

 

1,802

 

1,145

 

Collaboration agreements

 

63

 

62

 

188

 

186

 

Total revenues

 

970

 

1,011

 

3,746

 

5,067

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of government contract revenues

 

125

 

336

 

862

 

2,305

 

Cost of products and services

 

409

 

370

 

1,587

 

1,258

 

Research and development expenses

 

1,401

 

1,336

 

3,814

 

3,595

 

Marketing, general and administrative expenses

 

2,340

 

2,301

 

7,970

 

6,781

 

Patent amortization and royalties

 

337

 

341

 

1,016

 

1,063

 

Equity in loss of investee

 

107

 

247

 

618

 

737

 

Total operating expenses

 

4,719

 

4,931

 

15,867

 

15,739

 

Operating loss

 

(3,749

)

(3,920

)

(12,121

)

(10,672

)

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

2

 

58

 

17

 

183

 

Interest expense

 

(531

)

(403

)

(1,553

)

(408

)

Derivatives credits (charges)

 

977

 

16

 

(407

)

16

 

Total other income (expense)

 

448

 

(329

)

(1,943

)

(209

)

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(3,301

)

$

(4,249

)

$

(14,064

)

$

(10,881

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.44

)

$

(0.70

)

$

(2.01

)

$

(1.80

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted weighted average common shares outstanding

 

7,512,401

 

6,097,086

 

6,983,157

 

6,040,214

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

4



Table of Contents

 

COMBIMATRIX CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Operating activities:

 

 

 

 

 

Net loss

 

$

(14,064

)

$

(10,881

)

Adjustments to reconcile net loss to net cash flows from operating activities:

 

 

 

 

 

Depreciation and amortization

 

1,157

 

1,352

 

Non-cash stock compensation

 

2,535

 

1,556

 

Derivatives charges (credits)

 

407

 

(16

)

Equity in loss of investees

 

618

 

737

 

Warrants issued to consultants

 

135

 

 

Allowance for bad debt

 

278

 

248

 

Amortization of debt discount and issuance costs

 

890

 

181

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(43

)

(561

)

Inventory, prepaid expenses and other assets

 

(175

)

(284

)

Accounts payable, accrued expenses and other

 

322

 

(310

)

Deferred revenues

 

(212

)

(136

)

Net cash flows from operating activities

 

(8,152

)

(8,114

)

Investing activities:

 

 

 

 

 

Purchase of property and equipment

 

(59

)

(55

)

Sale of available-for-sale investments

 

1,526

 

4,030

 

Net cash flows from investing activities

 

1,467

 

3,975

 

Financing activities:

 

 

 

 

 

Proceeds from issuance of secured convertible debenture

 

 

10,000

 

Payment of debt issuance costs

 

 

(248

)

Net proceeds from issuance of common stock

 

7,846

 

711

 

(Repayment) draw on credit line

 

(820

)

808

 

Repayment of capital lease obligations

 

(15

)

(21

)

Net cash flows from financing activities

 

7,011

 

11,250

 

 

 

 

 

 

 

Increase in cash and cash equivalents

 

326

 

7,111

 

Cash and cash equivalents, beginning

 

7,579

 

2,314

 

Cash and cash equivalents, ending

 

$

7,905

 

$

9,425

 

 

 

 

 

 

 

Non-cash financing activities:

 

 

 

 

 

Reclassification of warrant liabilities to paid-in capital

 

$

 

$

1,780

 

 

 

 

 

 

 

Accrued interest paid in common stock

 

$

634

 

$

 

 

 

 

 

 

 

Conversion of secured convertible debenture to common stock

 

$

100

 

$

1,300

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5



Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.    OVERVIEW AND BACKGROUND

 

CombiMatrix Corporation (the “Company” “we” “us” and “our”) was originally incorporated in October 1995 as a California corporation and later reincorporated as a Delaware corporation in September 2000.  On December 13, 2002 (the “Merger Date”), we merged with and became a wholly owned subsidiary of Acacia Research Corporation (“Acacia”).  Also on the Merger Date, Acacia entered into a recapitalization transaction whereby Acacia created two classes of registered common stock called Acacia Research-CombiMatrix common stock (“AR-CombiMatrix stock”) and Acacia Research-Acacia Technologies common stock (“AR-Acacia Technologies stock”) and divided its existing Acacia common stock into shares of the two new classes of common stock.  On August 15, 2007, we split-off from Acacia (the “Redemption Date”), and all currently issued and outstanding shares of AR-CombiMatrix stock were redeemed and exchanged for shares of CombiMatrix common stock at a redemption ratio of ten shares of AR-CombiMatrix stock for one share of CombiMatrix common stock (the “Redemption Ratio”), which is currently traded on the Nasdaq Global Market.  Also, warrants to purchase AR-CombiMatrix stock became exercisable to purchase CombiMatrix common stock, adjusted for the Redemption Ratio.  As of the Redemption Date, we ceased to be a subsidiary of, or affiliated with, Acacia.

 

Description of the Company

 

We are a diversified biotechnology business that develops proprietary technologies, including products and services in the areas of drug development, genetic analysis, molecular diagnostics, nanotechnology and defense and homeland security markets, as well as in other potential markets where our products and services could be utilized. The technologies we have developed include a platform technology to rapidly produce user-defined, in-situ synthesized, oligonucleotide arrays for use in identifying and determining the roles of genes, gene mutations and proteins. This technology has a wide range of potential applications in the areas of genomics, proteomics, biosensors, drug discovery, drug development, diagnostics, combinatorial chemistry, material sciences and nanotechnology. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs.  We currently recognize revenues from selling these products and services and providing research and development services for organizations including the U.S. Department of Defense (“DoD”) and other strategic partners.

 

CombiMatrix Molecular Diagnostics, Inc. (“CMDX”), our wholly owned subsidiary located in Irvine, California, has developed capabilities of producing arrays that utilize bacterial artificial chromosomes, or “BACs,” which also enable genetic analysis.  CMDX functions primarily as a diagnostics reference laboratory.

 

Leuchemix Inc. (“Leuchemix”), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases.

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, certain information and footnotes required by generally accepted accounting principles in annual financial statements have been omitted or condensed in accordance with quarterly reporting requirements of the SEC.  These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2008, as reported by us in our Annual Report on Form 10-K filed on March 27, 2009.  The year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America.  The consolidated financial statements include all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair statement of our financial position as of September 30, 2009, and results of operations and cash flows for the interim periods presented.  The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the entire year.

 

6



Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

Liquidity and Risks

 

We have a history of incurring net losses and net operating cash flow deficits.  We are also deploying new and unproven technologies and continue to develop commercial products. We have several ongoing long-term development projects that involve experimental technology and may require several years and substantial expenditures to complete.  Based on our cash and investment balances as of December 31, 2008, we believed that our cash and cash equivalent balances, anticipated cash flows from operations and other external sources of available credit would be sufficient to meet our cash requirements to September 2009, which raised substantial doubt about our ability to continue as a going concern beyond this point.  On May 1, 2009, we closed a registered direct offering of our common stock and warrants which, after placement agent fees and other costs, netted approximately $7.6 million to us (see Note 7), which management believes extends our going concern to June 2010.

 

In order for us to continue operating as a going concern beyond June 2010, we will be required to increase revenues, reduce operating costs and possibly to obtain capital from external sources.  However, there can be no assurances that additional sources of financing, including the issuance of debt and/or equity securities will be available at times and at terms acceptable to us.  The issuance of equity securities, should that occur, will cause dilution to our shareholders.  If external sources of financing are not available or are inadequate to fund our operations, we will be required to reduce operating costs including research projects and personnel, which could jeopardize the future strategic initiatives and business plans of the Company.  For example, reductions in research and development activities and/or personnel at our Mukilteo, Washington facility could result in the inability to invest the resources necessary to continue to develop next-generation products and improve existing product lines in order to remain competitive in the marketplace, resulting in reduced revenues and cash flows from the sales of our CustomArrayTM products and services.  Also, reduction in operating costs at CMDX, should they occur, could jeopardize its ability to launch, market and sell additional products and services necessary in order to grow and sustain its operations and eventually achieve profitability.

 

Our business operations are also subject to certain risks and uncertainties, including:

 

·                  market acceptance of products and services;

 

·                  technological advances that may make our products and services obsolete or less competitive;

 

·                  increases in operating costs, including costs for supplies, personnel and equipment;

 

·                  the availability and cost of capital;

 

·                  the financial crisis affecting the global banking system and financial markets; and

 

·                  governmental regulation that may restrict our business.

 

Our success also depends on our ability to protect our intellectual property, the loss thereof or our failure to secure the issuance of additional patents covering elements of our business processes could materially harm our business and financial condition.  The patents covering our core technology begin to expire in 2018.

 

Our products and services are concentrated in a highly competitive market that is characterized by rapid technological advances, frequent changes in customer requirements and evolving regulatory requirements and industry standards.  Failure to anticipate or respond adequately to technological advances, changes in customer requirements, changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of planned products or services, could have a material adverse effect on our business and operating results.  The accompanying consolidated financial statements have been prepared assuming that the Company continues as a going concern.  The financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the matters discussed herein.

 

7



Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

2.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Recent Accounting Pronouncements.  In June 2009, the Financial Accounting Standards Board (“FASB”) issued the Accounting Standards Codification (“ASC”) as the single source of authoritative U.S. GAAP recognized by the FASB to be applied by nongovernmental entities in preparation of financial statements in conformity with U.S. GAAP, except for additional authoritative rules and interpretative releases issued by the SEC.  While the adoption of the ASC as of September 30, 2009 changes how accounting standards are referenced, the adoption did not have an impact on our consolidated financial statements.

 

In October 2009, the FASB ratified new authoritative accounting guidance to require companies to allocate revenue in multiple-element arrangements based on an element’s estimated selling price if vendor-specific or other third-party evidence of value is not available. The new guidance is effective for revenue transactions entered into during fiscal years beginning on or after June 15, 2010, with earlier application permitted.  We are currently evaluating both the timing and the impact of the pending adoption of the guidance on our consolidated financial statements.

 

In June 2009, the FASB issued new authoritative guidance to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity and requires ongoing qualitative reassessments of whether an enterprise is the primary beneficiary of a variable interest entity.  We will adopt this guidance for interim and annual reporting periods beginning on November 15, 2009.  We do not expect the adoption of this guidance to have any material impact on our consolidated financial statements.

 

In April 2009, the FASB issued additional authoritative guidance on the fair value of financial instruments, which provides: (i) further provisions on estimating fair value when the markets become inactive and quoted prices reflect distressed transactions; (ii) extended disclosure requirements for interim financial statements regarding the fair value of financial instruments; and (iii) new criteria for recording impairment charges on investments in debt instruments.  We adopted the guidance on a prospective basis in the interim period ended June 30, 2009 without material impact to our consolidated financial statements.

 

In June 2008, the FASB ratified new authoritative guidance addressing the accounting for certain instruments (or embedded features) determined to be indexed to an entity’s own stock.   This guidance provides that an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions.  We chose to early-adopt this guidance in 2008.  See Note 6 below for further discussion of the impact of this guidance to our consolidated financial statements.

 

Use of Estimates.  The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.

 

Revenue Recognition. We recognize revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been performed, (iii) amounts are fixed or determinable and (iv) collectibility of amounts is reasonably assured.

 

Revenue from the sale of products and services, including shipping and handling fees but excluding statutory taxes collected from customers, as applicable, are recognized when delivery has occurred or services have been rendered.  We sell our products and services directly to customers and also through distributors, and our right to collection is not dependent upon installation or a subsequent sale of our products to end-users.  Our standard agreements do not provide for credits, returns or exchanges with our customers or distributors.  Our distribution agreements include fixed pricing arrangements for our products and after customer acceptance, there is no written or implied right to return or exchange the products.

 

8



Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

Revenues from government contracts are recognized using the partial performance method of accounting, whereby performance to date is established based on costs incurred to the total amount of estimated costs at each reporting period.  Under the partial performance method of accounting, contract revenues and costs are recognized in the period that work is performed based on the percentage of actual incurred costs to total contract costs.  The partial performance method is used to recognize revenue because management considers actual costs incurred to be the best available measure of progress towards the completion of government contracts, the total profit can be reasonably computed, and collection is reasonably assured.  Actual contract costs include direct charges for labor and materials and indirect charges for labor, overhead and certain general and administrative charges.  Contract change orders and claims are included when they can be reliably estimated and are considered probable.  For contracts that extend over a one-year period, revisions in contract cost estimates, if they occur, have the effect of adjusting current period earnings applicable to performance in prior periods.  Should current contract estimates indicate an overall future loss to be incurred, a provision is made for the total anticipated loss in the current period.  Historically, contract revenue recognized approximates the amounts invoiced, resulting in no estimated costs and earnings in excess of billings or billings in excess of estimated costs and earnings.

 

Revenues from multiple-element arrangements involving license fees, up-front payments, milestone payments, products and/or services, which are received and/or billable by us in connection with other rights and services that represent continuing obligations of ours, are deferred until all of the elements have been delivered or until we have established objective and verifiable evidence of the fair value of the undelivered elements.

 

Deferred revenues arise from payments received in advance of the culmination of the earnings process.  Deferred revenues expected to be recognized within the next twelve months are classified within current liabilities.  Deferred revenues will be recognized as revenue in future periods when the applicable revenue recognition criteria as described above are met.

 

Stock-Based Compensation.  The compensation cost for all stock-based awards is measured at the grant date, based on the fair value of the award, and is recognized as an expense, on a straight-line basis, over the employee’s requisite service period (generally the vesting period of the equity award) which is generally three years.  The fair value of each option award is estimated on the date of grant using a Black-Scholes option valuation model.  Stock-based compensation expense is recognized only for those awards that are expected to vest using an estimated forfeiture rate.  We estimate pre-vesting option forfeitures at the time of grant and reflect the impact of estimated pre-vesting option forfeitures in compensation expense recognized.  Stock-based compensation expense for all periods presented attributable to our functional expense categories were as follows (in thousands; unaudited):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

 

 

 

 

 

 

 

 

 

 

Cost of products and services

 

$

13

 

$

12

 

$

61

 

$

23

 

Research and development

 

172

 

121

 

461

 

261

 

Marketing, general and administrative

 

704

 

654

 

2,013

 

1,272

 

Total non-cash stock compensation

 

$

889

 

$

787

 

$

2,535

 

$

1,556

 

 

Net Loss Per Share.  Basic and diluted net loss per share has been computed by dividing the net loss by the weighted average number of common shares issued and outstanding during the periods presented.  Options and warrants to purchase CombiMatrix stock are anti-dilutive and therefore are not included in the determination of the diluted net loss per share.  The following table presents a reconciliation of basic and diluted loss per share for all periods presented (in thousands, except share and per-share data; unaudited):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Numerator:

 

 

 

 

 

 

 

 

 

Loss applicable to common shareholders

 

$

(3,301

)

$

(4,249

)

$

(14,064

)

$

(10,881

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

7,512,401

 

6,097,086

 

6,983,157

 

6,040,214

 

Basic and diluted loss per share

 

$

(0.44

)

$

(0.70

)

$

(2.01

)

$

(1.80

)

 

 

 

 

 

 

 

 

 

 

Common stock options

 

1,980,577

 

1,579,490

 

1,980,577

 

1,579,490

 

Common stock warrants

 

3,813,646

 

2,593,958

 

3,813,646

 

2,593,958

 

Convertible debenture

 

1,120,000

 

732,940

 

1,120,000

 

732,940

 

Excluded potentially dilutive securities

 

6,914,223

 

4,906,388

 

6,914,223

 

4,906,388

 

 

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

Available-For-Sale Investments.  Investments in marketable securities with original maturities of less than three months are included in cash and cash equivalents, and investments with original maturities of greater than three months and less than one year are classified as short-term.  Investments in marketable securities are typically classified as available-for-sale, which are reported at fair value with related unrealized gains and losses in the value of such securities recorded as a component of accumulated other comprehensive income until realized.  We monitor our investments for impairment, which are deemed to be other-than-temporary based on a variety of factors including:  (a) the duration and severity of the impairment; (b) the ability and intent to hold an investment for a period of time sufficient for recovery of its carrying amount; and (c) the financial condition of the issuer.  All available evidence, both positive and negative, is considered to determine whether the carrying amount of the investment is recoverable within a reasonable period of time.  In general, management does not consider an investment impairment to be other-than-temporary if the duration and amount of the impairment is less than twelve months and five percent of the historical cost of the investment, respectively.

 

Fair Value Measurements.  We measure fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  As such, fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability.  We utilize a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

·

Level 1:

Observable market inputs such as quoted prices in active markets;

 

 

 

·

Level 2:

Observable market inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

 

 

 

·

Level 3:

Unobservable inputs where there is little or no market data, which require the reporting entity to develop its own assumptions.

 

Derivatives Embedded in Certain Debt Securities.  We evaluate financial instruments for freestanding or embedded derivatives.  Derivative instruments that have been separated from the host contract and do not qualify for hedge accounting are recorded at fair value with changes in value recognized in as other income (expense) in the consolidated statements of operations in the period of change.

 

Subsequent Events.  We have evaluated subsequent events and transactions for potential recognition or disclosure in the consolidated financial statements through November 13, 2009, the day the financial statements were issued.

 

3.     FAIR VALUE MEASUREMENTS

 

The following table summarizes, for each major category of financial assets or liabilities measured on a recurring basis, the respective fair value at September 30, 2009 and the classification by level of input within the fair value hierarchy defined above (in thousands; unaudited):

 

 

 

September 30,

 

Fair Value Measurements at

 

 

 

2009

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Cash equivalents

 

$

7,569

 

$

7,569

 

$

 

$

 

Available-for-sale investments (1)

 

 

 

 

 

Total

 

$

7,569

 

$

7,569

 

$

 

$

 

 

 

 

 

 

 

 

 

 

 

Liabilities:

 

 

 

 

 

 

 

 

 

Embedded derivatives (2)

 

$

(848

)

$

 

$

 

$

(848

)

 


(1)          All available-for-sale investments previously categorized as Level 3 assets were redeemed in January 2009.

(2)          Included in “other liabilities” in the accompanying September 30, 2009 consolidated balance sheet.  See Note 6 below for discussion of fair value measurements relating to embedded derivatives.

 

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

The following table is a reconciliation of financial assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine months ended September 30, 2009 (in thousands; unaudited):

 

 

 

Available-

 

 

 

 

 

For-Sale

 

Embedded

 

 

 

Investments

 

Derivatives

 

 

 

 

 

 

 

Balances, December 31, 2008

 

$

1,526

 

$

(469

)

Redemption of ARS

 

(1,526

)

 

Conversions

 

 

28

 

Derivative charges

 

 

(407

)

Balances, September 30, 2009

 

$

 

$

(848

)

 

At December 31, 2008, our available-for-sale investments included $1.5 million of auction rate securities (“ARS”) at par value.  Historically, the carrying value of our ARS approximated fair value due to active, liquid markets for these securities as well as the frequent resetting of the interest rates at auction, which typically occurred every 7 to 30 days.  However, in mid-February 2008, the market for ARS collapsed and as a result, our ARS experienced multiple failed auctions during 2008.  During the fourth quarter of 2008, one of the issuers of our holdings in ARS redeemed $350,000 at par value, bringing the total amount of ARS held by us as of December 31, 2008 to $1.5 million.  On January 2, 2009, all of our remaining ARS were liquidated at par value.

 

From mid-February 2008 through the third quarter of 2008, the fair values of our holdings in ARS were estimated using discounted cash flow models.  These models consider, among other things, the timing of expected future successful auctions, estimated future cash flows, collateralization and credit worthiness of underlying security investments and discount rates applied to the estimated future cash flows.  Since these inputs were not observable, they were classified as Level 3 inputs.  As a result of the lack of liquidity in the ARS market and not as a result of the quality of the underlying collateral, we recorded unrealized losses on our ARS of $31,000 and $166,000 for the three and nine months ended September 30, 2008, respectively.  However, due to liquidations of our ARS at par value prior to and subsequent to December 31, 2008, we reversed our previously recognized unrealized losses and classified our ARS as current assets at par value in our December 31, 2008 consolidated balance sheet.

 

4.     COMPREHENSIVE LOSS

 

The following table shows our comprehensive net loss for all periods presented (in thousands; unaudited):

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net unrealized loss on available-for-sale investments

 

$

 

$

(31

)

$

 

$

(166

)

Net loss

 

(3,301

)

(4,249

)

(14,064

)

(10,881

)

Comprehensive loss

 

$

(3,301

)

$

(4,280

)

$

(14,064

)

$

(11,047

)

 

5.  CREDIT LINE BORROWINGS

 

On May 9, 2008 and pursuant to a Loan Management Account agreement (the “LMA”) with a financial institution (the “Lender”), we borrowed $808,000 from the Lender, secured by investments held in an investment account with the Lender.  The LMA is similar to a revolving line of credit borrowing facility.  The LMA provided that we accrue monthly interest charges at an annual, variable rate of 1% plus the 30-day LIBOR rate.  The total amount available under the LMA ranged from 50% to 92% of investments pledged as collateral, based upon the amount and security type in our investment portfolio, up to a maximum amount of $2.8 million.  The LMA had no stated maturity for the principal and interest amounts borrowed by us.  However, because the Lender had the ability under the terms of the LMA to call in the principal amount of the borrowings at any time, we classified the liability as a component of current liabilities in the accompanying December 31, 2008 consolidated balance sheet.  The LMA balance of $820,000 as of December 31, 2008 was repaid by us during the first quarter of 2009, however the LMA remains available for future borrowings at similar terms if so chosen by management.

 

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

6.  SECURED CONVERTIBLE DEBENTURE

 

On July 10, 2008 (the “Closing Date”), we issued to YA Global Investments, L.P. (“YA”): (i) a secured convertible debenture (the “Debenture”) with an aggregate principal amount of $10 million, which was convertible into shares of our common stock at a fixed conversion price of $11.87 per share (and was recently reduced to $7.50 per share - see Note 7); and (ii) warrants (the “YA Warrants”) to purchase up to 336,984 shares of our common stock.  The Debenture is due on the earlier of July 10, 2010 (the “Term”) or within four months after receipt of payment of judgment or settlement proceeds from National Union Fire Ins. Co. of Pittsburgh, PA (“National Union”) in accordance with the $35.7 million judgment (the “Judgment”) issued by the U.S. District Court for the Central District of California (the “District Court”).  The Debenture bears interest at an annual rate of 10%, with interest payments due quarterly in either cash or our common stock, beginning October 2008.  We have the right to force conversion of the Debenture into our common stock if the volume-weighted average price (“VWAP”) of our stock exceeds between 125% and 135% of the fixed conversion price for a period of thirty consecutive trading days, among other conditions and restrictions.  We also have a cash redemption option whereby we have the right to pre-pay the Debenture during the Term, but only if our common stock is trading below the fixed conversion price, among other conditions.  Prepayment penalties range between 5% and 10% during the first fifteen months of the Term and are 0% thereafter until maturity.  The number of shares issuable to YA upon conversion of the Debenture may increase due to certain anti-dilution adjustments, including if we issue common stock at a price lower than the $7.50 fixed conversion price while the outstanding principal amount of the Debenture is at least $5 million.  As a result of our registered direct offering that closed on May 1, 2009, the fixed conversion price of the Debenture was reduced from $11.87 per share to $7.50 per share pursuant to an anti-dilution adjustment (see Note 7).  The Debenture is secured by the Judgment as well as our intellectual property.  The YA Warrants have a five-year term and allow YA to purchase: (i) 168,492 shares of common stock at an exercise price of $11.87; and (ii) 168,492 shares of common stock at an exercise price of $13.65.  We have the right to call the YA Warrants, but only if the VWAP of our common stock is at or greater than 130% of the YA Warrants’ exercise price for at least twenty consecutive trading days, among other conditions.  We have registered shares of our common stock that are issuable to YA upon conversion of the Debenture and exercise of the YA Warrants on Form S-3, which was declared effective by the SEC during the third quarter of 2008.

 

Recognition on the Closing Date

 

On the Closing Date, we recognized the Debenture and YA Warrants based on their relative fair values of $8.2 million and $1.8 million, respectively.  The fair value of the Debenture was determined using the convertible bond model, assuming a 15% yield.  The relative fair value of the YA Warrants was classified as a component of additional paid-in capital with the corresponding amount reflected as a contra-liability to the Debenture.  The fair value of the warrants was determined using the Black-Scholes model, assuming a term of five years, volatility of 75%, no dividends, and a risk-free interest rate of 3.1%.

 

The conversion feature, cash redemption option, potential acceleration of maturity of the Debenture upon payment of the Judgment proceeds and potential adjustments to the fixed conversion price all represent embedded derivatives that, as of the Closing Date, were valued in aggregate at $927,000 and recorded separately from the Debenture as other liabilities, with a corresponding amount reflected as an additional contra-liability to the Debenture.  The fair value of the embedded derivatives was determined using the convertible bond model, discounted cash flows and binomial lattice models.

 

As a result of separating the YA Warrants and embedded derivatives from the Debenture, the aggregate contra-liability totaling $2.9 million was recognized as of the Closing Date and was netted against the Debenture, which will accrete to the face amount due YA over the Term using the effective interest method, with the corresponding charges recorded as interest expense.

 

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COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

Recognition Subsequent to the Closing Date

 

Since the Closing Date through September 30, 2009, YA has converted $1.6 million of the Debenture into common stock, $1.5 million of which was converted in 2008 and $100,000 of which was converted during the second quarter of 2009.  As of September 30, 2009 and December 31, 2008, the remaining amount of the Debenture, net of the aggregate contra-liability, was $7.3 million and $6.5 million, respectively.  The embedded derivative liabilities were marked to fair value of $848,000 and $768,000 as of September 30, 2009 and 2008, respectively, resulting in net non-operating derivative credits (charges) of $977,000 and $(407,000) for the three and nine months ended September 30, 2009, respectively, and credits of $16,000 for the three and nine months ended September 30, 2008, respectively.  As of September 30, 2009, the remaining principal amount of the Debenture was $8.4 million, with an estimated fair value of $8.1 million (excluding the embedded derivative features).

 

Since the issuance of the Debenture through September 30, 2009, accrued interest to YA in the amount of $846,000 has been paid by issuing 103,679 shares of our common stock.  Subsequent to September 30, 2009 but prior to the issuance of this report, accrued interest to YA as of September 30, 2009 in the amount of $212,000 was paid by issuing 32,573 shares of our common stock.

 

7.  SHAREHOLDERS’ EQUITY

 

Common Stock

 

On May 1, 2009, we closed a registered direct offering (the “Offering”) of our common stock and warrants for gross proceeds of $8.25 million.  Under the terms of the Offering, we sold 1.1 million units for $7.50 per unit to certain investors.  Each unit consisted of one share of our common stock and one warrant, each warrant to purchase one share of our common stock at an exercise price of $9.00 per share.  The warrants may not be exercised until six months after the Offering and have a term of five years.  The warrants are also callable if our common stock trades at or above $22.50 per share during any 20 trading days during a period of 30 consecutive trading days, with a minimum daily trading volume of 50,000 shares each day during that 30 trading day period.  Subsequent to the date of the Offering, we listed the warrants on the Nasdaq Global Market under the symbol “CBMXW”.  Net proceeds from the Offering, net of placement agent fees and expenses, were approximately $7.6 million.  As a result of executing the Offering, the fixed conversion price of the Debenture has been reduced to $7.50 per share, effective May 1, 2009.

 

Warrants

 

Prior to the Redemption Date, Acacia had issued warrants to purchase approximately 23.8 million shares of AR-CombiMatrix stock in connection with various financing transactions.  As of the Redemption Date, all previously outstanding AR-CombiMatrix common stock warrants became exercisable for CombiMatrix common stock, adjusted for the Redemption Ratio discussed above.

 

Outstanding warrants to purchase CombiMatrix common stock are as follows (unaudited):

 

 

 

Shares of Common Stock

 

 

 

 

 

 

 

Issuable from Warrants

 

 

 

 

 

 

 

September 30,

 

December 31,

 

Exercise

 

 

 

Date of Issue

 

2009

 

2008

 

Price

 

Expiration

 

 

 

 

 

 

 

 

 

 

 

June 2009

 

129,688

 

 

$7.50 - $9.00

 

May 2014 - June 2014

 

May 2009

 

1,100,000

 

 

$9.00

 

May 2014

 

July 2008

 

336,984

 

336,984

 

$11.87 - $13.65

 

July 2013

 

May 2007

 

959,390

 

959,390

 

$5.50

 

May 2012

 

December 2006

 

1,127,936

 

1,127,936

 

$8.70 - $10.88

 

December 2011

 

September 2005

 

159,648

 

159,648

 

$24.00

 

September 2010

 

Total

 

3,813,646

 

2,583,958

 

 

 

 

 

 

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Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

On May 19, 2009 (the “Grant Date”), we issued three warrants (the “Consultant Warrants”) to a consultant to purchase a total of 125,000 shares of our common stock with an exercise price of $9.00 per share and a term of five years.  The first warrant is for 25,000 shares and becomes fully vested six months after the Grant Date.  The second and third warrants (the “Contingent Warrants”) are for 50,000 shares each of common stock, and become fully vested only if our underlying stock price achieves or exceeds $12.00 and $14.00 per share, respectively, for five consecutive trading days as quoted on Nasdaq, over a period of twenty-four months from the Grant Date.  If these terms are not achieved during this twenty-four month period, the Contingent warrants will expire on May 19, 2011.  Otherwise, if the vesting conditions are achieved within twenty-four months from the Grant Date, the Contingent warrants will become fully exercisable for the remainder of the five-year term.

 

The fair value of the Consultant Warrants is classified as a component of additional paid-in capital with the corresponding amount reflected as a component of marketing, general and administrative expenses in our consolidated statements of operations.  We recognized mark-to-model credits (charges) of $55,000 and $(116,000) for the three and nine months ended September 30, 2009, respectively, using the Black-Scholes model, assuming a remaining term of 4.6 years, volatility of 70%, no dividends, and a risk-free interest rate of 2.3%.  In addition, the fair value of the Contingent Warrants was determined using a Monte Carlo binomial stock simulation model to determine the probability that the vesting conditions will be achieved.  We will continue to recognize mark-to-model adjustments to the Consultant Warrants during their respective vesting periods.

 

8.    COMMITMENTS AND CONTINGENCIES

 

Collaboration and Research Agreements

 

On September 11, 2009, we executed a fifteen-month, $1.5 million contract with the U.S. Air Force Research Laboratory for the development of automated instrumentation that uses our semiconductor microarray technologies for detecting chemical, biological and environmental hazards that can impact the health of deployed military personnel.  Under the terms of this contract, we will perform research and development activities, as described under the contract, and will be reimbursed on a periodic basis for actual costs incurred to perform these obligations, plus a fixed fee, of up to $1.5 million.  As of September 30, 2009, we had incurred $54,000 in actual costs under this contract, which was approximately 5% complete.

 

On March 10, 2009, we executed a four-year, $858,000 contract with the NASA Ames Research Center (“NASA”) for further development of our microarray technologies.  The primary objective of the contract is to design and test a microfluidics system that incorporates our semiconductor-based microarray platform as part of an integrated genetic analysis system that can be deployed in space.  Under the terms of this contract, we will perform research and development activities during the first year (“Phase I”) for a fixed fee of $214,000.  If NASA chooses to continue development for each of the subsequent years two through four of the contract, we will continue development at similar funding levels to the first year, not to exceed a maximum fee of $858,000 for the entire contract period.  As of September 30, 2009, we had incurred $66,000 in actual costs for Phase I of this contract, which was approximately 42% complete.

 

On July 31, 2008, we executed a $250,000 contract with the DoD for the development of label-free detection techniques using our microarray technology.  These detection techniques involve the synthesis of molecules known as “aptamers,” which are molecules with unique biological properties.  We substantially completed this contract during the first quarter of 2009 and do not expect to incur additional costs or revenues from this contract beyond 2009.

 

On July 11, 2008, we executed a fifteen-month, $923,000 contract with the DoD to further development of our microarray technologies for a multipathogen detection system.  The primary objectives of the contract are to continue development of an automated biothreat agent detection system based upon our complementary metal oxide semiconductor microarray and electrochemical detection techniques, to continue the integration of serological and genomic assays for orthogonal testing and to explore new methods of detection that expand target identification, reduce reagent burden, and improve assay time.  Under the terms of this contract, we will perform research and development activities, as described under the contract, and will be reimbursed on a periodic basis for actual costs incurred to perform these obligations, plus a fixed fee, of up to $923,000.  We substantially completed this contract during the second quarter of 2009 and do not expect to incur additional costs or revenues from this contract beyond 2009.

 

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Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

On July 26, 2007, we executed a one-year, $2.2 million contract with the DoD to further development of our microarray technologies.  The primary objectives of the contract were to continue development of a multipathogen and chemical detection system.  Under the terms of this contract, we performed research and development activities, as described under the contract, and were reimbursed on a periodic basis for actual costs incurred to perform these obligations, plus a fixed fee, of up to $2.2 million.  We substantially completed this contract during the third quarter of 2008 and do not expect to incur additional costs or revenues from this contract beyond 2008.

 

On March 13, 2007, we executed a one-year, $869,000 contract with the DoD, focusing on the development of a field-deployable influenza genotyping system based on our electrochemical detection technology to be used for military and homeland security applications.  Under the terms of this contract, we performed research and development activities, as described under the contract, and were reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee, of up to $869,000.  We substantially completed this contract during the second quarter of 2008 and do not expect to incur significant costs or revenues from this contract beyond 2008.

 

On August 9, 2006, we executed a two-year, $1.9 million contract with the DoD, focusing on the integration of our electrochemical detection technology currently under development with our microfluidics “lab-on-a-chip” technology to be used for military and homeland security applications. Under the terms of this contract, we performed research and development activities, as described under the contract, and were reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee, of up to $1.9 million.  We substantially completed this contract during the fourth quarter of 2008 and do not expect to incur significant costs or revenues from this contract beyond 2008.

 

Human Resources

 

We provide certain severance benefits such that if an executive of CombiMatrix who is a vice president or higher is terminated for other than cause, death or disability, the executive will receive payments equal to three months’ base salary plus medical and dental benefits.  If termination occurs as a result of a change in control transaction, these benefits will be extended by three months.  Also, if our chief executive officer is terminated for other than cause, or for death or disability, he will receive payments equal to one year’s base salary plus medical and dental benefits.

 

Litigation

 

On September 30, 2002, we entered into a settlement agreement with Nanogen, Inc. (“Nanogen”) to settle all pending litigation between the parties.  Pursuant to the terms of the settlement agreement, we agreed to make quarterly payments to Nanogen equal to 12.5% of total sales of products developed by us and our affiliates based on the patents that had been in dispute in the litigation, up to an annual maximum amount of $1.5 million.  The minimum quarterly payments under the settlement agreement are $25,000 per quarter until the patents expire in 2018.  Royalty expenses recognized under the agreement for the three and nine months ended September 30, 2009 and 2008 were $25,000, $75,000, 25,000 and $116,000, respectively, and are included in patent amortization and royalties in the accompanying consolidated statements of operations.

 

In April 2005, Acacia and CombiMatrix filed a complaint against our insurance carrier, National Union, seeking reimbursement of litigation and settlement costs for a lawsuit, pursuant to our directors’ and officers’ insurance policy with National Union.  A trial was held and concluded during the fourth quarter of 2007.  In March 2008, the District Court issued its Judgment in favor of Acacia and us, and awarded approximately $32.1 million in monetary damages to be paid by National Union.  In accordance with the distribution agreement entered into between Acacia and us prior to our separation, all proceeds from the lawsuit will be paid to us.  In May 2008, the District Court awarded us an additional $3.6 million in attorneys’ fees and litigation costs, thereby increasing the overall award to $35.7 million.  This award was entered as a final Judgment in May 2008 and will continue to earn interest until paid. In September 2008, the District Court required National Union to post an appellate bond in the amount of $39.2 million to cover the Judgment as well as accrued interest charges.  The appellate bond will remain in place until the appeal process is concluded.  National Union has appealed the Judgment to the U.S. Ninth Circuit Court of Appeals (the “Appellate Court”), and we intend to vigorously defend against the appeal.  All appellate briefs by us and National Union were filed during the second quarter of 2009.  Recently, the Appellate Court set a date for an oral hearing whereby each party will have 15 minutes to present arguments supplementing those in the briefs.  The date of the hearing was originally November 2, 2009.  National Union has subsequently requested and was granted a continuance of the oral hearing due to a conflict with its attorneys’ schedules.  As of the date of this filing, the Appellate Court had not determined the revised date of the hearing.

 

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Table of Contents

 

COMBIMATRIX CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(Unaudited)

 

We are subject to other claims and legal actions that arise in the ordinary course of business.  We believe that the ultimate liability with respect to these claims and legal actions, if any, will not have a material effect on our financial position, results of operations or cash flows.  Based on a distribution agreement executed between us and Acacia, it is expected that such claims, legal actions, etc. attributable to CombiMatrix Corporation prior to the Redemption Date will remain with the Company subsequent to the Redemption Date, however.  As of the date of this report and for all periods presented, we are not aware of the existence of any such claims or legal actions.

 

9.    SUBSEQUENT EVENT

 

On November 10, 2009, our Board of Directors approved an Executive Change of Control Severance Plan (the “Severance Plan”) that affects certain of our senior management-level employees.  Pursuant to the Severance Plan, if a participating employee is involuntarily terminated (other than for death, disability or for cause) or resigns for “good reason” (as defined in the Severance Plan) during the two-year period following a “change of control” (as defined in the Severance Plan) of the Company, then, subject to execution of a release of claims against the Company, the employee will be entitled to receive: (i) a cash severance payment equal to one times annual base salary, in the case of our Chief Executive Officer; or one-half times annual base salary, in the case of other participating employees; (ii) immediate vesting of outstanding compensatory equity awards; and (iii) payment of COBRA premiums for the participating employee and eligible dependants for a pre-determined period of time.  Payment of benefits under the Severance Plan will be limited by provisions contained in Section 409A of the U.S. Internal Revenue Code.  The Severance Plan is administered by a plan administrator, which initially is the Compensation Committee of the Board of Directors.  In order to participate in the Severance Plan, an eligible employee must waive any prior retention or severance agreements.

 

16



Table of Contents

 

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

 

Cautionary Statement

 

You should read the following discussion and analysis in conjunction with the consolidated financial statements and related notes thereto contained in Part I, Item 1 of this report.  The information contained in this Quarterly Report on Form 10-Q is not a complete description of our businesses or the risks associated with an investment in our common stock.  We urge you to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the U.S. Securities and Exchange Commission, or “SEC,” including our Annual Report on Form 10-K, filed on March 27, 2009.

 

This report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. Reference is made in particular to the description of our plans and objectives for future operations, assumptions underlying such plans and objectives, and other forward-looking statements included in this report. Such statements may be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “believe,” “estimate,” “anticipate,” “intend,” “continue,” or similar terms, variations of such terms or the negative of such terms.  Such statements are based on management’s current expectations and are subject to a number of factors and uncertainties, which could cause actual results to differ materially from those described in the forward-looking statements.  Such statements address future events and conditions concerning product development, capital expenditures, earnings, litigation, regulatory matters, markets for products and services, liquidity and capital resources and accounting matters.  Actual results in each case could differ materially from those anticipated in such statements by reason of factors such as future economic conditions, changes in consumer demand, legislative, regulatory and competitive developments in markets in which we and our subsidiaries operate, results of litigation and other circumstances affecting anticipated revenues and costs.  We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.  Additional factors that could cause such results to differ materially from those described in the forward-looking statements are set forth in connection with the forward-looking statements and in the “Risk Factors” described in our Annual Report on Form 10-K filed on March 27, 2009.

 

General

 

We are a diversified biotechnology business that develops proprietary technologies, including products and services in the areas of drug development, genetic analysis, molecular diagnostics, nanotechnology and defense and homeland security markets, as well as in other potential markets where our products and services could be utilized. The technologies we have developed include a platform technology to rapidly produce user-defined, in-situ synthesized, oligonucleotide arrays for use in identifying and determining the roles of genes, gene mutations and proteins. This technology has a wide range of potential applications in the areas of genomics, proteomics, biosensors, drug discovery, drug development, diagnostics, combinatorial chemistry, material sciences and nanotechnology. Other technologies include proprietary molecular synthesis and screening methods for the discovery of potential new drugs.  We currently recognize revenues from selling these products and services and providing research and development services for organizations including the U.S. Department of Defense, or “DoD” and other strategic partners.

 

CombiMatrix Molecular Diagnostics, Inc., or “CMDX,” our wholly owned subsidiary located in Irvine, California, has developed capabilities of producing arrays that utilize bacterial artificial chromosomes, or “BACs,” which also enable genetic analysis.  CMDX functions primarily as a diagnostics reference laboratory.

 

Leuchemix Inc. (“Leuchemix”), a minority owned subsidiary, is developing a series of compounds to address a number of oncology-related diseases.

 

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Relationship With Acacia Research Corporation

 

We were originally incorporated in October 1995 as a California corporation and later reincorporated as a Delaware corporation in September 2000. On December 13, 2002, we merged with and became a wholly owned subsidiary of Acacia Research Corporation, or “Acacia.” On the same date, Acacia entered into a recapitalization transaction whereby Acacia created two classes of registered common stock called Acacia Research-CombiMatrix common stock (“AR-CombiMatrix stock”) and Acacia Research-Acacia Technologies common stock (“AR-Acacia Technologies stock”) and divided its existing Acacia common stock into shares of the two new classes of common stock.  On August 15, 2007 (the “Redemption Date”), we split-off from Acacia and all issued and outstanding shares of AR-CombiMatrix stock were redeemed and exchanged for shares of CombiMatrix common stock at a redemption ratio of ten shares of AR-CombiMatrix stock for one share of CombiMatrix common stock (the “Redemption Ratio”), which is publicly traded on the Nasdaq Global Market (symbol: “CBMX”).  Also, warrants to purchase AR-CombiMatrix stock became exercisable to purchase CombiMatrix common stock, adjusted for the Redemption Ratio.  As of the Redemption Date, we ceased to be a subsidiary of, or affiliated with, Acacia.

 

Liquidity

 

At December 31, 2008, we had cash, cash equivalents and available-for-sale investments of $9.1 million, which we believed would be sufficient to meet our cash requirements to September 2009.  On May 1, 2009, we closed a registered direct offering of our common stock and warrants which, after placement agent fees and other costs, netted approximately $7.6 million to us, which we believe extends our ability to continue operating as a going concern to June 2010 (see Liquidity and Capital Resources below as well as Note 7 to the consolidated interim financial statements included elsewhere herein for further discussion).

 

In order for our company to continue as a going concern beyond 2010 and ultimately to achieve profitability, we will be required to increase revenues, reduce operating costs and possibly to obtain capital from external sources.  However, there can be no assurance that such capital will be available at times and at terms acceptable to us, or that higher levels of product and service revenues will be achieved.  The issuance of additional equity securities, should that occur, will cause dilution to our shareholders.  If external financing sources are not available or are inadequate to fund our operations, we will be required to reduce operating costs including research projects and personnel, which could jeopardize our future strategic initiatives and business plans.  See Note 1 to the consolidated financial statements included elsewhere in this report for additional discussion of these matters.

 

Basis of Presentation of Financial Statements

 

The consolidated financial statements included in this Form 10-Q are consistent with our historical financial statements included in our Form 10-K for our fiscal year ended December 31, 2008.

 

Overview of Recent Business Activities

 

For the three and nine months ended September 30, 2009, our operating activities included the recognition of $970,000 and $3.7 million in revenues, respectively, including $133,000 and $949,000 in government contract revenues, respectively, $233,000 and $860,000 in CustomArray product and service revenues, respectively, and $603,000 and $1.9 million in diagnostic lab revenues, respectively.  Research and development expenses, excluding government contract costs and non-cash stock based compensation, increased slightly in the three and nine months ended September 30, 2009 due primarily to the ongoing activities related to our comprehensive cancer array test currently under development.  Marketing, general and administrative expenses, excluding non-cash stock compensation, increased for the nine months ended September 30, 2009 versus the comparable 2008 period due primarily to increased sales and marketing expenses at CMDX as well as increased investor and public relations costs.

 

Significant business developments that occurred during and subsequent to the third quarter ended September 30, 2009 were:

 

·                 In October 2009, Mr. Chris Emery and Dr. Lony Lim joined our wholly owned subsidiary, CMDX, as Chief Operating Officer and Vice President of Operations, respectively. Mr. Emery earned his B.S. degree from the University of California, San Diego, and his Master in Business Administration from Pepperdine University. He started his career in healthcare as a Sales Manager with Johnson & Johnson’s pharmaceutical division and has since spent more than 10 years in the cancer-focused diagnostics laboratory industry.  Mr. Emery was a Marketing Manager with US LABS, Inc. (a division of Laboratory Corporation of America Holdings) and was then promoted to National Sales Manager of the Oncology sales division.  Mr. Emery was Vice President of Sales & Marketing at Response Genetics, Inc., where he helped launch the company’s portfolio of molecular diagnostic, personalized medicine testing.  He recently consulted for Agendia, a global leader in microarray genomic profiling, as Director of Clinical Trials.  Dr. Lim received both his B.S. and his Ph.D. from the University of Wisconsin-Madison and completed the William McLendon Clinical Immunology Fellowship at the University of North Carolina Hospitals, Chapel Hill. He served as Director of Scientific Affairs, Director of Flow Cytometry and Director of Anatomic Pathology at US LABS and Scientific Director — Division of Immunology at AmeriPath Specialty Laboratories. He was one of the pioneers in the genesis of Luminex Corporation’s Multi-Analyte Profiling technology (xMAP®) and was instrumental in delivering the initial clinical acceptance of xMAP® technology, which is now widely used in both protein and molecular profiling applications across numerous clinical laboratories.

 

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·                 In October 2009, we announced that the Brooke Army Medical Center (or “BAMC”) was using our influenza-detection system to analyze influenza cases including those involving H1N1 Swine flu.  BAMC is a military hospital that is investigating the feasibility of screening all patients presenting in its emergency room with symptoms of respiratory distress and consenting to nasal swabs, by both electrochemical array-based diagnostics and bead-based multiplex fluorescent methods.

 

·                 In September 2009, we announced that we had received a contract from the U.S. Air Force Research Laboratory for $1.5 million to develop automated instrumentation that uses semiconductor microarray technologies for detecting chemical, biological and environmental hazards that can impact the health of deployed military personnel.

 

·                 In September 2009, we announced the hiring of Robert W. Baird & Co. (or “Baird”) to serve as a financial and strategic advisor in developing and reviewing certain strategies aimed at unlocking shareholder value and creating synergistic relationships for our company.

 

·                 In September 2009, we announced that the U.S. Ninth Circuit Court of Appeals (the “Appellate Court”) had set a date for an oral hearing regarding our $35.7 million judgment (the “Judgment”) against National Union and their subsequent appeal, whereby each party will have 15 minutes to present arguments supplementing those previously provided in the form of briefs to the Appellate Court earlier in 2009.  The date of the hearing set by the Appellate Court was originally November 2, 2009.  National Union has subsequently requested and was granted a continuance of the oral hearing due to a conflict with its attorneys’ schedules.  As of the date of this filing, the Appellate Court had not determined the revised date of the hearing.

 

·                 In July 2009, we announced that a validation study of our HerScanTM breast cancer test performed by CMDX, in collaboration with the Department of Pathology at the University of Texas Health Science Center in San Antonio, Texas was now available as an advance online publication in the official journal of the United States and Canadian Academy of Pathology, Modern Pathology.

 

Critical Accounting Estimates

 

Our unaudited interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America.  Preparation of these statements requires management to make judgments and estimates.  Some accounting policies have a significant impact on amounts reported in these financial statements.  A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Annual Report on Form 10-K, filed on March 27, 2009, in the Notes to the Consolidated Financial Statements and the Critical Accounting Estimates section.  In addition, refer to Note 2 to the consolidated interim financial statements included in Part I, Item 1 of this report.

 

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Comparison of the Results of Operations for the Three and Nine Months Ended September 30, 2009 and 2008

 

Revenues and Cost of Revenues (In thousands)

 

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

 

 

September 30,

 

Change

 

September 30,

 

Change

 

 

 

2009

 

2008

 

$

 

%

 

2009

 

2008

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Government contracts

 

$

133

 

$

343

 

$

(210

)

(61)%

 

$

949

 

$

2,380

 

$

(1,431

)

(60)%

 

Cost of government contract revenues

 

(125

)

(336

)

211

 

(63)%

 

(862

)

(2,305

)

1,443

 

(63)%

 

Products

 

250

 

158

 

92

 

58%

 

807

 

1,356

 

(549

)

(40)%

 

Services

 

524

 

448

 

76

 

17%

 

1,802

 

1,145

 

657

 

57%

 

Cost of products and services

 

(409

)

(370

)

(39

)

11%

 

(1,587

)

(1,258

)

(329

)

26%

 

Collaboration agreements

 

63

 

62

 

1

 

2%

 

188

 

186

 

2

 

1%

 

 

Government Contracts and Cost of Government Contracts.  Under the terms of our contracts with the DoD, we are reimbursed on a periodic basis for actual costs incurred to perform our obligations, plus a fixed fee.  Under the terms of our contract with NASA, we are reimbursed on a periodic basis, based on scheduled, contractual fixed amounts.  Revenues are recognized using the partial performance method of accounting, using the cost-to-cost approach to measure completeness at the end of the each reporting period.  Cost of government contracts reflect research and development expenses incurred in connection with our commitments under our current contracts with the DoD and NASA.

 

The decrease in government contract revenues for the three and nine months ended September 30, 2009 versus the comparable periods in 2008 was due primarily to fewer active contracts during 2009 than in 2008.  See Note 8 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts, completion rates and estimated costs to complete of our government contracts that are ongoing as well as prior contracts that were completed during the periods presented.  Due to the recent execution of a contract with the U.S. Air Force, we expect our government contract revenues to increase in the short-term.  As these contracts near completion, future contract revenues could be volatile and could decrease in the longer term if new government contracts are not awarded or executed.

 

Products and Cost of Products.  Product revenues and costs of products relate to domestic and international sales of our array products, which include DNA synthesizer instruments, CustomArray 12K, 4X2K, 2X40K and 90K DNA expression arrays, ElectraSense® microarray readers and related hardware, as well as the sale of CGH arrays sold by our wholly owned subsidiary, CMDX.  Product revenues increased in the three months ended September 30, 2009 versus the comparable period in 2008 due primarily to higher CGH array sales, while our CustomArray-related products sold in similar volumes to the comparable period in 2008.  For the nine-months ended September 30, 2009 versus 2008, product revenues decreased primarily due to lower CustomArray instrument sales.  As we expand our business focus from exclusively selling array-based research and development products to providing array-based diagnostic services, we have reduced internal sales staff, marketing and production efforts regarding sales of CustomArray products and instead have executed product distribution and manufacturing agreements with various third-party distributors for the sales of our suite of CustomArray products into the research and development markets.  Also, declining global economic conditions have negatively impacted the sales of our instruments.  As a result, CustomArray product revenues will likely be volatile and could decrease in future periods, depending largely on the sales efforts of our distributors.

 

Services.  Services revenues are comprised primarily of diagnostic lab services provided by CMDX as well as the amortization of one-year equipment maintenance and service contracts executed with certain customers of our DNA synthesizers.  Diagnostic services revenue from CMDX was $507,000 and $1.8 million for the three and nine months ended September 30, 2009, respectively, versus $445,000 and $1.1 million in the comparable periods in 2008, respectively.  These revenues have increased due to an increased number of diagnostic test offerings as well as increased customer demand for our suite of diagnostic lab services provided by CMDX, which is due primarily to increased sales and marketing efforts.  Including BAC array product sales, total diagnostic lab revenues at CMDX were $603,000 and $1.9 million for the three and nine months ended September 30, 2009, respectively versus $463,000 and $1.1 million in the comparable periods in 2008, respectively.

 

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Operating Expenses (In thousands)

 

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

 

 

September 30,

 

Change

 

September 30,

 

Change

 

 

 

2009

 

2008

 

$

 

%

 

2009

 

2008

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development expenses

 

$

1,401

 

$

1,336

 

$

65

 

5%

 

$

3,814

 

$

3,595

 

$

219

 

6%

 

Marketing, general and admin. expenses

 

2,340

 

2,301

 

39

 

2%

 

7,970

 

6,781

 

1,189

 

18%

 

Patent amortization and royalties

 

337

 

341

 

(4

)

(1)%

 

1,016

 

1,063

 

(47

)

(4)%

 

Equity in loss of of investees

 

107

 

247

 

(140

)

(57)%

 

618

 

737

 

(119

)

(16)%

 

 

Research and Development Expenses.  The increases in internal research and development expenses for the periods presented were due primarily to the ongoing development efforts underway relating to our comprehensive cancer array test.  In addition, for the three and nine months ended September 30, 2009 and 2008, research and development expenses included $172,000, $461,000, $121,000 and $261,000, respectively, of non-cash stock compensation expense.  These increases were due primarily to increases in the overall number of stock option awards granted to our employees during the past twelve months.  See Note 2 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts recognized for the periods presented.

 

Future research and development expenses will continue to be incurred in connection with our ongoing internal research and development efforts in the areas of genomics, diagnostics, drug discovery and product development.   We expect our research and development expenses to continue to fluctuate and such expenses could increase in future periods as additional internal research and development agreements are undertaken and/or as new research and development collaborations are executed with strategic partners.

 

Marketing, General and Administrative Expenses.  The increases in marketing, general and administrative expenses for the periods presented were due primarily to increases in sales and marketing expenses at CMDX, as well as increased investor and public relations expenses.  In addition, for the three and nine months ended September 30, 2009 and 2008, marketing, general and administrative expenses included $704,000, $2.0 million, $654,000 and $1.3 million, respectively, of non-cash stock compensation expense.  These increases were due primarily to increases in the overall number of stock option awards granted to our employees during the past twelve months.  See Note 2 to our consolidated interim financial statements included elsewhere in this report for a detailed description of the amounts recognized for the periods presented.

 

Equity in Loss of Investees.  For all periods presented, this expense represents our recognition under the equity method of accounting of our minority interests in the operations of Leuchemix, in which we own a one-third minority interest.  During the quarter ended September 30, 2009, our equity investment in Leuchemix reached $0 and as a result, we ceased recognizing additional expense from their operations.  This has caused a decrease in this expense for the three and nine months ended September 30, 2009 versus the comparable periods in 2008.

 

Other Non-Operating Items (In thousands)

 

 

 

Three Months Ended

 

 

 

Nine Months Ended

 

 

 

 

 

September 30,

 

Change

 

September 30,

 

Change

 

 

 

2009

 

2008

 

$

 

%

 

2009

 

2008

 

$

 

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

(531

)

$

(403

)

$

(128

)

32%

 

$

(1,553

)

$

(408

)

$

(1,145

)

281%

 

Derivative credits (charges)

 

977

 

16

 

961

 

6006%

 

(407

)

16

 

(423

)

(2644)%

 

 

Interest Expense.  Since July 2008, interest expense is recognized from the issuance of a secured convertible debenture (the “Debenture”), which accrues interest at an annual rate of 10% and with a current principal amount of $8.4 million as of September 30, 2009.  Interest expense also includes amortization of the $2.9 million of debt discount recognized from issuance of the Debenture and warrants using the effective interest method.

 

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Derivative Credits (Charges).  These amounts represent the net credits or charges recognized during the periods presented from mark-to-model adjustments to the embedded derivatives associated with the Debenture that were outstanding as of September 30, 2009 and 2008.  The conversion feature, cash redemption option, potential acceleration of maturity of the Debenture and potential adjustments to the fixed conversion price all represent embedded derivatives of the Debenture that are recorded separately at fair value as other liabilities, with the corresponding fair value adjustments reflected as non-operating charges or credits, depending upon the results of mark-to-model valuation adjustments.  The fair value of the embedded derivatives was determined using the convertible bond model, discounted cash flows and binomial lattice models.

 

Inflation

 

Inflation has not had a significant impact on our Company.

 

Liquidity and Capital Resources

 

At September 30, 2009, cash, cash equivalents and available-for-sale investments totaled $7.9 million versus to $9.1 million at December 31, 2008.  Working capital at September 30, 2009 was $7.4 million, compared to $7.6 million at December 31, 2008.  The net change in cash and cash equivalents for the periods presented was comprised of the following (in thousands):

 

 

 

Nine Months Ended

 

 

 

September 30,

 

 

 

2009

 

2008

 

Net cash flows from operations:

 

 

 

 

 

Operating activities

 

$

(8,152

)

$

(8,114

)

Investing activities

 

1,467

 

3,975

 

Financing activities

 

7,011

 

11,250

 

Increase in cash and cash equivalents

 

$

326

 

$

7,111

 

 

Operating Activities.  The overall net increase in cash used in operating activities for the nine months ended September 30, 2009 versus the comparable period in 2008 was due primarily to a decrease in cash receipts from customers, which totaled $3.6 million in 2009 versus $4.4 million in 2008.  This decrease was due primarily to lower DoD contract activity and thus lower billings and collections from DoD contracts in 2009 versus 2008.  This decrease was mostly offset by a decrease in operating cash outflows, which totaled $11.8 million in 2009 versus $12.6 million in 2008.  This decrease was due primarily to the net impact of the timing of the payments to certain vendors.

 

Investing Activities.  The change in net cash flows from investing activities was due primarily to net sales of available-for-sale investments in connection with ongoing cash management activities during the periods presented.  Also, for the nine months ended September 30, 2009 and 2008, we incurred $59,000 and $55,000, respectively, of capital expenditures.

 

Financing Activities.  The change in cash flows from financing activities was driven by certain financing transactions that were executed during the nine months ended September 30, 2009 and 2008 as follows:

 

·      For the nine months ended September 30, 2009, our financing activities were driven primarily by the execution of a registered direct offering (the “Offering”) of our common stock and warrants for gross proceeds of $8.25 million, which we closed on May 1, 2009.  Under the terms of the Offering, we sold 1.1 million units for $7.50 per unit to certain investors.  Each unit consisted of one share of our common stock and one warrant, each warrant to purchase one share of our common stock at an exercise price of $9.00 per share.  The warrants may not be exercised until six months after the Offering and have a term of five years.  Net proceeds from the Offering, less placement agent fees and expenses, were approximately $7.6 million.  Also impacting our net cash flows from financing activities was the repayment of credit line borrowings during the first quarter of 2009 totaling $820,000.  Finally, proceeds from the exercise of common stock options were $225,000 during the nine months ended September 30, 2009.

 

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·                  For the nine months ended September 30, 2008, our financing activities were driven primarily by the issuance to YA Global Investments, L.P. of: (i) the Debenture with an aggregate principal amount of $10 million, which was originally convertible into shares of our common stock at a fixed conversion price of $11.87 per share (and subsequently adjusted to $7.50 per share due to execution of the Offering described above); and (ii) warrants to purchase up to 336,984 shares of our common stock.  The Debenture is due on the earlier of July 10, 2010 or within four months after receipt of payment of the settlement proceeds from National Union in accordance with the Judgment.  The Debenture bears interest at an annual rate of 10%, with interest payments due quarterly in either cash or our common stock.  Also impacting our net cash flows from financing activities was a draw on our credit line totaling $808,000 during the second quarter of 2008.  Finally, proceeds from the exercise of common stock options were $711,000 during the nine months ended September 30, 2008.

 

Future Liquidity.  We believe that the additional capital from the Offering will allow us to meet our operating cash requirements to June 2010.  In order for us to continue to meet our cash requirements beyond this point, we will be required to increase revenues, reduce operating costs and possibly to obtain capital from external sources.  However, there can be no assurances that we will be able to secure additional sources of financing at times and at terms acceptable to management.  The issuance of additional equity securities, should that occur, will cause dilution to our shareholders.  If external financing sources are not available or are inadequate to fund our operations, management will be required to reduce our operating costs including research projects and personnel, which could jeopardize our future strategic initiatives and business plans.  For example, reductions in research and development activities and/or personnel at our Mukilteo, Washington facility could result in the inability to invest the resources necessary to continue to develop next-generation products and improve existing product lines in order to remain competitive in the marketplace, resulting in reduced revenues and cash flows from the sales of our CustomArray products and services.  Also, reductions in operating costs at CMDX, should they occur, could jeopardize our ability to launch, market and sell additional products and services necessary to grow and sustain our operations and eventually achieve profitability.

 

Capital Requirements.  We may also encounter unforeseen difficulties that may deplete our capital resources more rapidly than anticipated.  Any efforts to seek additional funding could be made through equity, debt or other external financing, and there can be no assurance that additional funding will be available on favorable terms, if at all.  Our long-term capital requirements will be substantial and the adequacy of available funds will depend upon many factors, including:

 

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

 

·                  our continued progress in research and development programs;

 

·                  the costs involved in filing, prosecuting, enforcing and defending any patents claims, should they arise;

 

·                  the costs involved in defending our Judgment against the appeal brought by National Union;

 

·                  our ability to license technology;

 

·                  competing technological developments;

 

·                  the creation and formation of strategic partnerships; and

 

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

 

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Table of Contents

 

Off-Balance Sheet Arrangements

 

We have not entered into off-balance sheet financing arrangements, other than operating leases for our office and laboratory premises.  We have no significant commitments for capital expenditures in 2009 or beyond.  We have executed two capital leases totaling $109,000 for certain laboratory equipment.  The following table lists our material known future cash commitments as of September 30, 2009:

 

 

 

Payments Due by Period (in thousands)

 

 

 

 

 

 

 

 

 

 

 

2013 and

 

 

 

2009

 

2010

 

2011

 

2012

 

Thereafter

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating leases

 

$

145

 

$

367

 

$

 

$

 

$

 

Capital leases

 

3

 

13

 

14

 

15

 

1

 

Minimum royalty payments

 

25

 

100

 

100

 

100

 

575

 

Secured convertible debenture (1)

 

 

8,400

 

 

 

 

Total contractual obligations

 

$

173

 

$

8,880

 

$

114

 

$

115

 

$

576

 

 


(1)          The principal amount of the Debenture as of September 30, 2009, which is due the earlier of July 10, 2010 or four months after receiving the settlement payment from National Union, is reflected as being due in July, 2010 (the maturity date of the Debenture), assuming no additional conversions or early prepayments occur.

 

Recent Accounting Pronouncements

 

Refer to Note 2 to our consolidated interim financial statements included in Part I, Item 1 of this report.

 

Item 3.                       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not required for smaller reporting companies.

 

Item 4T.     CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.  Our disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.  There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures.  Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation required by Rules 13a-15 and 15d-15 under the Exchange Act of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15 and 15d-15 under the Exchange Act as of September 30, 2009.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2009, the design and operation of our disclosure controls and procedures were effective.

 

Changes in Internal Controls

 

There were no changes in our internal control over financial reporting that occurred during our last fiscal quarter (the quarter ended September 30, 2009) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

 

PART II—OTHER INFORMATION

 

Item 1.  LEGAL PROCEEDINGS

 

In April 2005, Acacia and we filed a complaint in U.S. District Court for the Central District of California (the “District Court”) against our insurance carrier, National Union Fire Ins. Co. of Pittsburgh, PA (“National Union”), seeking reimbursement of litigation and settlement costs for a lawsuit, pursuant to our directors’ and officers’ insurance policy with National Union.  A trial was held and concluded during the fourth quarter of 2007.  In March 2008, the District Court issued the Judgment in favor of Acacia and us, and awarded approximately $32.1 million in monetary damages to be paid by National Union.  In accordance with the distribution agreement entered into between Acacia and us prior to our separation, all proceeds from the lawsuit will be paid to us.  In May 2008, the District Court awarded us an additional $3.6 million in attorneys’ fees and litigation costs, thereby increasing the overall award to $35.7 million.  This award was entered as a final Judgment in May 2008 and will continue to earn interest until paid.  In September 2008, the District Court required National Union to post an appellate bond in the amount of $39.2 million to cover the Judgment as well as accrued interest charges.  The appellate bond will remain in place until the appeal process is concluded.  National Union has appealed the Judgment to the U.S. Ninth Circuit Court of Appeals (the “Appellate Court”), and we intend to vigorously defend against the appeal.  All appellate briefs by us and National Union were filed during the second quarter of 2009.  Recently, the Appellate Court set a date for an oral hearing whereby each party will have 15 minutes to present arguments supplementing those in the briefs.  The date of the hearing set by the Appellate Court was originally November 2, 2009.  National Union has subsequently requested and was granted a continuance of the oral hearing due to a conflict with its attorneys’ schedules.  As of the date of this filing, the Appellate Court had not determined the revised date of the hearing.

 

Item 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

For the nine months ended September 30, 2009, we issued 89,274 shares of our common stock to YA in consideration of quarterly interest charges accrued during the fourth quarter of 2008 through the second quarter of 2009 under the terms of the Debenture.  The issuance of common stock to YA was made pursuant to an exemption under Rule 506 of Regulation D and/or Section 4(2) of the Securities Act of 1933.

 

On May 19, 2009 (the “Grant Date”), we issued three warrants (the “Consultant Warrants”) to a consultant to purchase a total of 125,000 unregistered shares of our common stock with an exercise price of $9.00 per share and a term of five years.  The first warrant is for 25,000 shares and becomes fully vested six months after the Grant Date.  The second and third warrants (the “Contingent Warrants”) are for 50,000 shares each of common stock, and become fully vested only if our underlying stock price achieves or exceeds $12.00 and $14.00 per share, respectively, for five consecutive trading days as quoted on Nasdaq, over a period of twenty-four months from the Grant Date.  If these terms are not achieved during this twenty-four month period, the Contingent warrants will expire on May 19, 2011.  Otherwise, if the vesting conditions are achieved within twenty-four months from the Grant Date, the Contingent warrants will become fully exercisable for the remainder of the five-year term.  The warrants were issued pursuant to an exemption under Rule 506 and/or Section 4(2) of the Securities Act of 1933.

 

Item 5.  OTHER INFORMATION

 

On November 10, 2009, our Board of Directors approved an Executive Change of Control Severance Plan (the “Severance Plan”) that affects certain of our senior management-level employees.  Pursuant to the Severance Plan, if a participating employee is involuntarily terminated (other than for death, disability or for cause) or resigns for “good reason” (as defined in the Severance Plan) during the two-year period following a “change of control” (as defined in the Severance Plan) of the Company, then, subject to execution of a release of claims against the Company, the employee will be entitled to receive: (i) a cash severance payment equal to one times annual base salary, in the case of our Chief Executive Officer; or one-half times annual base salary, in the case of other participating employees; (ii) immediate vesting of outstanding compensatory equity awards; and (iii) payment of COBRA premiums for the participating employee and eligible dependants for a pre-determined period of time.  Payment of benefits under the Severance Plan will be limited by provisions contained in Section 409A of the U.S. Internal Revenue Code.  The Severance Plan is administered by a plan administrator, which initially is the Compensation Committee of the Board of Directors.  In order to participate in the Severance Plan, an eligible employee must waive any prior retention or severance agreements.

 

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Item 6.  EXHIBITS

 

Exhibit
Number

 

Description

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation (1)

3.1a

 

Certificate of Amendment to Amended and Restated Certificate of Incorporation (2)

3.2

 

Amended and Restated Bylaws (3)

10.1

 

Research and Development Contract with U.S. Air Force Research Laboratory for the Development and Use of a Semiconductor Microarray For Detecting Exposure to Environmental Hazards (4)

10.2

 

Supply Agreement with Illumina, Inc. (5)

10.3

 

Executive Change in Control Severance Plan

31.1

 

Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

32.1

 

Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002

32.2

 

Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002

 


(1)

Incorporated by reference to Exhibit 3.1 to CombiMatrix Corporation’s Registration Statement on Form S-1 (SEC File No. 333-139679), which became effective June 8, 2007.

(2)

Incorporated by reference to Exhibit 3.1A to CombiMatrix Corporation’s Quarterly Report on Form 10-Q filed August 14, 2008.

(3)

Incorporated by reference to Exhibit 3.2 to CombiMatrix Corporation’s Registration Statement on Form S-1 (SEC File No. 333-139679), which became effective June 8, 2007.

(4)

Incorporated by reference to Exhibit 10.1 to CombiMatrix Corporation’s Current Report on Form 8-K filed September 14, 2009.

(5)

Portions of this exhibit have been omitted pursuant to a request for confidential treatment.

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

COMBIMATRIX CORPORATION

 

 

 

 

 

 

By:

/s/ AMIT KUMAR, PH.D.

 

 

Amit Kumar, Ph.D.

 

 

Chief Executive Officer

 

 

(Authorized Signatory and Principal Executive Officer)

 

 

 

 

 

 

 

By:

/s/ SCOTT R. BURELL

 

 

Scott R. Burell

 

 

Chief Financial Officer

 

 

(Principal Financial and Accounting Officer)

 

Date:   November 13, 2009

 

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Table of Contents

 

EXHIBIT INDEX

 

Exhibit
Number

 

Description

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation (1)

3.1a

 

Certificate of Amendment to Amended and Restated Certificate of Incorporation (2)

3.2

 

Amended and Restated Bylaws (3)

10.1

 

Research and Development Contract with U.S. Air Force Research Laboratory for the Development and Use of a Semiconductor Microarray For Detecting Exposure to Environmental Hazards (4)

10.2

 

Supply Agreement with Illumina, Inc. (5)

10.3

 

Executive Change in Control Severance Plan

31.1

 

Certification of Chief Executive Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

31.2

 

Certification of Chief Financial Officer pursuant to section 302 of the Sarbanes-Oxley Act of 2002

32.1

 

Certification of Chief Executive Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002

32.2

 

Certification of Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002

 


(1)

Incorporated by reference to Exhibit 3.1 to CombiMatrix Corporation’s Registration Statement on Form S-1 (SEC File No. 333-139679), which became effective June 8, 2007.

(2)

Incorporated by reference to Exhibit 3.1A to CombiMatrix Corporation’s Quarterly Report on Form 10-Q filed August 14, 2008.

(3)

Incorporated by reference to Exhibit 3.2 to CombiMatrix Corporation’s Registration Statement on Form S-1 (SEC File No. 333-139679), which became effective June 8, 2007.

(4)

Incorporated by reference to Exhibit 10.1 to CombiMatrix Corporation’s Current Report on Form 8-K filed September 14, 2009.

(5)

Portions of this exhibit have been omitted pursuant to a request for confidential treatment.

 

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