Company Quick10K Filing
Quick10K
Exagen
S-1 2019-08-23 Public Filing
8-K 2019-09-23 Amend Bylaw, Other Events, Exhibits
SIR Select Income REIT 2,027
NSM Nationstar 1,753
ELTP Elite Pharmaceuticals 50
SMRN Smartag International 43
MJNE MJ Holdings 27
BSTG Biostage 15
ABHD AbTech 0
IMN Glassbridge Enterprises 0
ALTA Alterola Biotech 0
PCFG Pacific Gold & Royalty 0
XGN 2019-08-23
Note 1. Organization
Note 2. Summary of Significant Accounting Policies
Note 3. Adoption of Asu 2014-09, Revenue From Contracts with Customers (Topic 606)
Note 4. Other Financial Information
Note 5. Share Purchase Rights
Note 6. Borrowings
Note 7. Warrants To Purchase Common or Preferred Stock
Note 8. Commitments and Contingencies
Note 9. Fair Value Measurements
Note 10. Redeemable Convertible Preferred Stock
Note 11. Stockholders' Deficit
Note 12. Stock Option Plan
Note 13. Income Taxes
Note 14. Related Parties
Note 15. 401(K) Plan
Note 16. Correction of Immaterial Misstatements in The Financial Statements for The Year Ended December 31, 2018
Note 17. Subsequent Events
Part II
Item 13. Other Expenses of Issuance and Distribution.
Item 14. Indemnification of Directors and Officers.
Item 15. Recent Sales of Unregistered Securities.
Item 16. Exhibits and Financial Statement Schedules.
Item 17. Undertakings.
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Exagen Filing 2019-08-23

XGN Filing


S-1 1 d692844ds1.htm S-1 S-1
Table of Contents

As filed with the Securities and Exchange Commission on August 23, 2019

Registration No. 333-                

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

EXAGEN INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   8071   20-0434866

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

1261 Liberty Way, Suite C

Vista, California 92081

(760) 560-1501

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Fortunato Ron Rocca

President and Chief Executive Officer

Exagen Inc.

1261 Liberty Way, Suite C

Vista, California 92081

(760) 560-1501

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copies to:

 

Cheston J. Larson

Matthew T. Bush

Jeffrey T. Woodley

Latham & Watkins LLP

12670 High Bluff Drive

San Diego, California 92130

(858) 523-5400

  

Charles S. Kim

Sean Clayton

Kristin VanderPas

Cooley LLP

4401 Eastgate Mall

San Diego, California 92121

(858) 550-6000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement is declared effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
Emerging growth company       

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act  

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of Securities To Be Registered   Proposed Maximum
Aggregate Offering
Price(1)
  Amount of
Registration Fee(2)

Common Stock, $0.001 par value per share

  $57,500,000   $6,969

 

 

(1)

Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

(2)

Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price. Includes shares of common stock that the underwriters have the option to purchase.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

 

PRELIMINARY PROSPECTUS (Subject to Completion)   August 23, 2019

 

 

                         Shares

 

 

LOGO

Common Stock

This is an initial public offering of common stock by Exagen Inc. We are offering                  shares of our common stock. The initial public offering price is expected to be between $        and $        per share.

Prior to this offering, there has been no public market for our common stock. We have applied to list our common stock on the Nasdaq Global Market under the symbol “XGN.”

We are an “emerging growth company” as that term is used in the Jumpstart Our Business Startups Act of 2012, and, as such, have elected to comply with certain reduced public company reporting requirements.

 

 

 

      Per share          Total    

Initial public offering price

  $                    $                

Underwriting discounts and commissions(1)

  $        $    

Proceeds to Exagen, before expenses

  $        $    

 

 

(1)

See “Underwriting” for a description of the compensation payable to the underwriters.

We have granted the underwriters an option for a period of 30 days to purchase up to             additional shares of common stock.

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 11.

Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares of common stock to purchasers on                     , 2019.

 

 

Joint Book-running Managers

 

Cowen   Cantor   William Blair

                    , 2019


Table of Contents

TABLE OF CONTENTS

 

    Page  

Prospectus Summary

    1  

Risk Factors

    11  

Special Note Regarding Forward-Looking Statements

    58  

Market and Industry Data

    59  

Use of Proceeds

    60  

Dividend Policy

    61  

Capitalization

    62  

Dilution

    65  

Selected Financial Data

    68  

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

    70  

Business

    92  

Management

    129  

Executive and Director Compensation

    137  

Certain Relationships and Related Person Transactions

    152  

Principal Stockholders

    158  

Description of Capital Stock

    161  

Shares Eligible for Future Sale

    167  

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders

    170  

Underwriting

    174  

Legal Matters

    182  

Experts

    182  

Change in Independent Accountant

    183  

Where You Can Find More Information

    184  

Index to Financial Statements

    F-1  

 

 

Neither we nor the underwriters have authorized anyone to provide you with information other than that contained in this prospectus or any free writing prospectus prepared by or on behalf of us or to which we have referred you. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We and the underwriters are offering to sell, and seeking offers to buy, common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus or any free writing prospectus is accurate only as of its date, regardless of its time of delivery or of any sale of shares of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

Through and including                     , 2019 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This delivery is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

For investors outside of the United States: We have not, and the underwriters have not, done anything that would permit this offering or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than the United States. Persons outside of the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.


Table of Contents

PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary does not contain all of the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the section in this prospectus entitled “Risk Factors” and our audited financial statements and the related notes thereto included elsewhere in this prospectus, before making an investment decision. As used in this prospectus, unless the context otherwise requires, references to “we,” “us,” “our,” “our company” and “Exagen” refer to Exagen Inc.

Company Overview

We are dedicated to transforming the care continuum for patients suffering from debilitating and chronic autoimmune diseases by enabling timely differential diagnosis and optimizing therapeutic intervention. We have developed and are commercializing a portfolio of innovative testing products under our AVISE® brand, several of which are based on our proprietary Cell-Bound Complement Activation Products, or CB-CAPs, technology. CB-CAPs assess the activation of the complement system, a biological pathway that is widely implicated across many autoimmune and autoimmune-related diseases, including systemic lupus erythematosus, or SLE. Our goal is to enable rheumatologists to improve care for patients through the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases, including SLE and rheumatoid arthritis, or RA. Our strategy includes leveraging our portfolio of testing products to market therapeutics through our sales channel and targeting the approximately 5,000 rheumatologists across the United States. Our business model of integrating testing products and therapeutics positions us to offer targeted solutions to rheumatologists and, ultimately, better serve patients.

We currently market nine testing products under our AVISE® brand, which we are leveraging to establish partnerships with leading pharmaceutical companies. In December 2018, we entered into a co-promotion agreement with Janssen Biotech, Inc., or the Janssen agreement, to exclusively promote SIMPONI® (golimumab), a subcutaneous, once-per-month, anti-tumor necrosis factor, or anti-TNF, biologic prescribed in combination with methotrexate, in the United States for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases. Combined U.S. sales of SIMPONI® and SIMPONI ARIA®, an intravenous formulation, were approximately $1.0 billion in 2018, of which we estimate approximately 50% was from sales of SIMPONI®. We began direct promotion of SIMPONI® in January 2019 and expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019 to support these promotion efforts. Unlike many diagnostic salesforces that are trained only to understand the comparative benefits of their tests, the specialized backgrounds of our salesforce coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified patient test reports and provide unique insights in a highly tailored discussion with rheumatologists. We therefore believe our strategy of integrating the promotion of testing products and therapeutics uniquely positions us to expand SIMPONI®’s U.S. market share. We expect our SIMPONI® promotion efforts to contribute incremental revenue in 2019 with our quarterly tiered promotion fee based on the incremental increase in total prescribed units above a predetermined average baseline of approximately 29,000 prescribed units per quarter.

We believe our strategy of integrating the promotion of testing products and therapeutics differentiates us from other diagnostic and pharmaceutical companies, and provides our specialized salesforce greater access to rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and who have a history using our portfolio of testing products.



 

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Our lead testing product, AVISE® CTD, enables differential diagnosis for patients presenting with symptoms indicative of a wide variety of connective tissue diseases, or CTDs, and other related diseases with overlapping symptoms. The comprehensive nature of AVISE® CTD allows for the testing of a number of relevant biomarkers in one convenient blood draw, as opposed to testing serially for individual biomarkers, which adds time and cost to the diagnostic process. We believe AVISE® CTD may provide clinical utility for over 23 million patients in the United States suffering from these diseases, which include SLE, RA, Sjögren’s syndrome, antiphospholipid syndrome, or APS, other autoimmune-related diseases such as autoimmune thyroid, and other disorders that mimic these diseases, such as fibromyalgia. There is an unmet need for rheumatologists to add clarity in their CTD clinical evaluations, and we believe there is a significant opportunity for our tests that enable the differential diagnosis of these diseases, particularly for potentially life-threatening diseases such as SLE. Our commitment to addressing this need is demonstrated by our strong track record of developing innovative testing products, as illustrated below:

 

LOGO

AVISE® CTD leverages our proprietary CB-CAPs technology to differentially diagnose SLE. AVISE® CTD provides rheumatologists and their patients with sensitive and specific results that allow for potentially faster and more accurate differential diagnosis of SLE as compared to other currently-marketed testing methods. Beyond SLE, AVISE® CTD allows rheumatologists to accurately diagnose other overlapping autoimmune and autoimmune-related diseases, including RA, with the same blood sample.

Our AVISE® SLE Monitor testing product also leverages our proprietary CB-CAPs technology by measuring two CB-CAPs biomarkers that offer insight into a patient’s disease activity. This test is designed to enable rheumatologists to effectively assess and optimize therapeutic intervention in patients diagnosed with SLE. Depending on disease severity, AVISE® SLE Monitor may be utilized by patients multiple times a year throughout their lives.

Our RA-focused testing products include AVISE® MTX and AVISE® Anti-CarP. AVISE® MTX is a drug monitoring test designed to aid in the optimization of methotrexate therapy, the standard of care and first-



 

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line therapy for patients with RA. AVISE® MTX is based on our proprietary methotrexate polyglutamate, or MTXPG, technology that measures blood levels of MTXPGs, the active metabolite of methotrexate linked to disease control in RA patients. Measuring MTXPGs allows rheumatologists to identify patients presenting with inadequate exposure to methotrexate, enabling them to optimize dosing and achieve therapeutic levels commensurate with adequate disease control. AVISE® Anti-CarP, which measures anti-carbamylated protein antibody, or anti-CarP, was developed by the Leiden University Medical Center and we recently introduced it as a biomarker-driven RA prognostic test through a distribution agreement with Inova Diagnostics, Inc. with the goal of identifying patients prone to more severe disease.

We market our AVISE® testing products using our specialized salesforce. Since the launch of AVISE® CTD in 2012, we have delivered over 326,000 of these tests, representing a compound annual growth rate of 87% through December 31, 2018, with limited incremental investment in our commercial infrastructure. Approximately 83,000 AVISE® CTD tests were delivered in 2018, representing 18% growth over 2017, and the number of ordering physicians in the fourth quarter of 2018 reached 1,298, representing 18% growth over the same period in 2017. In the first half of 2019, 50,792 AVISE® CTD tests were delivered, representing approximately 30% growth over the same period in 2018, and the number of ordering physicians in the first half of 2019 reached 1,711. In the first half of 2019, we achieved a record number of 766 adopting physicians, which we classify as those who had previously prescribed at least 11 tests in a quarter, compared to 635 in the same period in 2018. Nearly 100% of adopting physicians continue to order tests in subsequent quarters. From launch of our direct promotion of SIMPONI® in January 2019 to the end of the second quarter of 2019, weekly ordering from healthcare providers increased by approximately 10% and total weekly prescriptions increased by approximately 17%.

In addition, we continue to populate a growing proprietary database of over 300,000 de-identified patient test results. We believe the insight emerging from these results has the potential to unlock value for pharmaceutical and biotechnology companies in the commercialization of therapeutics. We believe we also have the ability to further leverage our database to optimize patient selection in clinical trials for companies developing therapeutics for autoimmune and autoimmune-related diseases. We plan to collaborate with our existing and future pharmaceutical and biotechnology partners to help maximize the full value of our in-house database.

We believe our strategy of integrating the promotion of testing products and therapeutics differentiates us from other diagnostic and pharmaceutical companies, and provides our specialized salesforce greater access to rheumatologists. Unlike many diagnostic salesforces that are trained only to understand the comparative benefits of their tests, the specialized backgrounds of our salesforce coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified test reports and provide unique insights in a highly tailored discussion with rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and who have a history using our portfolio of testing products.

We recently entered into the Janssen agreement for the promotion of SIMPONI® in order to advance our integrated testing and therapeutics strategy. To support the co-promotion of SIMPONI®, we expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019. This will enable us to conduct approximately 60,500 calls annually to rheumatologists, which we believe will enable us to achieve the optimal reach and frequency with rheumatologists. We also have agreements with other leading pharmaceutical companies, including GlaxoSmithKline LLC, or GSK, Horizon Pharma USA, Inc., or Horizon Therapeutics, and Corrona, LLC, that leverage our testing products and the data generated from such tests. We provide GSK, a leader in lupus therapeutics, our test result data to provide market insight into and help increase awareness of the



 

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benefits of an early and accurate diagnosis of SLE. Our agreement with Horizon Therapeutics entails utilizing our AVISE® MTX test to report on levels of MTXPG in patients undergoing methotrexate therapy in combination with its anti-gout product KRYSTEXXA® in an ongoing Phase 4 clinical trial. We also provide Corrona, the operator of the largest real world observational database in RA containing data from over 40,000 patients, with testing services and support. We plan to pursue additional partnerships with a focus on integrating therapeutics that are synergistic with our evolving portfolio of testing products.

We are led by an experienced management team with unique capabilities to execute on our strategy of integrating the promotion of testing products and therapeutics. Our senior management has an average of over 20 years of experience in the healthcare industry and many were previously involved with successfully building Prometheus Laboratories Inc., or Prometheus, which was focused on integrating diagnostics and therapeutics, prior to its acquisition by Nestlé Health Science S.A. in 2011.

Our Strategy

We develop and commercialize next-generation testing products and promote synergistic therapeutics to ultimately improve the care continuum for patients suffering from debilitating and chronic autoimmune diseases. The key tenets of our business strategy include:

 

   

Drive additional market penetration for our testing products.

 

   

Integrate the promotion of testing products and therapeutics for autoimmune and autoimmune-related diseases.

 

   

Continue our track record of developing innovative testing products.

 

   

Establish additional therapeutic partnerships.

 

   

Achieve meaningful margin expansion.

Risks Related to Our Business

Our ability to execute our business strategy is subject to numerous risks, as more fully described in the section entitled “Risk Factors” immediately following this prospectus summary. These risks include, among others:

 

   

We have a history of losses, we expect to incur net losses in the future and we may not be able to generate sufficient revenue to achieve and maintain profitability.

 

   

In the near-term, we expect that our financial results will depend primarily on sales of our testing products, and we will need to generate sufficient revenue from these testing products to grow our business.

 

   

Our future growth depends, in part, on our ability to execute on our strategy of integrating the promotion of our existing and future proprietary testing products with the promotion of therapeutics, and we may be unsuccessful in our promotion efforts for SIMPONI®, which could adversely affect our ability to implement this strategy.

 

   

We may be unable to manage our ongoing and future growth effectively, which could make it difficult to execute our business strategy.

 

   

If we lose or are unable to secure partners for our integrated testing and therapeutics strategy, or if our partners do not apply adequate resources to their relationships with us or are unable to provide, on a timely basis, an adequate and reliable supply of the therapeutics that we promote, our potential for profitability may be adversely affected.



 

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Our commercial success depends upon attaining and maintaining significant market acceptance of our testing products and promoted therapeutics among rheumatologists, patients, third-party payers and others in the medical community.

 

   

We rely on sole suppliers for some of the reagents, equipment and other materials used in our testing products, and we may not be able to find replacements or transition to alternative suppliers.

 

   

If we are unable to support demand for our current testing products or any of our future testing products or solutions, our business could suffer.

 

   

If third-party payers do not provide coverage and adequate reimbursement for our testing products, or they breach, rescind or modify their contracts or reimbursement policies or delay payments for our testing products or promoted therapeutics, or if we or our partners are unable to successfully negotiate payer contracts, our commercial success could be compromised.

 

   

Developing new testing products involves a lengthy and complex process, and we may not be able to commercialize on a timely basis, or at all, other testing products we are developing.

 

   

We conduct business in a heavily regulated industry, and any changes in regulations or the U.S. Food and Drug Administration’s, or FDA, enforcement discretion, or violations of regulations by us, could adversely affect our business, prospects, results of operations or financial condition.

 

   

If we are unable to maintain intellectual property protection or if we infringe the intellectual property of others, our competitive position could be harmed.

Corporate Information

We were incorporated under the laws of the state of New Mexico in 2002, under the name Exagen Corporation. In 2003, we changed our state of incorporation from New Mexico to Delaware by merging with and into Exagen Diagnostics, Inc., pursuant to which we changed our name to Exagen Diagnostics, Inc. In January 2019, we changed our name to Exagen Inc. Our principal executive offices are located at 1261 Liberty Way, Suite C, Vista, California 92081. Our telephone number is (760) 560-1501. Our website address is www.exagen.com. The information contained in, or accessible through, our website does not constitute part of this prospectus.

We use our trademarks in this prospectus as well as trademarks, tradenames and service marks that are the property of other organizations. Solely for convenience, certain trademarks and tradenames referred to in this prospectus appear without the ® and ™ symbols, but those references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or that the applicable owner will not assert its rights, to these trademarks and tradenames.

Implications of Being an Emerging Growth Company and a Smaller Reporting Company

As a company with less than $1.07 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act, enacted in April 2012. An emerging growth company may take advantage of reduced reporting requirements that are otherwise applicable to public companies. These provisions include, but are not limited to:

 

   

being permitted to present only two years of audited financial statements and only two years of related Management’s Discussion and Analysis of Financial Condition and Results of Operations in this prospectus;



 

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not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, as amended, or the Sarbanes-Oxley Act;

 

   

reduced disclosure obligations regarding executive compensation in our periodic reports, proxy statements and registration statements; and

 

   

exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

We may take advantage of these provisions until the last day of our fiscal year following the fifth anniversary of the date of the first sale of our common equity securities pursuant to an effective registration statement under the Securities Act of 1933, as amended, or the Securities Act, which such fifth anniversary will occur in 2024. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, or the Exchange Act, our annual gross revenues exceed $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period.

We have elected to take advantage of certain of the reduced disclosure obligations in the registration statement of which this prospectus is a part and may elect to take advantage of other reduced reporting requirements in future filings. As a result, the information that we provide to our stockholders may be different than you might receive from other public reporting companies in which you hold equity interests.

In addition, the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. We have elected to avail ourselves of this exemption and, therefore, we may not be subject to the same implementation timing for new or revised accounting standards as other public companies that are not emerging growth companies, which may make comparison of our financials to those of other public companies more difficult.

We are also a “smaller reporting company” as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an emerging growth company. We may take advantage of certain of the scaled disclosures available to smaller reporting companies and will be able to take advantage of these scaled disclosures for so long as our voting and non-voting common stock held by non-affiliates is less than $250.0 million measured on the last business day of our second fiscal quarter, or our annual revenue is less than $100.0 million during the most recently completed fiscal year and our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.



 

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The Offering

 

Common stock offered by us

                 shares.

 

Option to purchase additional shares

We have granted the underwriters an option exercisable for a period of 30 days after the date of this prospectus to purchase up to             additional shares of our common stock.

 

Common stock to be outstanding after this offering

                 shares (or                  shares if the underwriters exercise their option to purchase additional shares of our common stock in full).

 

Use of proceeds

We intend to use the net proceeds from this offering for working capital purposes and other general corporate purposes, including for selling and marketing activities, research and development activities and capital expenditures. See “Use of Proceeds” for a more complete description of the intended use of proceeds from this offering.

 

Risk factors

You should read the “Risk Factors” section of this prospectus and the other information in this prospectus for a discussion of factors to consider carefully before deciding to invest in shares of our common stock.

 

Proposed Nasdaq Global Market symbol

“XGN”

The number of shares of our common stock to be outstanding after this offering is based on                  shares of our common stock outstanding as of June 30, 2019, after giving effect to the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into 1,435,411,648 shares of our common stock (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019) and the issuance of                  shares of our common stock as a result of the expected net exercise of certain outstanding warrants we issued in 2013 that have an exercise price of $0.01 per share, or the 2013 Warrants, in connection with the completion of this offering, assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, which 2013 Warrants will terminate if not exercised prior to the completion of this offering, and excludes:

 

   

121,756,380 shares of our common stock issuable upon the exercise of stock options outstanding as of June 30, 2019, with a weighted-average exercise price of $0.01 per share;

 

   

149,097,864 shares of our common stock issuable upon the exercise of stock options to be granted under our 2019 Plan, contingent and effective upon the effectiveness of the registration statement of which this prospectus forms a part, with an exercise price that is equal to the initial public offering price;

 

   

                 shares of our common stock issuable upon the exercise of outstanding warrants (which number does not include the 2013 Warrants) as of June 30, 2019, with a weighted-average exercise price of $        per share;



 

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                 shares of our common stock reserved for future issuance under our 2019 Incentive Award Plan, or the 2019 Plan, which will become effective in connection with the completion of this offering (which number includes                  shares remaining available for issuance under our 2013 Stock Option Plan, as amended, or the 2013 Plan, which will become available for issuance under the 2019 Plan upon its effectiveness, but does not include any potential annual evergreen increases pursuant to the terms of the 2019 Plan); and

 

   

             shares of our common stock reserved for future issuance under our 2019 Employee Stock Purchase Plan, or ESPP, which will become effective in connection with the completion of this offering (which number does not include any potential annual evergreen increases pursuant to the terms of the ESPP).

Unless otherwise indicated, this prospectus reflects and assumes the following:

 

   

the filing and effectiveness of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws, each of which will occur immediately prior to the completion of this offering;

 

   

the issuance of 479,967,595 shares of our Series H redeemable convertible preferred stock in July 2019 (including the conversion of 148,928,337 shares of our Series G redeemable convertible preferred stock into 246,521,076 shares of our Series H redeemable convertible preferred stock in July 2019);

 

   

the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into 1,435,411,648 shares of our common stock (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019), which will occur in connection with the completion of this offering;

 

   

the termination of warrants to purchase                  shares of our common stock outstanding as of June 30, 2019, with exercise prices that are higher than the assumed initial public offering price of this offering and which will terminate if not exercised prior to the completion of this offering;

 

   

the adjustment of outstanding warrants to purchase 19,230,769 shares of our Series F redeemable convertible preferred stock into warrants to purchase 19,230,769 shares of our common stock, which will occur in connection with the completion of this offering;

 

   

no exercise of the outstanding options and warrants described above, other than the 2013 Warrants;

 

   

a one-for-    reverse stock split of our common stock to be effected prior to the completion of this offering; and

 

   

no exercise by the underwriters of their option to purchase additional shares of our common stock.



 

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Summary Financial Data

The following tables set forth a summary of our historical financial data as of, and for the periods ended on, the dates indicated. We have derived the summary statements of operations data for the years ended December 31, 2017 and 2018 from our audited financial statements included elsewhere in this prospectus. The statements of operations data for the six months ended June 30, 2018 and 2019 and the balance sheet data as of June 30, 2019 have been derived from our unaudited financial statements included elsewhere in this prospectus. You should read this data together with our audited financial statements and the related notes included elsewhere in this prospectus and the sections of this prospectus entitled “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results for any prior period are not indicative of our future results.

 

    Years Ended December 31,     Six Months Ended June 30,  
              2017                         2018(1)(3)                         2018(1)                          2019            
(in thousands, except share and per share data)         (As Revised)     (Unaudited)  

Statements of Operations Data:

       

Revenue

  $ 26,807     $ 32,440     $ 14,576     $ 19,734  

Operating expenses:

       

Costs of revenue (excluding amortization of purchased technology)

    14,137       15,379       7,524       9,434  

Selling, general and administrative expenses

    18,820       19,675       9,487       13,481  

Research and development expenses

    1,551       2,125       1,067       1,103  

Amortization of intangible assets

    186       141       94        

Change in fair value of acquisition-related liabilities

    (51                  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    34,643       37,320       18,172       24,018  
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (7,836     (4,880     (3,596     (4,284

Interest expense

    (2,948     (2,868     (1,394     (1,811

Loss on extinguishment of share purchase rights and 2013 Term Loan

    (6,050                  

Change in fair value of financial instruments

    (9,391     (318           467  

Other income, net

    45       112       51       139  
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (26,180     (7,954     (4,939     (5,489

Income tax (benefit) expense

    (549     58              
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (25,631     (8,012     (4,939     (5,489

Accretion of redeemable convertible preferred stock

    (5,353     (9,318     (3,694     (4,302

Deemed dividend recorded in connection with financing transactions

    (1,790     (1,152     (1,152      
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

  $ (32,774   $ (18,482   $ (9,785   $ (9,791
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted(2)

  $ (2.83   $ (1.60   $ (0.85   $ (0.85
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of shares used to compute net loss per share attributable to common stockholders, basic and diluted(2)

    11,577,921       11,577,921       11,577,921       11,583,144  
 

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(2)

    $         $    
   

 

 

     

 

 

 

Pro forma weighted-average number of shares used to compute pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(2)

       
   

 

 

     

 

 

 


 

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(1)

We adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as of January 1, 2018. See Note 3 to our audited financial statements included elsewhere in this prospectus for further discussion.

 

(2)

See Note 2 to our audited financial statements included elsewhere in this prospectus for an explanation of the method used to calculate the historical net loss and the historical and pro forma net loss per share attributable to common stockholders, basic and diluted, and the number of shares used in the computation of these per share amounts.

 

(3)

See Note 16 to our audited financial statements included elsewhere in this prospectus for a summary of the amounts and financial statement line items impacted by the revision.

 

    As of June 30, 2019  
    Actual     Pro Forma(1)(3)      Pro Forma
As  Adjusted(2)(3)
 
    (unaudited, in thousands)  

Balance Sheet Data:

 

Cash and cash equivalents

  $ 16,237     $                    $                

Working capital(4)

    18,210       

Total assets

    33,088       

Borrowings, including current portion, net of discounts and debt issuance costs

    25,331       

Capital lease obligations, including current portion

    602       

Redeemable convertible preferred stock warrant liabilities

    1,036       

Redeemable convertible preferred stock

    121,026       

Total stockholders’ deficit

    (121,734     

 

(1)

The pro forma balance sheet data gives effect to:

 

   

the receipt of $11.0 million in gross proceeds from the sale of 233,446,519 shares of our Series H redeemable convertible preferred stock in July 2019;

 

   

the conversion of 148,928,337 shares of our Series G redeemable convertible preferred stock into 246,521,076 shares of our Series H redeemable convertible preferred stock in July 2019;

 

   

the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 1,435,411,648 shares of our common stock (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019) and the resultant reclassification of (i) the carrying value of the redeemable convertible preferred stock to permanent equity and (ii) our redeemable convertible preferred stock warrant liabilities to additional paid-in capital, a component of stockholders’ equity (deficit), in connection with such conversion, all of which will occur in connection with the completion of this offering; and

 

   

the issuance of                  shares of our common stock as a result of the expected net exercise of the 2013 Warrants in connection with the completion of this offering, assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, which 2013 Warrants will terminate if not exercised prior to the completion of this offering.

 

(2)

The pro forma as adjusted balance sheet data gives effect to (i) the pro forma adjustments set forth in footnote (1) above and (ii) the issuance and sale of                  shares of our common stock in this offering at the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) by approximately $        , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million in the number of shares offered by us at the assumed initial public offering price would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) by approximately $        .

(3)

The pro forma and pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of our initial public offering determined at pricing.

 

(4)

We define working capital as current assets less current liabilities. See our audited financial statements and the related notes included elsewhere in this prospectus for further details regarding our current assets and current liabilities.



 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this prospectus, including our audited financial statements and related notes included elsewhere in this prospectus, before making an investment decision. If any of the following risks are realized, our business, financial condition, results of operations and prospects could be materially and adversely affected. In that event, the trading price of our common stock could decline and you could lose part or all of your investment.

Risks Related to Our Business and Strategy

We have a history of losses, we expect to incur net losses in the future and we may not be able to generate sufficient revenue to achieve and maintain profitability.

We have incurred net losses since our inception. For the years ended December 31, 2017 and 2018 and the six months ended June 30, 2019, we have incurred net losses of $25.6 million, $8.0 million (as revised) and $5.5 million, respectively, and we expect to incur additional losses this year and in future years. As of June 30, 2019, we had an accumulated deficit of $158.1 million. Over the next several years, we expect to continue to devote substantially all of our resources to increase adoption of, and reimbursement for, our testing products, to promote SIMPONI®, to develop future testing products and to continue to execute our integrated testing and therapeutics strategy. We may not be able to generate sufficient revenue to achieve and maintain profitability. Our failure to achieve and maintain profitability in the future could cause the market price of our common stock to decline.

We only recently began transitioning toward an integrated testing and therapeutics strategy. Consequently, any predictions about our future success, performance or viability may not be as accurate as they could be if we had a longer history of utilizing an integrated testing and therapeutics strategy in addition to the sale of our testing products.

In the near-term, we expect that our financial results will depend primarily on sales of our testing products, and we will need to generate sufficient revenue from these testing products to grow our business.

A significant majority of our historical revenue has been derived from the sale of our AVISE® CTD testing product, which we commercially launched in 2012. In the near term, we expect to continue to derive a majority of our revenue from sales of AVISE® CTD. We are in various stages of research and development with respect to other testing products that we may offer, but there can be no assurance that we will be able to commercialize these testing products.

The demand for our testing products may decrease or may not continue to increase at historical rates for a number of reasons. In addition, at any point in time we may decide to no longer commercialize any of our testing products for any number of reasons. While we have experienced revenue growth from the sale of our testing products, we may not be able to sustain this growth or maintain existing revenue levels. Further, we cannot ensure the continued availability of our testing products in commercial quantities at acceptable costs. If we are unable to increase sales of our testing products, expand reimbursement for our testing products, or successfully develop and commercialize additional testing products, our revenue and our ability to achieve and sustain profitability would be impaired, and the market price of our common stock could decline.

 

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Our future growth depends, in part, on our ability to execute on our strategy of integrating the promotion of our existing and future proprietary testing products with the promotion of therapeutics, and we may be unsuccessful in our promotion efforts for SIMPONI®, which could adversely affect our ability to implement this strategy.

We are in the process of integrating our historical testing products business with the promotion of therapeutics in an integrated testing and therapeutics strategy. Our integrated testing and therapeutics strategy leverages our sales and marketing efforts, targeting rheumatologists for the commercialization of our testing products to promote therapeutics. As a result, our future growth is dependent, in part, on our ability to leverage our unique commercial model of offering testing products combined with therapeutics, including with respect to the Janssen agreement, which we entered into in December 2018 to exclusively promote SIMPONI® in the United States. Pursuant to the Janssen Agreement, we are entitled to receive a tiered promotion fee based on the total number of incremental prescriptions written above an established baseline. Our ability to effectively co-promote SIMPONI® will require us to be successful in a range of activities, including hiring, training and deploying additional sales representatives and creating demand for SIMPONI® through our commercial and sales activities as well as those of Janssen Biotech, Inc., or Janssen. If we encounter difficulties promoting SIMPONI®, our ability to generate significant revenue under the Janssen Agreement will be harmed. Janssen also has the right to terminate the Janssen agreement with or without cause after 30-days’ notice. If Janssen were to exercise this right, we may be unable to recoup substantial investments we have made and intend to make in order to support the promotion of SIMPONI®. We have a limited history partnering with pharmaceutical companies for the promotion of therapeutics. Consequently, any predictions made about our future success or viability with respect to our promotion activities may not be as accurate as they could be if we had a history of successfully co-promoting therapeutics.

If we fail to successfully promote SIMPONI®, our ability to implement our integrated testing and therapeutics strategy and generate sufficient revenue to grow and sustain our business, and our business, financial condition and results of operations, will be materially adversely affected.

We may be unable to manage our ongoing and future growth effectively, which could make it difficult to execute our business strategy.

In addition to the need to scale our testing capacity, our future growth plans will also impose significant added responsibilities on management, including the need to identify, recruit, train and integrate additional employees and the need to manage additional relationships with various partners, suppliers and other third parties. In particular, we expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019 to help increase reach and frequency and support our integrated promotion of testing products and therapeutics. In addition, rapid and significant growth may strain our administrative and operational infrastructure and require us to expand our financial, development, regulatory, manufacturing, marketing and sales capabilities or contract with third parties to provide these capabilities for us. Our ability to manage our business and growth, as well as function as a public company, will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. The time and resources required to optimize these systems is uncertain, and failure to complete optimization in a timely and efficient manner could adversely affect our operations. If we are unable to manage our ongoing and future growth effectively, it may be difficult for us to execute our business strategy and our business could be harmed.

If we lose or are unable to secure partners for our integrated testing and therapeutics strategy, or if our partners do not apply adequate resources to their relationships with us or are unable to provide, on a timely basis, an adequate and reliable supply of the therapeutics that we promote, our potential for profitability may be adversely affected.

In addition to the Janssen agreement, we plan to opportunistically evaluate, and may continue to enter into, additional agreements with pharmaceutical companies to integrate the promotion of our

 

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testing products with their therapeutics. We have also entered into, and may continue to enter into, other agreements that leverage our testing products and data generated from such tests. For example, we provide GSK our test result data to provide market insight into and help increase awareness of the benefits of an early and accurate diagnosis of SLE; and our AVISE® MTX test data is used by Horizon Therapeutics to report on levels of MTXPG in patients undergoing methotrexate therapy in combination with its anti-gout product, KRYSTEXXA®, in an ongoing Phase 4 clinical trial.

The amount and timing of resources applied by our current or potential future partners are largely outside of our control. For example, we have limited control over, and rely on Janssen for, numerous activities that are critical to our ability to successfully promote SIMPONI®, such as pricing decisions, manufacture and supply of SIMPONI®, reimbursement support, marketing materials, the prosecution and enforcement of patents and other intellectual property rights related to SIMPONI® and public communications and presentations regarding SIMPONI®. We likewise have limited control of how our other partners use the information provided by our testing products.

If any of our current or future partners breaches or terminates our agreements, or fails to conduct the activities contemplated by our agreements in a timely manner, our success promoting the applicable therapeutics, testing products or information provided thereby could be diminished or blocked completely. It is possible that partners will change their strategic focus, pursue alternative technologies or develop alternative products, either on their own or in collaboration with others. For example, under the Janssen agreement, Janssen is not prohibited from developing or commercializing products that are competitive with SIMPONI®. If Janssen commercializes any competing products, it may provide lower levels of support to SIMPONI® or may terminate our agreement entirely. The effectiveness of our partners, if any, in marketing the applicable therapeutics will also affect our revenue and earnings. In addition, if our other partners encounter problems with our testing products or information provided by our testing products that they rely on as part of their efforts, our reputation and that of our testing products could be damaged, and it could impair our ability to enter into future agreements to promote therapeutics.

We rely on Janssen to provide, on a timely basis, an adequate and reliable supply of SIMPONI®. Any delay or interruption of supply or Janssen’s failure to comply with regulatory or other requirements could limit its ability to make, or cause it to cease sales, of SIMPONI®. Any manufacturing defect or error discovered after SIMPONI® has been produced and distributed could result in even more significant consequences, including costly recall procedures. In addition, the importation of pharmaceutical products into the United States is subject to regulation by the FDA, and the FDA can refuse to allow an imported product into the United States if it appears that the product fails to comply with applicable laws or regulations. Moreover, Janssen and its third-party manufacturers and suppliers may experience difficulties related to their overall business and financial stability. To the extent Janssen faces manufacturing difficulties or is unable to provide an adequate and reliable supply of SIMPONI® on a timely basis, our reputation could be harmed and our business could suffer.

We do not have the capability and do not intend to discover or develop therapeutics on our own. Therefore, the success of our integrated testing and therapeutics strategy depends in part on our ability to acquire additional rights to promote therapeutics from new or existing partners. Other companies, many of which have substantially greater financial, marketing and sales resources than we do, also compete with us for the acquisition of rights to therapeutics. In addition, under the Janssen agreement, we are prohibited from selling or promoting certain types of products that are used to treat the same indications that SIMPONI® is used to treat. We may not be able to successfully negotiate any additional agreements to promote therapeutics and, if established, these relationships may not be successful. For example, potential partners, particularly those that are actively marketing their own therapeutics, may be unwilling to license commercialization rights to us or otherwise enter into terms that allow us to meaningfully participate in sales growth for their products, which could limit the

 

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potential availability and value to us of additional agreements to promote therapeutics. The inability to enter into agreements for additional therapeutics could limit the overall growth of our business and adversely affect our business, financial condition and results of operations. Disputes could also arise between us and our existing or future partners, as to a variety of matters, including financial and intellectual property matters or other obligations under our agreements. These disputes would be both expensive and time-consuming and may result in delays in the success of therapeutics or could damage our relationship with a partner.

We may experience limits on our revenue if rheumatologists decide not to order our testing products or our promoted therapeutics or if we are otherwise unable to create or maintain demand for our testing products and promoted therapeutics.

If we are unable to create or maintain demand for either our testing products or promoted therapeutics in sufficient volume, we may not generate sufficient revenue to become profitable. To generate increased demand, we will need to continue to educate rheumatologists about the benefits of our testing products through publications in peer-reviewed medical journals, presentations at medical conferences and other similar means. We will also need to generate demand for both our testing products and promoted therapeutics through one-on-one education by our salesforce. We also plan to focus on educating patients about the benefits of these testing products and therapeutics, which we believe will be necessary to generate further demand. In addition, our inability to obtain and maintain coverage and adequate reimbursement from third-party payers may limit adoption by rheumatologists. With respect to SIMPONI® in particular, if we are unable to generate sales above certain thresholds agreed to with Janssen, we will not receive any payments under the Janssen agreement.

Rheumatologists may rely on guidelines issued by industry groups regarding the diagnosis, prognosis, treatment and monitoring of autoimmune and autoimmune-related diseases, and the monitoring of the effectiveness of therapeutic drugs used to treat such diseases before utilizing any diagnostic test or monitoring solution.

Our commercial success depends upon attaining and maintaining significant market acceptance of our testing products and promoted therapeutics among rheumatologists, patients, third-party payers and others in the medical community.

Our success depends on our ability to continue to develop and market testing products and promote therapeutics that are recognized and accepted as safe, effective, reliable and cost effective, and any testing product or promoted therapeutic that we offer may not gain or maintain market acceptance among rheumatologists, third-party payers, patients and the medical community. Market acceptance of our testing products and promoted therapeutics depends on a number of factors, including:

 

   

the perceived accuracy of our test results by rheumatologists and patients;

 

   

the potential and perceived advantages of our testing products and promoted therapeutics over alternative products and therapeutics;

 

   

the demonstration in clinical studies of the performance and clinical validity of our testing products, the results of which studies may not replicate the positive results from earlier studies;

 

   

the demonstration of clinical efficacy and safety of our promoted therapeutics compared to other more-established products;

 

   

the introduction of new tests or therapeutics products that compete with our testing products or our promoted therapeutics or the introduction of generic versions of our promoted therapeutics;

 

   

the product cost in relation to alternative products;

 

   

the prevalence and severity of any adverse effects from our promoted therapeutics;

 

   

the willingness of the target patient population to try new therapies and of rheumatologists to prescribe these therapies;

 

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any restrictions on the use of our promoted therapeutics, if approved, together with other medications

 

   

publicity concerning our testing products and promoted therapeutics or competing products and treatments;

 

   

the availability of coverage and adequate reimbursement by third-party payers, including government authorities;

 

   

relative convenience and ease of administration; and

 

   

the effectiveness of our sales and marketing efforts.

In addition, if we or our partners had to withdraw a product from the market, it could harm our business and could impact market acceptance of our other testing products or promoted therapeutics. If our testing products and promoted therapeutics do not achieve an adequate level of acceptance by rheumatologists, hospitals, third-party payers or patients, we may not generate sufficient revenue from that testing product or therapeutic and may not become or remain profitable. Our efforts to educate the medical community and third-party payers regarding the benefits of our testing products and promoted therapeutics may require significant resources and may never be successful.

The sizes of the markets for our testing products and promoted therapeutics have not been established with precision, and may be smaller than we estimate.

Our estimates of the annual total addressable markets for our current and potential future testing products and promoted therapeutics are based on a number of internal and third-party estimates. These include, without limitation, the number of patients with autoimmune and autoimmune-related diseases and the assumed prices at which we can sell testing products and our partners can sell therapeutics in markets that have not been established. While we believe our assumptions and the data underlying our estimates are reasonable, these assumptions and estimates may not be correct and the conditions supporting our assumptions or estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors. As a result, our estimates of the annual total addressable market for our current and potential future testing products and promoted therapeutics may prove to be incorrect. If the actual number of patients who would benefit from our testing products and promoted therapeutics, the price at which we and our partners can sell future testing products, or the annual total addressable market for our testing products and promoted therapeutics is smaller than we have estimated, it may impair our sales growth and have an adverse impact on our business.

We may expend our limited resources to pursue a particular testing product or promoted therapeutic and fail to capitalize on other testing products or promoted therapeutics that may be more profitable or for which there is a greater likelihood of success.

Because we have limited financial and managerial resources, we focus on specific testing products and promoted therapeutics. As a result, we may forego or delay pursuit of opportunities with others that could have had greater commercial potential. Our resource allocation decisions may cause us to fail to capitalize on viable commercial products or profitable market opportunities. In addition, our spending on current and future research and development programs for testing products may not yield any commercially viable testing products. If we do not accurately evaluate the commercial potential or target market for a potential testing product or promoted therapeutic, we may forego other similar arrangements which would have been more advantageous for us to pursue.

 

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Our operating results may fluctuate significantly, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations or any guidance we may provide.

Our quarterly and annual operating results may fluctuate significantly, which makes it difficult for us to predict our future operating results. These fluctuations may occur due to a variety of factors, many of which are outside of our control, including, but not limited to:

 

   

our ability to successfully market and sell our AVISE® testing products and continue to promote SIMPONI®;

 

   

the extent to which our current testing and future testing products, if any, are eligible for coverage and reimbursement from third-party payers;

 

   

the timing and cost of, and level of investment in, research, development, regulatory approval and commercialization activities relating to our testing products, which may change from time to time, and our ability to successfully commercialize new testing products;

 

   

the cost of supplies, equipment and materials used for our testing products and laboratory operations, which may vary depending on the quantity of production and the terms of our agreements with third-party suppliers and manufacturers;

 

   

expenditures that we may incur to acquire, develop or commercialize additional testing products and technologies;

 

   

the level of demand for our testing products and promoted therapeutics, which may vary significantly;

 

   

the receipt, timing and mix of revenue for our testing products and promoted therapeutics;

 

   

future accounting pronouncements or changes in our accounting policies;

 

   

the rate and extent to which payers make an overpayment determination and require us to return all or some portion of payments which we received in a prior period; and

 

   

the timing and success or failure of competing products, or any other change in the competitive landscape of our industry, including consolidation among our competitors or partners.

The cumulative effects of these factors could result in large fluctuations and unpredictability in our quarterly and annual operating results. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Investors should not rely on our past results as an indication of our future performance.

This variability and unpredictability could also result in our failing to meet the expectations of industry or financial analysts or investors for any period. If our revenue or operating results fall below the expectations of analysts or investors or below any forecasts we may provide to the market, it could have a material adverse effect on our business, financial condition and results or operations.

We rely on sole suppliers for some of the reagents, equipment and other materials used in our testing products, and we may not be able to find replacements or transition to alternative suppliers.

We rely on sole suppliers for critical supply of reagents, equipment and other materials that we use to perform the tests that comprise our testing products. We also purchase components used in our testing product transportation kits from sole-source suppliers. Some of these items are unique to these suppliers and vendors. While we have developed alternate sourcing strategies for many of these materials and vendors, we cannot be certain whether these strategies will be effective or the alternative sources will be available when we need them. We are not a major customer of some of our suppliers, and these suppliers may therefore give other customers’ needs higher priority than ours. If our suppliers can no longer provide us with the materials we need to perform the tests that comprise our testing products, if the materials do not meet our quality specifications, or if we cannot obtain

 

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acceptable substitute materials, an interruption in test processing could occur and, in certain circumstances, we may be required to amend or cancel test results we have issued.

In addition, if we should encounter delays or difficulties in securing the quality and quantity of equipment we require for our testing products, we may need to reconfigure our test processes, which could result in an interruption in sales. Any such interruption may significantly affect our future revenue and harm our customer relations and reputation. In addition, in order to mitigate these risks, we may need to maintain inventories of these supplies at higher levels than would be the case if multiple sources of supply were available.

If we are unable to support demand for our current testing products or any of our future testing products or solutions, our business could suffer.

If demand for our testing products or any of our future testing products or solutions grows, we will need to continue to scale our testing capacity and processing technology, expand customer service, billing and systems processes and enhance our internal quality assurance program. We may also need additional certified laboratory scientists and other scientific and technical personnel to process higher volumes of our testing products. We cannot assure you that any increases in scale, related improvements and quality assurance will be successfully implemented or that appropriate personnel will be available. We will also need to purchase additional equipment, some of which can take several months or more to procure, setup and validate, and increase our software and computing capacity to meet increased demand. Failure to implement necessary procedures, transition to new processes, hire the necessary personnel, obtain any necessary additional equipment and increase software and computing capacity could result in higher costs of processing tests or inability to meet demand. There can be no assurance that we will be able to perform our testing on a timely basis at a level consistent with demand, or that our efforts to scale our operations, expand our personnel, equipment, software and computing capacities, or implement process enhancements will be successfully implemented and will not negatively affect the quality of test results. In addition, there can be no assurance that we will have adequate space in our laboratory facility to accommodate such required expansion. We are also currently collaborating with third parties in an effort to implement multiplex technology in our laboratory. We may experience difficulties securing a partner for this technology and integrating such technology into our existing laboratory operations, which could affect our ability to meet demand for our testing products. If we encounter difficulty meeting market demand or quality standards, our reputation could be harmed and our future prospects and our business could suffer.

If third-party payers do not provide coverage and adequate reimbursement for our testing products, or they breach, rescind or modify their contracts or reimbursement policies or delay payments for our testing products or promoted therapeutics, or if we or our partners are unable to successfully negotiate payer contracts, our commercial success could be compromised.

Successful commercialization of our testing products depends, in large part, on the availability of coverage and adequate reimbursement from third-party payers, including government payers, such as Medicare and Medicaid and private insurers. For the testing products that we develop and commercialize as well as the therapeutics we promote, each third-party payer decides whether to cover the product, the amount it will reimburse for a covered product and the specific conditions for reimbursement.

Reimbursement by third-party payers may depend on a number of factors, including the payer’s determination that tests using our technologies are:

 

   

not experimental or investigational;

 

   

medically necessary;

 

   

demonstrated lead to improved patient outcomes;

 

   

appropriate for the specific patient;

 

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cost-saving or cost-effective;

 

   

supported by peer-reviewed medical journals; and

 

   

included in clinical guidelines.

If we are unable to provide third-party payers with sufficient evidence of the clinical utility and validity of our test, they may not provide coverage, or may provide limited coverage, which will adversely affect our revenue and our ability to succeed. In addition, clinicians may be less likely to order a test unless third-party payers pay a substantial portion of the test price. Therefore, coverage determinations and reimbursement levels and conditions are critical to commercial success, and if we are not able to secure positive coverage determinations and reimbursement levels, our business will be materially adversely affected.

Third-party payers and other entities also conduct technology assessments of new medical tests and devices and provide and/or sell the results of their assessments to other parties. These assessments may be used by third-party payers and health care providers as grounds to deny coverage for or refuse to use a test or procedure. In addition, third-party payers, have increased their efforts to control the cost, utilization and delivery of healthcare services. These measures have resulted in reduced payment rates and decreased utilization for the diagnostics industry.

Effective April 25, 2012, Palmetto GBA, the Medicare molecular diagnostic services program’s, or MolDx Program’s, contractor, assigned the AVISE® MTX assay a unique identifier and determined that the test meets the applicable Medicare coverage criteria to support dose optimization and therapeutic decision making for patients diagnosed with RA on methotrexate. Our current Medicare contractor, Noridian, has adopted this coverage policy. Other third-party payers make their own decisions as to whether to establish a policy to reimburse our testing products, however, and because approvals must be sought on a payer by payer basis, establishing broad coverage is a time-consuming and costly process. There are many third-party payers who have not yet established a coverage policy applicable to our testing products. In addition, several Blue Cross Blue Shield plans and Aetna issued non-coverage policies with respect to AVISE® Lupus, determining that AVISE® Lupus does not meet the medical criteria for coverage and is considered investigational and/or experimental.

While our testing products are reimbursed by a number of third-party payers, we do not currently have contracts with significant private payers. We have in the past, and will likely in the future, experience delays and temporary interruptions in the receipt of payments from third-party payers due to changes in their internal processes, documentation requirements and other issues, which could cause our revenue to fluctuate from period to period.

If we are not successful in reversing existing non-coverage policies, or if other third-party payers issue negative coverage policies, these policies could have a material adverse effect on our business and operations. Even if many third-party payers currently reimburse for our testing products, such payers may withdraw coverage at any time, review and adjust the rate of reimbursement, require co-payments from patients or stop paying for our testing products altogether, any of which would reduce our revenue.

Billing for our testing products is complex, and we must dedicate substantial time and resources to the billing process to be paid for our testing products.

Billing for our testing products is complex, time consuming and expensive. Depending on the billing arrangement and applicable law, we bill various third-party payers, including Medicare and private insurance companies, as well as patients, all of which have different billing requirements. We generally bill third-party payers for our testing products and pursue reimbursement on a case-by-case basis where pricing contracts are not in place. We may also face increased risk in our collection efforts,

 

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including long collection cycles and potential delays in claims processing, which could adversely affect our business, results of operations and financial condition.

Several factors contribute to the complexity of the billing process, including:

 

   

differences between the list price for our testing products and the reimbursement rates of third-party payers;

 

   

compliance with complex federal and state regulations related to billing Medicare;

 

   

disputes among third-party payers as to which party is responsible for payment;

 

   

differences in coverage among third-party payers;

 

   

the effect of patient deductibles, co-payments or co-insurance;

 

   

differences in information and billing requirements among third-party payers;

 

   

changes to billing codes used for our testing products;

 

   

risk of government audits related to billing;

 

   

incorrect or missing billing information; and

 

   

the resources required to manage the billing and claims appeals process.

We use standard industry billing codes, known as CPT codes, to bill for our testing products. If these codes were to change, there is a risk of an error being made in the claim adjudication process. Such errors can occur with claims submission, third-party transmission or in the processing of the claim by the payer. Claim adjudication errors may result in a delay in payment processing or a reduction in the amount of the payment received.

As we introduce new testing products, we will need to add new codes to our billing process as well as our financial reporting systems. Failure or delays in effecting these changes in external billing and internal systems and processes could negatively affect our collection rates, revenue and cost of collecting.

Our billing activities require us to implement compliance procedures and oversight, train and monitor our employees, and undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. When payers deny our claims, in order to obtain reimbursement for services that we provide, we may challenge coverage and payment denials. Payers also conduct external audits to evaluate payments, which add further complexity to the billing process. If the payer makes an overpayment determination, there is a risk that we may be required to return all or some portion of prior payments we have received. Additionally, the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, collectively the Affordable Care Act, or ACA, established a requirement for providers and suppliers to report and return any overpayments received from government payers under the Medicare and Medicaid programs within 60 days of identification. Failure to identify and return such overpayments exposes the provider or supplier to liability under federal false claims laws.

Additionally, from time to time, third-party payers change processes that may affect timely payment. These changes may result in uneven cash flow or impact the timing of revenue recognized with these payers. With respect to payments received from governmental programs, factors such as a prolonged government shutdown could cause significant regulatory delays or could result in attempts to reduce payments made to us by federal government healthcare programs. In addition, third-party payers may refuse to ultimately make payment if their processes and requirements have not been met on a timely basis. These billing complexities, and the related uncertainty in obtaining payment for our testing products could negatively affect our revenue and cash flow, our ability to achieve profitability, and the consistency and comparability of our results of operations.

 

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In 2018, Noridian posted the final Medicare Physician Fee Schedule, or MPFS, and Clinical Laboratory Fee Schedule, or CLFS, which establishes the reimbursement rates to be paid by Medicare for our coverage area for tests performed after January 1, 2019. We have estimated that the implementation of these reimbursement rates will result in an approximate 10.1% reduction in anticipated reimbursements from Medicare from our AVISE® CTD testing product from levels experienced in 2018. Revenue from Medicare comprised 30% and 27% of our revenue in the year ended December 31, 2018 and the six months ended June 30, 2019, respectively. Revenue from the sale of our AVISE® CTD testing products comprised 82% and 83% of our revenue in the year ended December 31, 2018 and the six months ended June 30, 2019, respectively.

We also rely on a third-party provider to provide revenue cycle management software systems for certain processing and collection functions. In the past, we have experienced delays in claims processing as a result of our third-party provider making changes to its invoicing system, as well as not submitting claims to payers within the timeframe required. If claims for our testing products are not submitted to payers on a timely basis, or if we are required to switch to a different systems provider, it could have an adverse effect on our revenue and our business.

Our reliance on third parties requires us to share our trade secrets, which increases the possibility that a competitor will discover them or that our trade secrets will be misappropriated or disclosed.

At times, we share our proprietary technology and confidential information, including trade secrets, with third parties that conduct studies and other services on our behalf. We seek to protect our proprietary technology, in part, by entering into confidentiality agreements, consulting agreements or other similar agreements with our advisors, employees and consultants prior to beginning research or disclosing proprietary information. These agreements typically limit the rights of the third parties to use or disclose our confidential information. Despite the contractual provisions employed when working with third parties, the need to share trade secrets and other confidential information increases the risk that such trade secrets become known by our competitors, are intentionally or inadvertently incorporated into the technology of others or are disclosed or used in violation of these agreements. Given that our proprietary position is based, in part, on our know-how and trade secrets and despite our efforts to protect our trade secrets, a competitor’s discovery of our proprietary technology and confidential information or other unauthorized use or disclosure would impair our competitive position and may have a material adverse effect on our business, financial condition, results of operations and prospects.

Significant safety or efficacy issues could arise for our promoted therapeutics, which could have an adverse effect on our revenue and financial condition.

Pharmaceutical products receive regulatory approval based on data obtained in controlled clinical trials of limited duration. Following regulatory approval, these products will be used over longer periods of time in many patients. Investigators may also conduct additional, and perhaps more extensive, studies. If new safety or efficacy issues are reported or if new scientific information becomes available (including results of post-marketing Phase 4 trials), or if governments change standards regarding safety, efficacy or labeling, our partners may be required to amend the conditions of use for a therapeutic. For example, a partner may voluntarily provide or be required to provide updated information on a therapeutic’s label or narrow its approved indication, either of which could reduce the therapeutic’s market acceptance. If safety or efficacy issues with a partner’s therapeutic arise, sales of the therapeutic could be halted by the partner or by regulatory authorities. Safety or efficacy issues affecting suppliers’ or competitors’ products also may reduce the market acceptance of one of our partner’s therapeutics.

New data about a partner’s therapeutics, or products similar to a partner’s therapeutics, could negatively impact demand for such therapeutics due to real or perceived safety issues or uncertainty

 

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regarding efficacy and, in some cases, could result in product withdrawal. Furthermore, new data and information, including information about therapeutic misuse, may lead government agencies, professional societies, practice management groups or organizations involved with various diseases to publish guidelines or recommendations related to the use of such therapeutics or the use of related therapies or place restrictions on sales. Such guidelines or recommendations may lead to lower sales of the applicable therapeutics and reduce our revenue or otherwise adversely affect our business, prospects, results of operations or financial condition.

If we are unable to maintain or expand our sales and marketing force to adequately address our customers’ and current or future partners’ needs, our business may be adversely affected.

We sell our testing products through our own specialized salesforce and have recently increased our salesforce in order to achieve the optimal reach and frequency and support our strategy of integrating the promotion of testing products and therapeutics. Our testing products compete in a concentrated specialty market, that of autoimmune and autoimmune-related diseases, and utilizing a specialized salesforce is integral to our integrated testing and therapeutics strategy. As such, we believe it is necessary to maintain a salesforce that includes sales representatives with specific technical backgrounds and industry expertise. For example, to support the co-promotion of SIMPONI®, we expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019. Additional agreements for the promotion of therapeutics may require us to further expand our specialized salesforce. Training of additional sales representatives can be costly and time consuming, particularly given the level of experience and sophistication we seek in our salesforce. In addition, until recently, not all of our sales representatives have promoted therapeutics, including SIMPONI®, as part of our organization, and they will need to complete additional training in order to effectively promote SIMPONI® and any other therapeutics that we promote through additional agreements. If we are unable to effectively retain, train and integrate additional sales representatives, it may adversely affect our ability to effectively market and sell our testing products. In addition, competition for highly specialized sales personnel is intense, and we may not be able to attract and retain personnel or be able to maintain an efficient and effective sales and marketing force.

Our future sales will depend in large part on our ability to maintain an effective salesforce. If we are unsuccessful in this regard, it could negatively impact our revenue growth and potential profitability.

If we are unable to compete successfully, we may be unable to increase or sustain our revenue or achieve profitability.

Our principal competition for our testing products is traditional methods used by healthcare providers to test patients with CTD-like symptoms. Such traditional methods include testing for a broad range of diagnostic, immunology and chemistry biomarkers, such as anti-nuclear antibodies, or ANA, and anti-double-stranded DNA, or anti-dsDNA, and serum complement biomarkers, such as C3 and C4. We also face competition from commercial laboratories, such as Laboratory Corporation of America Holdings, Quest Diagnostics Incorporated, ARUP Laboratories, Inc. and the Mayo Clinic, all of which have existing infrastructures to support the commercialization of diagnostic services. Large, multispecialty group medical clinics, health systems and academic medical university-based clinics may provide in-house clinical laboratories offering autoimmune and autoimmune-related disease testing services. Additionally, we compete against regional clinical laboratories providing testing in the autoimmune and autoimmune-related disease field, including Rheumatology Diagnostics Laboratories, Inc. Other potential competitors include companies that might develop diagnostic or disease or drug monitoring products, such as Myriad Genetics, Inc., Progentec Diagnostics Inc., Kypha, LLC, Genalyte Inc., Protagen AG, DxTerity Diagnostics Inc., HealthTell, Inc. and Immunovia AB. In the future, we may also face competition from companies developing new products or technologies.

 

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Direct competition for the promotion of SIMPONI® includes all other companies with anti-TNF biologics and the marketing companies supporting their distribution and promotion. These products include HUMIRA® and RINVOQTM from Abbvie Inc., ENBREL® from Amgen Inc., CIMZIA® from UCB, INFLECTRA® from Pfizer, (biosimilar REMICADE®) and RENFLEXIS® from Merck & Co. (biosimilar REMICADE®). Additional competitors include companies with other biologic drugs indicated for RA that have significant sales or sales potential. Specifically, these include ORENCIA® from Bristol-Myers Squibb Company, ACTEMRA® from Roche, RITUXAN® from Roche, XELJANZ® from Pfizer, KEVZARA® from Sanofi S.A. and OLUMIANT® from Eli Lilly and Company. There are also several late-stage RA drug and biosimilar development programs and several additional RA products that have minimal sales to date or that are indicated for other rheumatic indications competitive to SIMPONI® such as psoriatic arthritis and ankylosing spondylitis.

We believe the principal competitive factors in our target market include: quality and strength of clinical and analytical validation data; confidence in diagnostic results; safety and efficacy with respect to promoted therapeutics; sales and marketing capabilities; the extent of reimbursement; inclusion in clinical guidelines; cost-effectiveness; and ease of use.

Many of our potential competitors have widespread brand recognition and substantially greater financial, technical and research and development resources and selling and marketing capabilities than we do. Others may develop products with prices lower than ours that could be viewed by rheumatologists and payers as functionally equivalent to our solution or offer solutions at prices designed to promote market penetration, which could force us to lower the list price of our products and affect our ability to achieve profitability. If we are unable to change clinical practice in a meaningful way or compete successfully against current and future competitors, we may be unable to increase market acceptance and sales of our products, which could prevent us from increasing our revenue or achieving profitability and could cause the market price of our common stock to decline.

To compete successfully we must be able to demonstrate, among other things, that our testing products are accurate and cost effective and that we are effective in promoting therapeutics.

Developing new testing products involves a lengthy and complex process, and we may not be able to commercialize on a timely basis, or at all, other testing products we are developing.

We will continue to devote considerable resources to the research and development of our planned future testing products and enhancements to our current testing products. We may not be able to develop testing products with the clinical utility necessary to be useful and commercially successful. There are certain products for which a commercial launch would trigger additional payment obligations to licensors of the technology. In these cases, if the economic projections of the product do not outweigh the additional obligations, we may not launch these products. In order to develop and commercialize testing products, we need to:

 

   

expend significant funds to conduct substantial research and development;

 

   

conduct successful validation studies;

 

   

develop and scale our laboratory processes to accommodate different tests;

 

   

achieve and maintain required regulatory certifications;

 

   

develop and scale our infrastructure to be able to analyze increasingly large amounts of data; and

 

   

build the commercial infrastructure to market and sell new testing products.

Our testing product development process involves a high degree of risk and may take several years. Our testing product development efforts may fail for many reasons, including:

 

   

failure to identify additional biomarkers to incorporate into our testing products;

 

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failure or sub-optimal performance of the testing product at the research or development stage;

 

   

difficulty in accessing archival patient blood specimens, especially specimens with known clinical results; or

 

   

failure of clinical validation studies to support the effectiveness of the test.

Typically, few research and development projects result in commercial products, and success in early clinical studies often is not replicated in later studies. At any point, we may abandon development of a testing product candidate or we may be required to expend considerable resources repeating clinical studies, which would adversely affect the timing for generating potential revenue from a new testing product and our ability to invest in other products in our pipeline. In addition, as we develop testing products, we will have to make significant investments in product development, marketing and selling resources. If a clinical validation study fails to demonstrate the prospectively defined endpoints of the study, we might choose to abandon the development of the testing product or product feature that was the subject of the clinical study, which could harm our business. Additionally, competitors may develop and commercialize competing products or technologies faster than us or at a lower cost.

Developing new testing products and enhancements to our existing technologies is expensive and time consuming, and there is no assurance that such activities will result in significant new marketable testing products, enhancements to our current technologies, design improvements, cost savings, revenue or other expected benefits. If we spend significant resources on research and development and are unable to generate an adequate return on our investment or divert resources away from other, more attractive growth opportunities, our business and results of operations may be materially and adversely affected.

If we cannot enter into new clinical study collaborations, our product development and subsequent commercialization could be delayed.

In the past, we have entered into clinical study collaborations, and our success in the future depends in part on our ability to enter into additional collaborations with highly regarded institutions. This can be difficult due to internal and external constraints placed on these organizations. Some organizations may limit the number of collaborations they have with any one company so as to not be perceived as biased or conflicted. Organizations may also have insufficient administrative and related infrastructure to enable collaborations with many companies at once, which can extend the time it takes to develop, negotiate and implement a collaboration. Additionally, organizations often insist on retaining the rights to publish the clinical data resulting from the collaboration. The publication of clinical data in peer-reviewed medical journals is a crucial step in commercializing and obtaining reimbursement for testing products such as our testing products, and our inability to control when and if results are published may delay or limit our ability to derive sufficient revenue from any solution.

We may acquire businesses or assets, form joint ventures or make investments in other companies or technologies that could harm our operating results, dilute our stockholders’ ownership, increase our debt or cause us to incur significant expense.

As part of our business strategy, we may pursue acquisitions of complementary businesses or assets, as well as technology licensing arrangements and other strategic transactions or collaborations with third parties. We also may pursue strategic alliances that leverage our core technology and industry experience to expand our offerings or distribution, make investments in other companies or acquire ownership rights to therapeutics that are synergistic with our testing products. To date, other than our acquisition of the medical diagnostics division of Cypress Bioscience, Inc. in 2010, we have not acquired other companies or therapeutics and, except with respect to certain collaboration agreements executed in connection with our integrated testing and therapeutics strategy, we have limited experience with respect to the formation of strategic alliances and joint ventures. If we make any acquisitions, we may not be able to integrate these acquisitions successfully into our existing

 

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business, and we could assume unknown or contingent liabilities. Any future acquisitions by us also could result in significant write-offs or the incurrence of debt and contingent liabilities, any of which could harm our operating results. Integration of an acquired company, business or assets also may require management resources that otherwise would be available for ongoing development of our existing business. We may not identify or complete these transactions in a timely manner, on a cost-effective basis, or at all, and we may not realize the anticipated benefits of any acquisition, technology license, strategic alliance, joint venture or investment.

To finance any acquisitions or investments, we may choose to issue shares of our stock as consideration, which would dilute the ownership of our stockholders. Once we become a public company, if the price of our common stock is low or volatile, we may not be able to acquire other companies for stock. Alternatively, it may be necessary for us to raise additional funds for these activities through public or private financings or through the issuance of debt. Additional funds may not be available on terms that are favorable to us, or at all, and any debt financing may involve covenants limiting or restricting our ability to take certain actions.

Also, the anticipated benefit of any strategic alliance, joint venture or acquisition may not materialize or such strategic alliance, joint venture or acquisition may be prohibited. In addition, our loan agreement restricts our ability to pursue certain mergers, acquisitions, amalgamations or consolidations that we may believe to be in our best interest. Additionally, future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses or write-offs of goodwill, any of which could harm our financial condition. We cannot predict the number, timing or size of future joint ventures or acquisitions, or the effect that any such transactions might have on our operating results.

The diagnostics and therapeutics industries are subject to rapidly changing technology, which could make our testing products, promoted therapeutics and other testing products we develop obsolete.

Our industry is characterized by rapid technological changes, frequent new product introductions and enhancements and evolving industry standards. These advances require us to continuously develop our technology and work to develop new solutions to keep pace with evolving standards of care. Our testing products could become obsolete unless we continually innovate and expand our testing product offerings to include new clinical applications. If we are unable to develop new testing products or to demonstrate the applicability of our testing products for other diseases, our sales could decline and our competitive position could be harmed. In addition, if our promoted therapeutics become obsolete and we are unable to expand such agreements or find new partners, our sales could decline and our competitive position could be harmed. For example, with respect to SIMPONI® and the treatment of RA, active psoriatic arthritis, or active ankylosing spondylitis, there are many novel therapeutic approaches in development and we expect that the competition in this market will increase dramatically. If new therapeutics make SIMPONI® obsolete or diminish the degree to which rheumatologists prescribe it, our ability to generate revenue under the Janssen agreement will be harmed.

Our failure to maintain relationships or build new relationships with key opinion leaders could materially adversely impact our business and prospects.

Key opinion leaders are able to influence clinical practice by publishing research and determining whether new tests should be integrated into clinical guidelines. We rely on key opinion leaders early in the development process to help ensure our clinical studies are designed and executed in a way that clearly demonstrates the benefits of our testing products to physicians and payers. Our failure to maintain or build new relationships with such key opinion leaders could affect rheumatologist and patient perception of our testing products and result in a loss of existing and future customers and therefore materially adversely impact our business and prospects.

 

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If we are sued for errors and omissions or professional liability, we could face substantial liabilities that exceed our resources.

The marketing, sale and use of our testing products could lead to liability claims if someone were to allege that any such testing product failed to perform as it was designed. We may also be subject to liability for errors in the results we provide to rheumatologists or for a misunderstanding of, or inappropriate reliance upon, the information we provide. We may also be subject to similar types of claims related to testing products we may develop in the future. An errors and omissions or professional liability claim could result in substantial damages and be costly and time consuming for us to defend. Although we maintain professional liability insurance, we cannot assure you that our insurance would fully protect us from the financial impact of defending against these types of claims or any judgments, fines or settlement costs arising out of any such claims. Any errors or omissions or professional liability claim brought against us, with or without merit, could increase our insurance rates or prevent us from securing insurance coverage in the future. Additionally, any product liability lawsuit could cause injury to our reputation or cause us to suspend sales of our testing products. Similarly, any product liability lawsuit affecting our partners could also cause injury to our reputation or cause the applicable partner to suspend sales of its therapeutics. We may also initiate a correction or removal for one of our testing products, issue a safety alert or undertake a field action or recall to reduce a risk to health posed by potential failure of our products to perform as designed, which could lead increase costs and lead to increased scrutiny by regulatory authorities and our customers regarding the quality and safety of our testing products and to negative publicity, including safety alerts, press releases or administrative or judicial actions. The occurrence of any of these events could have an adverse effect on our business and results of operations.

The loss of members of our senior management team or our inability to attract and retain highly skilled scientists, technicians and salespeople could adversely affect our business.

Our success depends largely on the skills, experience and performance of key members of our executive management team, including Fortunato Ron Rocca, our President and Chief Executive Officer, and others in key management positions. The efforts of each of these persons will be critical to us as we continue to develop our technologies and test processes and focus on our growth. If we were to lose one or more of these key employees, we may experience difficulties in competing effectively, developing our technologies and implementing our business strategy.

In addition, our research and development programs and commercial laboratory operations depend on our ability to attract and retain highly skilled scientists, including licensed clinical laboratory scientists and biostatisticians. We may not be able to attract or retain qualified scientists and technicians in the future due to the intense competition for qualified personnel among life science businesses, particularly in Southern California. Because it is expected that there will be a shortage of clinical laboratory scientists in coming years, it may become more difficult to hire sufficient numbers of qualified personnel. We also face competition from universities and public and private research institutions in recruiting and retaining highly qualified scientific personnel. Additionally, our success depends on our ability to attract and retain qualified and highly-specialized salespeople. We may have difficulties locating, recruiting or retaining qualified salespeople, which could cause a delay or decline in the rate of adoption of our testing products and the sale of promoted therapeutics. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that could adversely affect our ability to support our research and development, clinical laboratory and sales efforts. All of our employees are at-will, which means that either we or the employee may terminate their employment at any time. We do not carry key man insurance for any of our employees.

 

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If our sole laboratory facility becomes damaged or inoperable, we are required to vacate our existing facility or we are unable to expand our existing facility as needed, we will be unable to perform our testing services and our business will be harmed.

We currently derive all of our revenue from tests conducted at a single laboratory facility located in Vista, California. Vista is situated on or near earthquake fault lines. Our facility and equipment could be harmed or rendered inoperable by natural or man-made disasters, including earthquake, fire, flood, power loss, communications failure or terrorism. In particular, we store all of our flow cytometers, the instrument we use to detect CB-CAPs on cells, at our Vista facility. If all of our flow cytometers were rendered inoperable simultaneously pursuant to a natural or man-made disaster, we would be unable to perform these key tests as we do in the ordinary course of our business. The inability to perform the tests contained in our testing products or to reduce the backlog of analyses that could develop if our facility is inoperable, for even a short period of time, may result in the loss of customers or harm to our reputation, and we may be unable to regain those customers or repair our reputation in the future. Additionally, we store our bio-repository of specimens, which were collected in collaboration with leading academic institutions and help us to further validate our testing products, at our Vista facility. If these specimens were destroyed pursuant to a natural or man-made disaster or otherwise become unavailable, our ability to develop new testing products may be delayed. Furthermore, our facility and the equipment we use to perform our research and development work could be unavailable or costly and time-consuming to repair or replace. It would be difficult, time-consuming and expensive to rebuild our facility or license or transfer our proprietary technology to a third-party, particularly in light of the licensure and accreditation requirements for a commercial laboratory like ours. Even in the unlikely event we are able to find a third party with such qualifications to enable us to conduct the tests contained in our testing products, we may be unable to negotiate commercially reasonable terms.

In order to rely on a third party to perform the tests contained in our testing products, we would need to engage another facility with established state licensure and Clinical Laboratory Improvement Amendments of 1988, or CLIA, accreditation under the scope of which tests could be performed following validation and other required procedures. We cannot assure you that we would be able to find another CLIA-certified facility willing to comply with the required procedures, that any such facility would be willing to perform the tests contained in our testing products for us on commercially reasonable terms, or that it would be able to meet our quality standards.

In order to establish an additional clinical reference laboratory facility, we would have to spend considerable time and money securing adequate space, constructing the facility, recruiting and training employees, and establishing the additional operational and administrative infrastructure necessary to support a second facility. We may not be able, or it may take considerable time, to replicate our testing processes or results in a new facility. Additionally, any new clinical reference laboratory facility opened by us would be subject to certification under CLIA and licensing by several states, including California and New York, which could take a significant amount of time and result in delays in our ability to begin operations.

We believe we have the capacity to meet our projected needs for at least the next 12 months, although we may grow at a rate that is faster than we expect. Beyond this time frame, we may need to further expand our laboratory space. Any future expansion could disrupt laboratory operations, resulting in an inability to meet customer turnaround time expectations, and could be delayed, resulting in slower realization of laboratory efficiencies anticipated from the use of the expanded facilities. Adverse consequences resulting from a delay in the laboratory expansion could harm our relationships with our customers and our reputation, and could affect our ability to generate revenue.

We carry insurance for damage to our property and the disruption of our business, but this insurance may not cover all of the risks associated with damage or disruption to our business, provide

 

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coverage in amounts sufficient to cover our potential losses or continue to be available to us on acceptable terms, if at all.

Business disruptions could seriously harm our future revenue and financial condition and increase our costs and expenses.

Our operations could be subject to earthquakes, power shortages, telecommunications failures, water shortages, floods, hurricanes, typhoons, fires, extreme weather conditions, medical epidemics and other natural or manmade disasters or business interruptions, for which we are predominantly self-insured. We rely on third- party manufacturers to produce our testing products. Our ability to obtain clinical supplies of our testing products could be disrupted if the operations of these suppliers were affected by a man-made or natural disaster or other business interruption. In addition, our corporate headquarters is located in Vista, California near major earthquake faults and fire zones, and the ultimate impact on us of being located near major earthquake faults and fire zones and being consolidated in a certain geographical area is unknown. The occurrence of any of these business disruptions could seriously harm our operations and financial condition and increase our costs and expenses.

Our testing process involves the use of sophisticated state-of-the-art equipment that requires precise calibration, and issues affecting such equipment may delay delivery or impact the quality of the test results to rheumatologists or otherwise adversely affect our operations.

As part of our process of determining CB-CAPs, which is part of our AVISE® Lupus product, we utilize a number of flow cytometers that require calibration and performance validation according to the requirements of the College of American Pathologists, or CAP, at specified time intervals. While we believe we have implemented appropriate controls and metrics in our laboratory to meet such requirements, we cannot provide any assurance that our instruments will not fall out of specification, in which case we would be required to re-calibrate them. Failure to timely re-calibrate our instruments could negatively impact the test results, which could result in liability and harm our reputation. Patient specimens degrade and become unusable generally within 48 hours of collection. Therefore, if we do not have other sufficient properly functioning flow cytometers due to failure to meet specifications or they otherwise become inoperable, our ability to process patient specimens in the required timeframe would be compromised and our business could be harmed.

If we use hazardous materials in a manner that causes contamination or injury, we could be liable for resulting damages.

We are subject to federal, state and local laws, rules and regulations governing the use, discharge, storage, handling and disposal of biological material, chemicals and waste. We cannot eliminate the risk of accidental contamination or injury to employees or third parties from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for any resulting damages, remediation costs and any related penalties or fines, and any liability could exceed our resources or any applicable insurance coverage we may have. The cost of compliance with these laws and regulations may become significant, and our failure to comply may result in substantial fines or other consequences, either of which could negatively affect our operating results.

Failure in our information technology, telephone or other systems could significantly disrupt our operations and adversely affect our business and financial condition.

Information technology and telephone systems are used extensively in virtually all aspects of our business, including laboratory testing, sales, billing, customer service, logistics and management of medical data. The success of our business depends on the ability to obtain, process, analyze, maintain and manage this data. Our management relies on our information systems because:

 

   

patient specimens must be received, tracked and processed on a timely basis;

 

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test results must be reported on a timely basis;

 

   

billings and collections for all customers must be managed efficiently and accurately;

 

   

third party ancillary billing services require proper tracking and reporting;

 

   

pricing and other information related to our services is needed by our salesforce and other personnel in a timely manner to conduct business;

 

   

patient-identifiable health information must be securely held and kept confidential;

 

   

regulatory compliance requires proper tracking and reporting; and

 

   

proper recordkeeping is required for operating our business, managing employee compensation and other personnel matters.

Our business, results of operations and financial condition may be adversely affected if, among other things:

 

   

our information technology, telephone or other systems fail or are interrupted for any extended length of time;

 

   

services relating to our information technology, telephone or other systems are not kept current;

 

   

our information technology, telephone or other systems do not have the capacity to support expanded operations and increased levels of business;

 

   

data is lost or unable to be restored or processed; or

 

   

data is corrupted due to a breach of security.

Despite the precautionary measures we have taken to prevent breakdowns in our information technology, telephone and other systems, sustained or repeated system failures that interrupt our ability to process test orders, deliver test results or perform testing in a timely manner or that cause us to inadvertently disclose or lose patient information could adversely affect our business, results of operations and financial condition.

Security breaches, loss of data and other disruptions to us, our third-party service providers or our partners could compromise sensitive information related to our business or prevent us from accessing critical information and expose us to liability, which could adversely affect our business and our reputation.

In the ordinary course of our business, we and our partners, and our respective third-party service providers collect and store sensitive data, such as legally protected health information, including de-identified test reports, personally identifiable information about our patients, credit card information, intellectual property, and our proprietary business and financial information. We manage and maintain our applications and data utilizing a combination of on-site and vendor-owned systems. We face a number of risks related to our protection of, and our service providers’ protection of, this critical information, including loss of access, unauthorized disclosure and unauthorized access, as well as risks associated with our ability to identify and audit such events. In addition, we have limited control over the storage of sensitive data by our third-party therapeutics partners as well as risks related to the transfer and sale of de-identified data files to such partners.

The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure, and that of our third-party billing and collections provider, may be vulnerable to attacks by hackers or viruses or otherwise breached due to employee error, malfeasance or other activities. While we have not experienced any such attack or breach, if such an event were to occur, our networks would be compromised and the information we

 

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store on those networks could be accessed by unauthorized parties, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, as amended by the Health Information Technology for Exonomic and Clinical Health Act, or the HITECH Act, and their implementing regulations and regulatory penalties. Unauthorized access, loss or dissemination could also disrupt our operations, including our ability to process tests, provide test results, bill payers or patients, process claims and appeals, provide customer assistance services, conduct research and development activities, collect, process and prepare company financial information, provide information about our products and other patient and rheumatologist education and outreach efforts through our website and manage the administrative aspects of our business and could damage our reputation, any of which could adversely affect our business.

In addition, the interpretation and application of federal and state consumer, health-related and data protection laws in the United States are often uncertain, contradictory and in flux. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. If so, this could result in government-imposed fines or orders requiring that we change our practices, which could adversely affect our business. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices, systems and compliance procedures in a manner adverse to our business.

Performance issues, service interruptions or price increases by our shipping carrier could adversely affect our business, results of operations and financial condition, and harm our reputation and ability to provide testing services on a timely basis.

Expedited, reliable shipping is essential to our operations. While we have recently begun working with United Parcel Service, we still rely extensively on a single carrier, Federal Express Corporation for reliable and secure point-to-point transport of patient specimens to our laboratory and enhanced tracking of these patient specimens. Should Federal Express, or any other carrier we may use in the future, encounter delivery performance issues such as loss, damage or destruction of a specimen, it may be difficult to replace our patient specimens in a timely manner and such occurrences may damage our reputation and lead to decreased utilization from rheumatologists for our testing services and increased cost and expense to our business. In addition, any significant increase in shipping time could adversely affect our ability to receive and process patient specimens on a timely basis.

If we or Federal Express were to terminate our relationship, we would be required to find another party to provide expedited, reliable point-to-point transport of our patient specimens. There are only a few other providers of such nationwide transport services, and there can be no assurance that we will be able to enter into arrangements with such other providers on acceptable terms, if at all. Finding a new provider of transport services would be time-consuming and costly and result in delays in our ability to provide our testing services. Even if we were to enter into an arrangement with any such provider, there can be no assurance that they will provide the same level of quality in transport services currently provided to us by Federal Express. If any new provider does not provide, or if Federal Express does not continue to provide, the required quality and reliability of transport services at the same or similar costs, it could adversely affect our business, reputation, results of operations and financial condition.

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

Under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, or the Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50 percentage-point change (by value) in its equity ownership by “5-percent shareholders,” as defined in the Code, over a three-year period), the corporation’s ability to use its pre-change net operating loss, or NOL,

 

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carryforwards and other pre-change tax attributes to offset its post-change federal taxable income and taxes, as applicable, may be limited. Under recently enacted U.S. tax legislation, federal NOL carryforwards generated in periods after December 31, 2017, may be carried forward indefinitely but may only be used to offset 80% of our taxable income annually. Our ability to use a portion of our NOL carryforwards is subject to limitation under Section 382 of the Code as a result of a prior ownership change. If we undergo an ownership change in connection with this offering, or as a result of subsequent shifts in our stock ownership, our ability to utilize our NOL carryforwards and other pre-change tax attributes could be further limited by Sections 382 and 383 of the Code. Similar provisions of state tax law may also apply. As a result, if we earn net taxable income, our ability to use such pre-change NOL carryforwards and other pre-change tax attributes to offset taxable income and taxes, as applicable, may be limited.

Recent U.S. tax legislation may materially adversely affect our financial condition, results of operations and cash flows.

Recently enacted U.S. tax legislation, known as the Tax Cuts and Jobs Act of 2017, has significantly changed the U.S. federal income taxation of U.S. corporations, including by reducing the U.S. corporate income tax rate and revising the rules governing NOLs. Many of these changes are effective immediately, without any transition periods or grandfathering for existing transactions. The legislation is unclear in many respects and could be subject to potential amendments and technical corrections, as well as interpretations and implementing regulations by the U.S. Treasury and U.S. Internal Revenue Service, any of which could lessen or increase certain adverse impacts of the legislation. In addition, it is unclear how these U.S. federal income tax changes will affect state and local taxation, which often uses federal taxable income as a starting point for computing state and local tax liabilities. Based on our current evaluation of this legislation, the reduction of the U.S. corporate income tax rate required a provisional write-down of our deferred income tax assets (including the value of our NOL carryforwards and our tax credit carryforwards).

There may be other material adverse effects resulting from the legislation that we have not yet identified. While some of the changes made by the tax legislation may adversely affect us in one or more reporting periods and prospectively, other changes may be beneficial on a going forward basis. We continue to work with our tax advisors to determine the full impact that the recent tax legislation as a whole will have on us. We urge our investors to consult with their legal and tax advisors with respect to such legislation and the potential tax consequences of investing in our common stock.

Our term loan contains restrictions that limit our flexibility in operating our business, and if we fail to comply with the covenants and other obligations under our loan agreement, the lenders may be able to accelerate amounts owed under the facility and may foreclose upon the assets securing our obligations.

In September 2017, we entered into a loan and security agreement, or the loan agreement, with Innovatus Life Sciences Lending Fund I, LP, or Innovatus. The loan agreement is collateralized by substantially all of our personal property, including our intellectual property. The loan agreement also subjects us to certain affirmative and negative covenants, including limitations on our ability to transfer or dispose of assets, merge with or acquire other companies, make investments, pay dividends, incur additional indebtedness and liens and conduct transactions with affiliates. We are also subject to certain covenants that require us to maintain a minimum liquidity of at least $2.0 million and achieve certain minimum amounts of annual revenue, and are required under certain conditions to make mandatory prepayments of outstanding principal. As a result of these covenants, we have certain limitations on the manner in which we can conduct our business, and we may be restricted from engaging in favorable business activities or financing future operations or capital needs until our current debt obligations are paid in full or we obtain the consent of Innovatus, which we may not be able to obtain. On December 7, 2018, we borrowed an additional $5.0 million under the loan

 

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agreement, as a result of meeting the requisite trailing twelve-month revenue and gross margin milestones. As of June 30, 2019, there was $25.0 million in principal outstanding under the term loan and an additional $1.0 million outstanding representing interest at 2.5% per annum payable in-kind by adding the amount to the outstanding principal balance of the term loans. Under the loan agreement, we are required to repay any outstanding principal and capitalized interest in monthly installments over a two-year period commencing on October 1, 2020. We cannot be certain that we will be able to generate sufficient cash flow or revenue to meet the financial covenants or pay the principal and accrued interest on our debt.

In addition, upon the occurrence of an event of default, Innovatus, among other things, can declare all indebtedness due and payable immediately, which would adversely impact our liquidity and reduce the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes. An event of default includes, but is not limited to, our failure to pay any amount due and payable under the loan agreement, the occurrence of a material adverse change in our business as defined in the loan agreement, our breach of any representation or warranty in the loan agreement, our breach of any covenant in the loan agreement (subject to a cure period in some cases), a change in control as defined in the loan agreement, our default on any debt payments to a third party in an amount exceeding $500,000 or any voluntary or involuntary insolvency proceeding. If an event of default occurs and we are unable to repay amounts due under the loan agreement, Innovatus could foreclose on substantially all of our personal property, including our intellectual property. We cannot be certain that future working capital, borrowings or equity financings will be available to repay or refinance our debt to Innovatus or any other debt we may incur in the future.

We may require substantial additional capital to finance our planned operations, which may not be available to us on acceptable terms or at all. Our failure to obtain additional financing when needed on acceptable terms, or at all, could force us to delay, limit, reduce or eliminate our product development programs, commercialization efforts or other operations.

We expect capital expenditures and operating expenses to increase over the next several years as we expand our infrastructure, commercial operations and research and development activities. We believe, based on our current plan, that the net proceeds from this offering, together with our current cash and cash equivalents and anticipated future revenue, will be sufficient to meet our anticipated cash requirements for at least the next 12 months. We have based this estimate on assumptions that may prove to be wrong, and we could use our capital resources sooner than we currently expect. Our operating plans and other demands on our cash resources may change as a result of many factors currently unknown to us, and we may need to seek additional funds sooner than planned, through public or private equity or debt financings or other sources, such as strategic collaborations. If our available cash balances, net proceeds from this offering and anticipated future revenue are insufficient to satisfy our liquidity requirements, including because of lower demand for our testing products or promoted therapeutics or lower-than-expected rates of reimbursement from commercial third-party payers and government payers, or other risks described in this “Risk Factors” section, we may seek to raise additional capital through equity offerings, debt financings, collaborations or licensing arrangements. In the case of the incurrence of further indebtedness, the loan agreement, subject to certain customary exceptions, restricts our ability to incur additional indebtedness or encumber any of our property without the prior consent of Innovatus. Under the loan agreement, we are required to make monthly interest payments at a rate equal to 11% (provided that 2.50% of the 11% is payable in-kind by adding the amount to the outstanding principal balance of the term loans). We may also consider raising additional capital in the future to expand our business, pursue strategic investments, take advantage of financing opportunities, or for other reasons. In addition, we may seek additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or future operating plans. The timing and amounts of our future capital requirements are difficult to forecast and will depend on numerous factors, including: our ability to maintain and grow sales of our testing products, as well as the costs associated with conducting

 

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clinical studies to demonstrate the utility of our testing products and support reimbursement efforts; our ability to successfully promote therapeutics; fluctuations in working capital; the costs to expand our sales and marketing capabilities; the costs of developing our product pipeline, including the costs associated with conducting our ongoing and future validation studies; the additional costs we may incur as a result of operating as a public company and the extent to which we in-license, acquire or invest in complementary businesses or products.

Additional funding may not be available to us on acceptable terms, or at all. If we raise funds by issuing equity securities, dilution to our stockholders could result, and the market price of our common stock could decline. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. The incurrence of additional indebtedness or the issuance of certain equity securities could result in increased fixed payment obligations and could also result in restrictive covenants, such as limitations on our ability to incur additional debt or issue additional equity, limitations on our ability to acquire or license intellectual property rights, and other operating restrictions that could adversely affect our ability to conduct our business. In addition, our current loan agreement restricts our ability to incur additional indebtedness or encumber any of our property without the prior consent of Innovatus, subject to certain exceptions. In the event that we enter into collaborations or licensing arrangements to raise capital, we may be required to accept unfavorable terms. These agreements may require that we relinquish or license to a third party on unfavorable terms our rights to technologies or product candidates that we otherwise would seek to develop or commercialize ourselves, or reserve certain opportunities for future potential arrangements when we might be able to achieve more favorable terms. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate one or more research and development programs or selling and marketing initiatives. In addition, we may have to work with a partner on one or more of our testing products, promoted therapeutics or market development programs, which could lower the economic value of those programs to our company.

The FDA may modify its enforcement discretion policy with respect to LDTs in a risk-based manner, and we may become subject to extensive regulatory requirements and may be required to conduct additional clinical trials prior to continuing to sell our existing tests or launching any other tests we may develop, which may increase the cost of conducting, or otherwise harm, our business.

If the FDA ends its policy of enforcement discretion with respect to LDTs, and our testing products become subject to the FDA’s requirements for premarket review of medical devices, we may be required to cease commercial sales of our testing products and conduct additional clinical testing prior to making submissions to the FDA to obtain premarket clearance or approval. If we are required to conduct such clinical trials, delays in the commencement or completion of clinical testing could significantly increase our test development costs and delay commercialization of any currently-marketed tests that we may be required to cease selling or the commercialization of any future tests that we may develop. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial.

We may find it necessary to engage contract research organizations to perform data collection and analysis and other aspects of our clinical trials, which might increase the cost and complexity of our trials. We may also depend on clinical investigators, medical institutions and contract research organizations to perform the trials, and would control only certain aspects of their activities. Nevertheless, we would be responsible for ensuring that each of our trials is conducted in accordance with the applicable protocol, legal, regulatory and scientific standards, and our reliance on these third parties would not relieve us of our regulatory responsibilities.

 

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We and our third party contractors are required to comply with good clinical practices, or GCPs, which are regulations and guidelines enforced by the FDA, the Competent Authorities of the Member States of the European Economic Area, or EEA, and comparable foreign regulatory authorities for products in clinical development. Regulatory authorities enforce these GCPs through periodic inspections of trial sponsors, principal investigators and trial sites. If we or any third party contractor fails to comply with applicable GCPs, the clinical data generated in clinical trials may be deemed unreliable and the FDA, Competent Authorities of the Member States of the EEA or comparable foreign regulatory authorities may require us to perform additional clinical trials before clearing or approving our marketing applications. A failure to comply with these regulations may require us to repeat clinical trials, which would delay the regulatory clearance or approval process. In addition, if these parties do not successfully carry out their contractual duties or obligations or meet expected deadlines, or if the quality, completeness or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or for other reasons, our clinical trials may have to be extended, delayed or terminated. Many of these factors would be beyond our control. We may not be able to enter into replacement arrangements without undue delays or considerable expenditures. If there are delays in testing or clearances or approvals as a result of the failure to perform by third parties, our research and development costs would increase, and we may not be able to obtain regulatory clearance or approval for our testing products. In addition, we may not be able to establish or maintain relationships with these parties on favorable terms, if at all. Each of these outcomes would harm our ability to market our testing products, or to achieve sustained profitability.

The FDA requires medical device manufacturers to comply with, among other things, current good manufacturing practices for medical devices, known as the Quality System Regulation, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process; the medical device reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur; labeling regulations, including the FDA’s general prohibition against promoting products for unapproved or “off-label” uses; and the reports of corrections and removals regulation, which requires manufacturers to report to the FDA if a device correction or removal was initiated to reduce a risk to health posed by the device or to remedy a violation of the FDCA caused by the device which may present a risk to health.

Even if we were able to obtain FDA clearance or approval for one or more of our testing products, if required, a testing product may be subject to limitations on the indications for which it may be marketed or to other regulatory conditions. In addition, such clearance or approval may contain requirements for costly post-market testing and surveillance to monitor the safety or efficacy of the product.

The FDA has broad post-market enforcement powers, and if unanticipated problems with our testing products arise, or if we or our suppliers fail to comply with regulatory requirements following FDA clearance or approval, we may become subject to enforcement actions such as:

 

   

adverse publicity, warning letters, untitled letters, fines, injunctions, consent decrees and civil penalties;

 

   

repair, replacement, refunds, recalls, termination of distribution, administrative detention or seizures of our testing products;

 

   

operating restrictions, partial suspension or total shutdown of production;

 

   

customer notifications or repair, replacement or refunds;

 

   

refusing our requests for 510(k) clearance or PMA approvals or foreign regulatory approvals of new testing products, new intended uses or modifications to existing testing products;

 

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withdrawals of current 510(k) clearances or PMAs or foreign regulatory approvals, resulting in prohibitions on sales of our testing products;

 

   

FDA refusal to issue certificates to foreign governments needed to export testing products for sale in other countries; and

 

   

criminal prosecution

Any of these sanctions could also result in higher than anticipated costs or lower than anticipated sales and have a material adverse effect on our reputation, business, results of operations and financial condition.

In addition, the FDA’s and other regulatory authorities’ policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approvals. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing authorization that we may have obtained and we may not achieve or sustain profitability, which would adversely affect our business, prospects, financial condition and results of operations.

Risks Related to Regulatory and Compliance Matters

Healthcare policy and payment changes may have a material adverse effect on our financial condition and results of operations.

Reimbursement to healthcare providers, such as specialized diagnostic service providers like us, is subject to continuing change in policies by third-party payers including governmental payers, such as Medicare and Medicaid, private insurers and other private payers, such as hospitals and private medical groups. Statutory and regulatory changes, retroactive rate adjustments and administrative rulings, and other policy changes may be implemented with little or no prior notice, all of which could materially decrease the range of services for which we are reimbursed or the reimbursement rates paid for our testing products.

On April 1, 2014, the Protecting Access to Medicare Act of 2014, or PAMA, was signed into law, which, among other things, implemented a new payment system for clinical laboratory tests reimbursed under the CLFS. Under the law, clinical laboratories must report laboratory test payment data for each Medicare-covered clinical diagnostic lab test that it furnishes. The reported data must include the payment rate and the volume of each test that was paid by each private third-party payer. Laboratories that fail to report the required payment information may be subject to substantial civil monetary penalties. We bill Medicare for our testing products, and therefore we are subject to reporting requirements under PAMA.

The final PAMA ruling was issued June 17, 2016. Data for reporting for the new PAMA process began in 2017, and in 2018, the Medicare payment rate for each clinical diagnostic lab test, with some exceptions, equaled the weighted median of the reported private third-party payer payment for the test, as calculated using data collected by applicable laboratories during the data collection period and reported to the Centers for Medicare and Medicaid Services, or CMS, during a specified data reporting period. These revisions to the CLFS have altered payment rates for clinical diagnostic lab tests under the CLFS, with estimated reductions in Medicare reimbursement rates for AVISE® CTD of 3.2% and 10.1% in 2018 and 2019, respectively. We cannot be sure how revisions to the CLFS will effect reimbursement rates in the future.

Other laws make changes impacting clinical laboratories, many of which have already gone into effect. The ACA, enacted in March 2010, requires each medical device manufacturer to pay an excise tax in an amount equal to 2.3% of the price for which such manufacturer sells its medical devices that

 

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are listed with the FDA. This excise tax has been temporarily suspended until December 31, 2019, unless additional congressional action is taken. On December 14, 2018, a U.S. District Court Judge in the Northern District of Texas, or Texas District Court Judge, ruled that the entire ACA is invalid based primarily on the fact that the Tax Cuts and Jobs Act of 2017 repealed the tax-based shared responsibility payment imposed by the ACA, on certain individuals who fail to maintain qualifying health coverage for all or part of a year, which is commonly referred to as the “individual mandate”. While the Texas District Court Judge, as well as the current presidential administration and CMS, have stated that this ruling will have no immediate effect, it is unclear how this decision, subsequent appeals, and other efforts to repeal and replace the ACA will impact the ACA and our business.

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. There have been judicial and Congressional challenges to certain aspects of the ACA, as well as efforts by the current presidential administration to repeal and replace the ACA, and we expect that there will be additional challenges and amendments to the ACA in the future. We are monitoring the impact of the ACA in order to enable us to determine the trends and changes that may be necessitated by the legislation and that, in turn, may potentially impact our business over time.

Additionally, the Budget Control Act of 2011, among other things, resulted in aggregate reductions to Medicare payments to providers of 2% per fiscal year, beginning April 1, 2013, and due to additional legislative amendments to the statute, these reductions will remain in effect through 2027 unless additional congressional action is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

Some of our flow cytometry tests are reimbursed by the Medicare program under the MPFS. On April 16, 2015, President Obama signed the Medicare Access and CHIP Reauthorization Act of 2015, or MACRA, which, among other actions, repealed the previous statutory formula by which CMS established annual updates to MPFS rates. MACRA created the Merit-Based Incentive Payment System which, beginning in 2019, more closely aligns physician payments with composite performance on performance metrics similar to three existing incentive programs (i.e., the Physician Quality Reporting System, the Value-based modifier program and the Electronic Health Record Meaningful Use program) and incentivizes physicians to enroll in alternative payment methods. At this time, we do not know whether these changes to the physician payment systems will have any impact on orders or payments for our testing products.

Medicare payments are significant to our business, not only because approximately 28% and 27% of the total payments we received from payers in the year ended December 31, 2018 and the six months ended June 30, 2019, respectively, were derived from the Medicare program, but also because other payers often use the MPFS and CLFS amounts as a benchmark to develop their payment rates. We cannot predict whether Medicare and other third-party payer reimbursement rates that mirror Medicare’s will be sufficient to make our testing products commercially attractive.

In addition, some third-party payers have implemented, or are in the process of implementing, laboratory benefit management programs, often using third-party benefit managers to manage these programs. The stated goals of these programs are to help improve the quality of outpatient laboratory services, support evidence-based guidelines for patient care and lower costs. The impact on

 

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laboratories, such as ours, of active laboratory benefit management by third parties is unclear, and we expect that it could have a negative impact on our revenue in the short term. It is possible that third-party payers will resist reimbursement for testing products that we offer in favor of less expensive tests, may require pre-approval for our testing products or may impose additional pricing pressure on and substantial administrative burden for reimbursement for our testing products.

Product pricing by companies is currently, and is expected to continue to be, under close scrutiny. Such scrutiny has resulted in several recent congressional inquiries and proposed and enacted federal and state legislation designed to, among other things, bring more transparency to product pricing, review the relationship between pricing and patient programs, and reform government program reimbursement methodologies for products. At the state level, legislatures have increasingly passed legislation and implemented regulations designed to control product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access and marketing cost disclosure and transparency measures.

We also cannot predict whether future healthcare initiatives will be implemented at the federal or state level or in countries outside of the United States in which we may do business in the future, or the effect any future legislation or regulation will have on us. Although we cannot predict the full effect of the recent legislative changes discussed above, including taxes imposed by the ACA, cost reduction measures, the expansion in government’s role in the U.S. healthcare industry and PAMA’s changes to the reimbursement methodology under the CLFS, such changes individually or in the aggregate may result in decreased profits to us and/or lower reimbursement by third-party payers for our testing products, which may adversely affect our business, financial condition and results of operations.

Complying with numerous regulations pertaining to our business is an expensive and time-consuming process, and any failure to comply could result in substantial penalties.

We are subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA regulations mandate specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. We have a current certificate of accreditation under CLIA to perform testing through our accreditation by CAP. To renew this certificate, we are subject to survey and inspection every two years. Moreover, CLIA inspectors may make random inspections of our clinical reference laboratory.

Although we are required to hold a certificate of accreditation or compliance under CLIA that allows us to perform high complexity testing, we are not required to hold a certificate of accreditation through CAP. We could alternatively maintain a certificate of accreditation from another accrediting organization or a certificate of compliance through inspection by surveyors acting on behalf of the CLIA program. If our accreditation under CAP were to terminate, either voluntarily or involuntarily, we would need to convert our certification under CLIA to a certificate of compliance (or to a certificate of accreditation with another accreditation organization) in order to maintain our ability to perform clinical testing and to continue commercial operations. Whether we would be able to successfully maintain operations through either of these alternatives would depend upon the facts and circumstances surrounding termination of our CAP accreditation, such as whether any deficiencies were identified by CAP as the basis for termination and, if so, whether these were addressed to the satisfaction of the surveyors for the CLIA program (or another accrediting organization).

The failure to comply with CLIA requirements can result in enforcement actions, including the revocation, suspension, or limitation of our CLIA certificate of accreditation, as well as a directed plan of correction, state on-site monitoring, civil money penalties, civil injunctive suit and/or criminal penalties. We must maintain CLIA compliance and certification to be eligible to bill for tests provided to

 

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Medicare beneficiaries. If we were to be found out of compliance with CLIA program requirements and subjected to sanctions, our business and reputation could be harmed. Even if it were possible for us to bring our laboratory back into compliance, we could incur significant expenses and potentially lose revenue in doing so.

We are also required to maintain a license to conduct testing in California. California laws establish standards for day-to-day operation of our clinical reference laboratory, including the training and skills required of personnel and quality control. In addition, our clinical reference laboratory is licensed on a product-specific basis by New York as an out of state laboratory and our testing products, as LDTs, must be approved by the New York Department of Health, or NYDOH, on a product-by-product basis before they are offered in New York. We are also be subject to periodic inspection by the NYDOH and required to demonstrate ongoing compliance with NYDOH regulations and standards. To the extent NYDOH identified any non-compliance and we are unable to implement satisfactory corrective actions to remedy such non-compliance, the State of New York could withdraw approval for our testing products. New York law also mandates proficiency testing for laboratories licensed under New York state law, regardless of whether or not such laboratories are located in New York. Moreover, several other states require that we hold licenses to test specimens from patients in those states. Other states may have similar requirements or may adopt similar requirements in the future. Although we have obtained licenses from states where we believe we are required to be licensed, we may become aware of other states that require out-of-state laboratories to obtain licensure in order to accept specimens from the state, and it is possible that other states currently have such requirements or will have such requirements in the future.

If we were to lose our CLIA accreditation or California license, whether as a result of a revocation, suspension or limitation, we would no longer be able to sell our testing products, which would limit our revenue and harm our business. If we were to lose our license or fail to obtain or maintain NYDOH approval for our laboratory developed tests in New York or if we were to lose our license in other states where we are required to hold licenses, we would not be able to test specimens from those states which would limit our revenue.

If we fail to comply with healthcare laws and regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.

We and our partners, including those with whom we may enter into co-promotion or co-marketing arrangements, are also subject to healthcare fraud and abuse regulation by both the federal government and the states in which we or our partners conduct our business. These laws include, without limitation, state and federal anti-kickback, self-referral, fraud and abuse, false claims, and physician sunshine laws and regulations.

The Federal Anti-kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving any remuneration (including any kickback, bribe or rebate), directly or indirectly, overtly or covertly, in cash or in kind, to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any good, facility, item or service, including laboratory services, reimbursable, in whole or in part, under Medicare, Medicaid or other federally financed healthcare programs. The term “remuneration” has been broadly interpreted to include anything of value. The Federal Anti-kickback Statute has been interpreted to apply to arrangements between manufacturers on one hand and prescribers, purchasers and formulary managers on the other. Although there are a number of statutory exceptions and regulatory safe harbors protecting certain common activities from prosecution, the exceptions and safe harbors are drawn narrowly. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability. Failure to meet all of the requirements of a particular applicable statutory exception or regulatory safe harbor, however, does not make the conduct per se illegal under the Federal Anti-Kickback Statute. Instead, the legality of the arrangement will be evaluated on a case-by-case basis based on a cumulative review of all of its facts and circumstances. Several courts have interpreted the

 

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statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the Federal Anti-Kickback Statute has been violated. Further, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it. in order to have committed a violation In addition, the government may assert that a claim including items or services resulting from a violation of the Federal Anti-kickback Statute constitutes a false or fraudulent claim for purposes of the false claims laws.

On June 25, 2014, the Office of Inspector General of the Department of Health and Human Services, or the OIG, released a Special Fraud Alert, expressing concern regarding laboratory payments made to referring physicians and physician group practices for blood specimen collection, processing, and packaging. Specifically, the OIG expressed concern that such arrangements may implicate the Federal Anti-Kickback Statute when laboratories make payments to physicians for services that are already covered and reimbursed by Medicare, or are not commercially reasonable or exceed fair market value, all in order to induce physicians to order tests from such laboratory. Because the choice of laboratory and the decision to order laboratory tests is made or strongly influenced by the physician, with little or no input from patients, such payment may induce physicians to order more laboratory tests than are medically necessary, particularly when the payments are tied to, or take into account, the volume or value of business generated by the physician. We had entered into certain arrangements with physicians for services related to specimen collection, transporting and handling. Effective August 2015, we terminated all such agreements. To date, no regulatory authorities have contacted us regarding these arrangements. To the extent our prior arrangements are found to be inconsistent with applicable laws, we may be subject to significant penalties, including criminal penalties, and exclusion from participation in U.S. federal or state health care programs.

The Federal civil and criminal false claims law, including the False Claims Act, prohibit, among other things, any person from knowingly presenting or causing to be presented a false claim for payment to the federal government, or knowingly making or causing to be made a false statement to get a false or fraudulent claim paid by the federal government. A claim includes “any request or demand” for money or property presented to the U.S. government. In addition, private individuals have the ability to bring actions under these false claims laws in the name of the government alleging false and fraudulent claims presented to or paid by the government (or other violations of the statutes) and to share in any amounts paid by the entity to the government in fines or settlement. Such suits, known as qui tam actions, have increased significantly in the healthcare industry in recent years. In addition, the federal civil monetary penalties statute imposes penalties against any person or entity that, among other things, is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent. The majority of states also have statutes or regulations similar to the federal anti-kickback and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payer.

We are also subject to the federal physician self-referral prohibitions, commonly known as the Stark Law, which prohibits, among other things, physicians who have a financial relationship, including an investment, ownership or compensation relationship with an entity, from referring Medicare patients for designated health services, which include clinical laboratory services, unless an exception applies. Similarly, entities may not bill Medicare or any other party for services furnished pursuant to a prohibited referral. Many states have their own self-referral laws as well, which in some cases apply to all third-party payers, not just Medicare and Medicaid.

In addition, under the federal civil monetary penalties statute, a person is prohibited from offering or transferring to a Medicare or Medicaid beneficiary any remuneration, including waivers of co-payments and deductible amounts (or any part thereof), that the person knows or should know is likely to influence the beneficiary’s selection of a particular provider, practitioner or supplier of Medicare or Medicaid

 

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payable items or services. Moreover, in certain cases, providers who routinely waive copayments and deductibles for Medicare and Medicaid beneficiaries can also be held liable under the Federal Anti-kickback Statute and civil False Claims Act. One of the statutory exceptions to the prohibition is non-routine, unadvertised waivers of copayments or deductible amounts based on individualized determinations of financial need or exhaustion of reasonable collection efforts. The OIG emphasizes, however, that this exception should only be used occasionally to address special financial needs of a particular patient. Although this prohibition applies only to federal healthcare program beneficiaries, the routine waivers of copayments and deductibles offered to patients covered by commercial payers may implicate applicable state laws related to, among other things, unlawful schemes to defraud, excessive fees for services, tortious interference with patient contracts and statutory or common law fraud. To the extent our patient assistance programs are found to be inconsistent with applicable laws, we may be required to restructure or discontinue such programs, or be subject to other significant penalties.

The ACA, among other things, also imposed new reporting requirements on manufacturers of certain devices, drugs and biologics for certain payments and transfers of value by them and in some cases their distributors to physicians and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members. Manufacturers must submit reports by the 90th day of each calendar year. Because we manufacture our own LDTs solely for use by or within our own laboratory, we believe that we are exempt from these reporting requirements. We cannot assure you, however, that our regulators, principally the federal government, will agree with our determination, and a determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business, prospects, results of operations or financial condition.

It is possible that some of our business activities could be subject to challenge under one or more of such laws, including our promotion of SIMPONI®, which is subject to restriction of off-label use discussions Such a challenge, regardless of the outcome, could have a material adverse effect on our business, business relationships, reputation, financial condition and results of operations. Although an effective compliance program can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, achieving and sustaining compliance with these laws may prove costly. If we or our operations, or any of the rheumatologists or entities with whom we do business are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to significant penalties, including administrative, civil and/or criminal penalties, damages, fines, disgorgement, individual imprisonment, exclusion from participation in U.S. federal or state health care programs, such as Medicare and Medicaid in the U.S. and similar programs outside the U.S., a corporate integrity agreement or other agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations, any of which could materially adversely affect our ability to operate our business and our financial results. To the extent that any of our testing products are sold in a foreign country, we may be subject to similar foreign laws and regulations, which may include, for instance, applicable post-marketing requirements, including safety surveillance, anti-fraud and abuse laws, and implementation of corporate compliance programs and reporting of payments or transfers of value to healthcare professionals.

Failure to comply with HIPAA, the HITECH Act, their implementing regulations, and similar comparable state laws and regulations affecting the transmission, security and privacy of health information could result in significant penalties.

Numerous federal and state laws and regulations, including HIPAA and the HITECH Act, govern the collection, dissemination, security, use and confidentiality of individually identifiable health information. HIPAA and the HITECH Act require us to comply with standards for the use and disclosure

 

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of individually identifiable health information within our company and with third parties. The Standards for Privacy of Individually Identifiable Health Information, or Privacy Standards, and the Security Standards for the Protection of Electronic Protected Health Information, or Security Standards, under HIPAA establish a set of basic national privacy and security standards for the protection of individually identifiable health information by health plans, healthcare clearinghouses and certain healthcare providers, referred to as covered entities, and the business associates with whom such covered entities contract for services. Notably, whereas HIPAA previously directly regulated only these covered entities, the HITECH Act, which was signed into law as part of the stimulus package in February 2009, made certain of the Security Standards directly applicable to business associates. Further, the HITECH Act and the Final HIPAA Omnibus Rule that was promulgated in 2013, made additional parts of HIPAA directly applicable to business associates. As a result, both covered entities and business associates are now subject to significant civil and criminal penalties for failure to comply with the Privacy Standards and/or the Security Standards.

HIPAA and the HITECH Act also include standards for common healthcare electronic transactions and code sets, such as claims information, plan eligibility, payment information and the use of electronic signatures, and privacy and electronic security of individually identifiable health information. Covered entities, such as certain health care providers, are required to conform to such transaction set standards, known as the Standards for Electronic Transactions, pursuant to HIPAA.

HIPAA requires covered entities to develop and maintain policies and procedures with respect to individually identifiable health information that is used or disclosed, including the adoption of administrative, physical and technical safeguards to protect such information. The HITECH Act expands the notification requirement for breaches of individually identifiable health information, restricts certain disclosures and sales of individually identifiable health information and provides a tiered system for civil monetary penalties for HIPAA violations. The Final HIPAA Omnibus Rule modifies the breach reporting standard in a manner that will likely make more data security incidents qualify as reportable breaches. The HITECH Act also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce HIPAA and seek attorney fees and costs associated with pursuing federal civil actions. Additionally, certain states have adopted comparable privacy and security laws and regulations, some of which may be more stringent than HIPAA.

If we do not comply with the requirements of HIPAA, the HITECH Act or applicable state privacy and security laws, we could be subject to criminal or civil sanctions that could adversely affect our financial condition. The costs of complying with privacy and security related legal and regulatory requirements are burdensome and could have a material adverse effect on our business. These laws are subject to interpretation by various courts and other governmental authorities, thus creating potentially complex compliance issues for us, as well as our physician clients. In addition, we are unable to predict what changes to the HIPAA Privacy Standards and Security Standards might be made in the future or how those changes could affect our business. Any new legislation or regulation in the area of privacy and security of personal information, including individually identifiable health information, could also adversely affect our business operations.

We are subject to U.S. and certain foreign export and import controls, sanctions, embargoes, anti-corruption laws, and anti-money laundering laws and regulations. Compliance with these legal standards could impair our ability to compete in domestic and international markets. We can face criminal liability and other serious consequences for violations, which can harm our business.

We are subject to export control and import laws and regulations, including the U.S. Export Administration Regulations, U.S. Customs regulations, various economic and trade sanctions

 

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regulations administered by the U.S. Treasury Department’s Office of Foreign Assets Controls, the U.S. Foreign Corrupt Practices Act of 1977, as amended, or FCPA, the U.S. domestic bribery statute contained in 18 U.S.C. § 201, the U.S. Travel Act, the USA PATRIOT Act, and other state and national anti-bribery and anti-money laundering laws in the countries in which we conduct activities. Anti-corruption laws are interpreted broadly and prohibit companies and their employees, agents, contractors, and other collaborators from authorizing, promising, offering, or providing, directly or indirectly, improper payments or anything else of value to recipients in the public or private sector. We may engage third parties to sell our testing products outside the United States, to conduct clinical trials, and/or to obtain necessary permits, licenses, patent registrations, and other regulatory approvals. We have direct or indirect interactions with officials and employees of government agencies or government-affiliated hospitals, universities, and other organizations. We can be held liable for the corrupt or other illegal activities of our employees, agents, contractors, and other collaborators, even if we do not explicitly authorize or have actual knowledge of such activities. Any violations of the laws and regulations described above may result in substantial civil and criminal fines and penalties, imprisonment, the loss of export or import privileges, debarment, tax reassessments, breach of contract and fraud litigation, reputational harm, and other consequences.

Our future growth may depend, in part, on our ability to operate in foreign markets, where we would be subject to additional regulatory burdens and other risks and uncertainties.

Our future growth may depend, in part, on our ability to develop and commercialize our testing products and promote therapeutics in foreign markets. We are not permitted to market or promote any of our testing products or promote therapeutics before we or our partners receive regulatory approval from applicable regulatory authorities in foreign markets, and we or they may never receive such regulatory approvals for any of our testing products or promoted therapeutics. To obtain separate regulatory approval in many other countries parties must comply with numerous and varying regulatory requirements regarding safety and efficacy and governing, among other things, clinical trials, commercial sales, pricing and distribution of our testing products. If we or our partners obtain regulatory approval of our testing products and promoted therapeutics, and ultimately commercialize our testing products or promoted therapeutics in foreign markets, we would be subject to additional risks and uncertainties, including:

 

   

different regulatory requirements for approval of drugs in foreign countries;

 

   

reduced protection for intellectual property rights;

 

   

the existence of additional third-party patent rights of potential relevance to our business;

 

   

unexpected changes in tariffs, trade barriers and regulatory requirements;

 

   

economic weakness, including inflation, or political instability in particular foreign economies and markets;

 

   

compliance with tax, employment, immigration and labor laws for employees living or traveling abroad;

 

   

foreign currency fluctuations, which could result in increased operating expenses and reduced revenue, and other obligations incident to doing business in another country;

 

   

foreign reimbursement, pricing and insurance regimes;

 

   

workforce uncertainty in countries where labor unrest is common;

 

   

production shortages resulting from any events affecting raw material supply or manufacturing capabilities abroad; and

 

   

business interruptions resulting from geopolitical actions, including war and terrorism, or natural disasters including earthquakes, typhoons, floods and fires.

 

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Risks Related to our Intellectual Property

If we are unable to maintain intellectual property protection our competitive position could be harmed.

Our ability to protect our technologies such as CB-CAPs and methotrexate polyglutamates, or MTXPGs, affects our ability to compete and to achieve sustained profitability. We rely on a combination of U.S. and foreign patents and patent applications, copyrights, trademarks and trademark applications, and contractual restrictions to protect our intellectual property rights. We cannot be certain that the claims in our granted patents and pending patent applications covering our AVISE® testing products will be considered patentable or enforceable by the United States Patent and Trademark Office, or the USPTO, courts in the United States, or by patent offices and courts in foreign countries. If we fail to protect our intellectual property, third parties may be able to compete more effectively against us and we may incur substantial litigation costs in our attempts to recover or restrict use of our intellectual property.

We apply for patents covering our testing products and technologies and uses thereof, as we deem appropriate, however we may fail to apply for patents on important testing products and technologies in a timely fashion or at all, or we may fail to apply for patents in potentially relevant jurisdictions, or we may cease our prosecution and maintenance of patents in potentially relevant jurisdictions. Currently, we have an exclusive license to 13 issued U.S. patents, and certain corresponding foreign counterpart patents, relevant to our AVISE® testing products. We also own two pending U.S. patent applications relevant to our AVISE® testing products. While we intend to pursue additional patent applications, it is possible that our pending patent applications and any future applications may not result in issued patents. Even if such patents do successfully issue, third parties may challenge the validity, enforceability or scope thereof, which may result in such patents being narrowed, invalidated or held unenforceable. Any successful opposition to our patents could deprive us of exclusive rights necessary for the further development of our AVISE® testing products. Furthermore, even if they are unchallenged, our patents may not adequately protect our intellectual property, provide exclusivity for our AVISE® testing products or prevent others from designing around our claims.

We might not have been the first to make the inventions covered by each of our pending patent applications and we might not have been the first to file patent applications for these inventions. To determine the priority of these inventions, we may have to participate in interference proceedings, derivation proceedings or other post-grant proceedings declared by the USPTO that could result in substantial cost to us. No assurance can be given that our patent applications will have priority over other patent applications. In addition, recent changes to the patent laws of the United States allow for various post-grant opposition proceedings that have not been extensively tested, and their outcome is therefore uncertain. Furthermore, if third parties bring these proceedings against our patents, we could experience significant costs and management distraction.

In addition to the protection afforded by patents, we rely on trade secret protection and confidentiality agreements to protect proprietary know-how that is not patentable, or that we elect not to patent, processes for which patents are difficult to enforce and any other elements of our AVISE® testing products and development processes that involve proprietary know-how, information or technology that is not covered by patents. However, trade secrets can be difficult to protect. While we use commercially reasonable efforts to protect our trade secrets, our licensors, employees, consultants, contractors and other advisors may unintentionally or willfully disclose such trade secret information to third parties and competitors. We attempt to protect our proprietary technology in large part by entering into confidentiality and non-disclosure agreements with our employees, consultants and other contractors. We cannot assure you, however, that these agreements will not be breached, that we will have adequate remedies for any breach or that competitors will not know of, or independently discover, our trade secrets. We cannot assure you that others will not independently

 

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develop substantially equivalent proprietary information or be issued patents that may prevent the sale of our testing products, technologies, services or know-how or require licensing and the payment of significant fees or royalties by us in order to produce our testing products, technologies or services. Further, we cannot be certain that the steps we have taken will prevent the misappropriation of our trade secrets and other confidential information.

Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate. If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States may be less willing to protect trade secrets. If we are unable to prevent unauthorized material disclosure of our trade secrets and other confidential information to third parties, and in particular in jurisdictions where we have not filed for patent protection, we may not be able to establish or maintain a competitive advantage in our market, which could materially adversely affect our business, operating results and financial condition.

Certain of our testing products utilize unpatented technology that is publicly available and can be used by our competitors.

Certain of our AVISE® testing products, such as AVISE® CTD, utilize both patented technology and publicly available technology that is not protected by patents or other intellectual property rights. We believe that using certain publicly available technology allows us to offer a better and more comprehensive testing product. However, the publicly available technology which we rely upon is also used in, and may continue to be used in, products which compete with our AVISE® testing products. Our competitors may independently develop competing diagnostic products and services that do not infringe our intellectual property.

Changes in U.S. patent law could diminish the value of patents in general, thereby impairing our ability to protect our AVISE® testing products.

Our success is heavily dependent on intellectual property, particularly on obtaining and enforcing patents. Obtaining and enforcing patents in the diagnostics industry involves both technological and legal complexity, and is therefore costly, time-consuming and inherently uncertain. The United States has enacted and is currently implementing wide-ranging patent reform legislation. Recent U.S. Supreme Court rulings have narrowed the scope of patent protection available in certain circumstances and weakened the rights of patent owners in certain situations. In addition to increasing uncertainty with regard to our ability to obtain patents in the future, this combination of events has created uncertainty with respect to the value of patents, once obtained. Depending on decisions by the U.S. Congress, the federal courts and the USPTO, the laws and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce our existing patents and patents that we might obtain in the future. We cannot predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents. We may not develop additional proprietary products, methods and technologies that are patentable.

Some of our intellectual property has been discovered through government funded programs and thus may be subject to federal regulations such as “march-in” rights, certain reporting requirements and a preference for U.S.-based companies. Compliance with such regulations may limit our exclusive rights, and limit our ability to contract with non-U.S. manufacturers.

Some of the intellectual property rights we have acquired or licensed or may acquire or license in the future may have been generated through the use of U.S. government funding and may therefore be subject to certain federal regulations. For example, some of the research and development work related to our CB-CAPs technology was funded by government research grants. As a result, the U.S. government may have certain rights to intellectual property embodied in our testing products pursuant to the Bayh-Dole Act of 1980, or Bayh-Dole Act. These U.S. government rights include a non-exclusive,

 

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non-transferable, irrevocable worldwide license to use inventions for any governmental purpose. In addition, the U.S. government has the right, under certain limited circumstances, to require us to grant exclusive, partially exclusive, or non-exclusive licenses to any of these inventions to a third party if it determines that: (i) adequate steps have not been taken to commercialize the invention; (ii) government action is necessary to meet public health or safety needs; or (iii) government action is necessary to meet requirements for public use under federal regulations (also referred to as “march-in rights”). The U.S. government also has the right to take title to these inventions if the grant recipient fails to disclose the invention to the government or fails to file an application to register the intellectual property within specified time limits. Intellectual property generated under a government funded program is also subject to certain reporting requirements, compliance with which may require us to expend substantial resources. In addition, the U.S. government requires that any products embodying any of these inventions or produced through the use of any of these inventions be manufactured substantially in the United States. This preference for U.S. industry may be waived by the federal agency that provided the funding if the owner or assignee of the intellectual property can show that reasonable but unsuccessful efforts have been made to grant licenses on similar terms to potential licensees that would be likely to manufacture substantially in the United States or that under the circumstances domestic manufacture is not commercially feasible. This preference for U.S. industry may limit our ability to contract with non-U.S. product manufacturers for products covered by such intellectual property. To the extent any of our future intellectual property is also generated through the use of U.S. government funding, the provisions of the Bayh-Dole Act may similarly apply.

We may not be able to protect our intellectual property rights throughout the world.

Filing, prosecuting and defending patents on our AVISE® testing products in all countries throughout the world would be prohibitively expensive. Moreover, we believe that obtaining foreign patents may be more difficult than obtaining domestic patents because of differences in patent laws and, accordingly, our patent position may be stronger in the United States than abroad. In addition, the laws of some foreign countries do not protect intellectual property rights in the same manner and to the same extent as laws in the United States. Various countries limit the subject matter that can be patented and limit the ability of a patent owner to enforce patents in the medical and other related fields. This may limit our ability to obtain or utilize those patents internationally. In order to manage our foreign patent costs and focus on the U.S. market, we made the decision to cease the prosecution and maintenance of certain of our foreign patents and patent applications related to our CB-CAPs technology, which is used in our AVISE® testing products. Consequently, we may not be able to prevent third parties from practicing our inventions in all countries outside the United States. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop their own products and further, may export otherwise infringing products to territories where we have patent protection but enforcement of such patent protection is not as strong as that in the United States. These products may compete with our AVISE® testing products and our patents or other intellectual property rights may not be effective or sufficient to prevent them from competing.

Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favor the enforcement of patents, trade secrets and other intellectual property protection, particularly those relating to biotechnology products, which could make it difficult for us to stop the infringement of our patents or marketing of competing products in violation of our proprietary rights generally. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business, could put our patents at risk of being invalidated or interpreted narrowly, and could provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially meaningful. Accordingly, our efforts to enforce our intellectual property rights around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we develop or license.

 

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The patent protection and patent prosecution for some of our testing products may be dependent on third parties.

We or our licensors may fail to identify patentable aspects of inventions made in the course of development and commercialization activities before it is too late to obtain patent protection on them. Therefore, we may miss potential opportunities to strengthen our patent position. It is possible that defects of form in the preparation or filing of our patents or patent applications may exist, or may arise in the future, for example with respect to proper priority claims, inventorship, claim scope, or requests for patent term adjustments. If we or our licensors, whether current or future, fail to establish, maintain or protect such patents and other intellectual property rights, such rights may be reduced or eliminated. If our licensors are not fully cooperative or disagree with us as to the prosecution, maintenance or enforcement of any patent rights, such patent rights could be compromised. If there are material defects in the form, preparation, prosecution, or enforcement of our patents or patent applications, such patents may be invalid and/or unenforceable, and such applications may never result in valid, enforceable patents. Any of these outcomes could impair our ability to prevent competition from third parties, which may have an adverse impact on our business.

As a licensee of third parties, we rely on third parties to file and prosecute patent applications and maintain patents and otherwise protect the licensed intellectual property under some of our license agreements. We have not had and do not have primary control over these activities for certain of our patents or patent applications and other intellectual property rights. We cannot be certain that such activities by third parties have been or will be conducted in compliance with applicable laws and regulations or will result in valid and enforceable patents or other intellectual property rights. Pursuant to the terms of the license agreements with some of our licensors, the licensors may have the right to control enforcement of our licensed patents or defense of any claims asserting the invalidity of these patents and even if we are permitted to pursue such enforcement or defense, we will require the cooperation of our licensors. We cannot be certain that our licensors will allocate sufficient resources or prioritize their or our enforcement of such patents or defense of such claims to protect our interests in the licensed patents. Even if we are not a party to these legal actions, an adverse outcome could harm our business because it may permit other parties to compete with us If any of our licensors or any of our future licensors or future collaborators fail to appropriately prosecute and maintain patent protection for patents covering any of our testing products, our ability to develop and commercialize those testing products may be adversely affected and we may not be able to prevent competitors from making, using and selling competing products.

In addition, even where we have the right to control patent prosecution of patents and patent applications we have acquired or licensed from third parties, we may still be adversely affected or prejudiced by actions or inactions of our predecessors or licensors and their counsel that took place prior to us assuming control over patent prosecution.

Our technology acquired or licensed from various third parties may be subject to retained rights. Our predecessors or licensors often retain certain rights under their agreements with us, including the right to use the underlying technology for noncommercial academic and research use, to publish general scientific findings from research related to the technology, and to make customary scientific and scholarly disclosures of information relating to the technology. It is difficult to monitor whether our predecessors or licensors limit their use of the technology to these uses, and we could incur substantial expenses to enforce our rights to our licensed technology in the event of misuse.

If we are limited in our ability to utilize acquired or licensed technologies, or if we lose our rights to critical in-licensed technology, we may be unable to successfully develop, out-license, market and sell our testing products, which could adversely affect our business. Our business strategy depends on the successful development of licensed and acquired technologies into commercial products. Therefore,

 

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any limitations on our ability to utilize these technologies may impair our ability to develop, out-license or market and sell our testing products.

If we fail to comply with our obligations in the agreements under which we license intellectual property rights from third parties or otherwise experience disruptions to our business relationships with our licensors, we could lose license rights that are important to our business.

We are a party to a number of license agreements under which we are granted intellectual property rights that are important to our business. For example, certain patent rights related to AVISE® Lupus are licensed from the University of Pittsburgh, certain patent rights related to AVISE® MTX are licensed from Prometheus. Our existing license agreements as related to our AVISE® testing products impose various regulatory and/or commercial diligence obligations, payment of milestones and/or royalties and other obligations. If we fail to comply with our obligations under a license agreement, the license agreement may be terminated, in which event we would not be able to further develop or market certain AVISE® testing products. Additionally, we may not always have the first right to maintain, enforce or defend our licensed intellectual property rights and, although we would likely have the right to assume the maintenance, enforcement and defense of such intellectual property rights if our licensors do not, our ability to do so may be compromised by our licensors’ acts or omissions.

Licensing of intellectual property rights is of critical importance to our business and involves complex legal, business and scientific issues. Disputes may arise between us and our licensors regarding intellectual property rights subject to a license agreement, including the scope of rights granted under the license agreement and other interpretation-related issues, and whether and the extent to which our technology and processes infringe on intellectual property rights of the licensor that are not subject to the licensing agreement. If disputes over intellectual property rights that we have licensed prevent or impair our ability to maintain our current licensing arrangements on acceptable terms, our business, results of operations, financial condition and prospects may be adversely affected. We may enter into additional licenses in the future and if we fail to comply with obligations under those agreements, we could suffer adverse consequences.

Obtaining and maintaining our patent protection depends on compliance with various procedural, document submission, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with these requirements.

The USPTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent process. Periodic maintenance fees, renewal fees, annuity fees and various other governmental fees on any issued patents and/or applications are due to be paid to the USPTO and foreign patent agencies in several stages over the lifetime of the patents and/or applications. Our outside counsel has systems in place to monitor deadlines to pay these fees and to remind us of these fees, and our outside counsel employs an outside firm to pay these fees due to the USPTO and to foreign patent agencies based on our instructions. In the aggregate, these fees can be cost prohibitive for an early-stage company. Accordingly, we made a financially-driven decision to prioritize our payment of these fees and to allow certain of our applications to lapse, particularly with respect to our ex-U.S. rights licensed from the University of Pittsburgh related to our CB-CAPs technology. The permanent lapse of certain of these ex-U.S. rights may result in our patent position being stronger in the United States than abroad, such as in countries that are part of the European Patent Convention, and third parties may be able to compete more effectively against us in countries outside the United States, including in those countries that belong to the European Patent Convention. Additionally, while an inadvertent lapse may sometimes be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or

 

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patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. In such an event, our competitors might be able to enter the market earlier than should otherwise have been the case, which would have a material adverse effect on our business.

We may not be successful in obtaining or maintaining necessary rights to product components and processes for our development pipeline through acquisitions and in-licenses.

Presently we have intellectual property rights, through licenses from third parties and under patents that we own, related to our AVISE® testing products. Because our programs may involve additional products that require the use of proprietary rights held by third parties, the growth of our business will likely depend in part on our ability to acquire, in-license or use these proprietary rights. We may be unable to acquire or in-license proprietary rights that we identify as being necessary for our AVISE® testing products, and our partner may be unable to acquire any necessary rights for our promoted therapeutics. Even if we are able to obtain a license to such proprietary rights, it may be non-exclusive, thereby giving our competitors access to the same technologies licensed to us. In that event, we may be required to expend significant time and resources to develop or license replacement technology.

The licensing and acquisition of third-party proprietary rights is a competitive area, and companies, which may be more established, or have greater resources than we do, may also be pursuing strategies to license or acquire third-party proprietary rights that we may consider necessary or attractive in order to further develop our AVISE® testing products or our partners consider necessary or attractive in order to promote their therapeutic. More established companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities.

In addition, companies that perceive us to be a competitor may be unwilling to assign or license rights to us, either on reasonable terms, or at all. We also may be unable to license or acquire third-party intellectual property rights on terms that would allow us to make an appropriate return on our investment, or at all. If we or our partner are unable to successfully obtain rights to required third-party intellectual property rights on commercially reasonable terms, our ability to further develop our AVISE® testing products and promote therapeutics, and our business, financial condition and prospects for growth could suffer.

Third-party claims alleging intellectual property infringement may prevent or delay our development efforts.

Our commercial success depends in part on our avoiding infringement of the patents and proprietary rights of third parties. There is a substantial amount of litigation, both within and outside the United States, involving patents and other intellectual property rights in the diagnostics industry, as well as administrative proceedings for challenging patents, including interference and reexamination proceedings before the USPTO or oppositions and other comparable proceedings in foreign jurisdictions. The Leahy-Smith America Invents Act introduced new procedures including inter partes review and post grant review. The implementation of these procedures bring the possibility of third party challenges to our patents and the outcome of such challenges could result in a loss or narrowing of our patent rights. In such an event, our competitors might be able to enter the market earlier than should otherwise have been the case, which would have a material adverse effect on our business. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields in which we are developing our AVISE® testing products. As the diagnostics industry expands and more patents are issued, the risk increases that our activities related to our AVISE® testing products may give rise to claims of infringement of the patent rights of others.

We cannot assure you that any of our current or future AVISE® testing products will not infringe existing or future patents. Although we are not aware of any issued patents that will prevent us from

 

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marketing our AVISE® testing products, there may be third-party patents of which we are currently unaware with claims to materials or methods of manufacture related to the use or manufacture of our AVISE® testing products. If a third party that owns such a patent asserts it successfully against one of our current or future AVISE® testing products, we may be unable to market our product, which could materially harm our business and because patent applications can take many years to issue and may be confidential for 18 months or more after filing, there may be currently pending third-party patent applications which may later result in issued patents that our AVISE® testing products or our technologies may infringe, or which such third parties claim are infringed by the use of our technologies.

Parties making claims against us for infringement or misappropriation of their intellectual property rights may seek and obtain injunctive or other equitable relief, which could effectively block our ability to further develop one or more of our AVISE® testing products. Defense of these claims, regardless of their merit, would involve substantial expenses and would be a substantial diversion of employee resources from our business. In the event of a successful claim of infringement against us, we may have to pay substantial damages, including treble damages and attorneys’ fees if we are found to be willfully infringing a third party’s patents, obtain one or more licenses from third parties, pay royalties or redesign our infringing products, which may be impossible or require substantial time and monetary expenditure. We cannot predict whether any such license would be available at all or whether it would be available on commercially reasonable terms. Furthermore, even in the absence of litigation, we may need to obtain licenses from third parties to advance our research or development of our AVISE® testing products. We may fail to obtain any of these licenses at a reasonable cost or on reasonable terms, if at all. In that event, we would be unable to further develop our AVISE® testing products, which could harm our business significantly. Even if we were able to obtain a license, the rights may be nonexclusive, which may give our competitors access to the same intellectual property.

In addition to infringement claims against us, if third parties have prepared and filed patent applications in the United States that also claim technology to which we have rights, we may have to participate in interference proceedings in the USPTO to determine the priority of invention. Third parties may also attempt to initiate reexamination, post grant review or inter partes review of our patents in the USPTO. We may also become involved in similar proceedings in the patent offices in other jurisdictions regarding our intellectual property rights with respect to our AVISE® testing products and technology.

We may be involved in proceedings to protect or enforce our patents or the patents of our licensors, which could be expensive, time-consuming and unsuccessful.

Third parties may infringe, misappropriate or otherwise violate our existing patents, patents that may issue to us in the future, or the patents of our licensors that are licensed to us. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time-consuming. We may not be able to prevent, alone or with our licensors, misappropriation of our intellectual property rights, particularly in countries where the laws may not protect those rights as fully as in the United States.

In addition, if we or one of our licensors initiated legal proceedings against a third party to enforce a patent covering one of our AVISE® testing products, the defendant could counterclaim that the patent covering such AVISE® testing product is invalid and/or unenforceable. In patent litigation in the United States, defendant counterclaims alleging invalidity and/or unenforceability are commonplace, and there are numerous grounds upon which a third party can assert invalidity or unenforceability of a patent. Such proceedings could result in an invalidation of our patents. The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to the validity question, for example, we cannot be certain that there is no invalidating prior art, of which we and the patent examiner were unaware during prosecution. If a defendant were to prevail on a legal assertion of invalidity and/or

 

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unenforceability, we would lose at least part, and perhaps all, of the patent protection on our AVISE® testing products. Such a loss of patent protection could have a material adverse impact on our business.

Litigation proceedings may fail and, even if successful, may result in substantial costs and distract our management and other employees. Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, there could be public announcements of the results of hearings, motions or other interim proceedings or developments. If securities analysts or investors perceive these results to be negative, it could have a substantial adverse effect on the price of our common stock.

Because of the expense and uncertainty of litigation, we may not be in a position to enforce our intellectual property rights against third parties.

Because of the expense and uncertainty of litigation, we may conclude that even if a third party is infringing our patents or other intellectual property rights, the risk-adjusted cost of bringing and enforcing such a claim or action may be too high or not in the best interest of our company or our stockholders. We are not aware of any third party infringement of our intellectual property rights that would have a materially adverse impact on our business. In addition, there can be no assurance that our licensors will be willing to bring and enforce claims to prevent third parties from infringing intellectual property that is licensed to us, particularly if the affected intellectual property is less important to the licensor’s business than to ours. In such cases, we may decide that the more prudent course of action is to simply monitor the situation or initiate or seek some other non-litigious action or solution.

We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed confidential information of third parties.

We have received confidential and proprietary information from third parties. In addition, we employ individuals who were previously employed at other companies in our industry. We may be subject to claims that we or our employees, consultants or independent contractors have inadvertently or otherwise improperly used or disclosed confidential information of these third parties or our employees’ former employers. Further, we may be subject to ownership disputes in the future arising, for example, from conflicting obligations of consultants or others who are involved in developing our AVISE® testing products. We may also be subject to claims that former employees, collaborators or other third parties have an ownership interest in our patents or other intellectual property. Litigation may be necessary to defend against these and other claims challenging our right to and use of confidential and proprietary information. If we fail in defending any such claims, in addition to paying monetary damages, we may lose our rights therein. Such an outcome could have a material adverse effect on our business. Even if we are successful in defending against these claims, litigation could result in substantial cost and be a distraction to our management and employees.

Risks Related to this Offering and Our Common Stock

An active, liquid and orderly market for our common stock may not develop, and you may not be able to resell your common stock at or above the public offering price. Our stock price may be volatile, and you may not be able to sell shares of our common stock at or above the price you paid.

Prior to this offering, there has been no public market for our common stock, and an active public market for our stock may not develop or be sustained after this offering. We and the representatives of the underwriters will determine the initial public offering price of our common stock through negotiation. This price will not necessarily reflect the price at which investors in the market will be willing to buy and

 

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sell our stock following this offering. In addition, the trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:

 

   

actual or anticipated variations in our and our competitors’ financial condition and results of operations;

 

   

announcements by us or our competitors of new products, strategic partnerships or capital commitments;

 

   

changes in reimbursement by current or potential third-party payers;

 

   

issuance of new securities analysts’ reports or changed recommendations for our stock;

 

   

actual or anticipated changes in regulatory oversight of our testing products;

 

   

developments or disputes concerning our intellectual property or other proprietary rights;

 

   

commencement of, or our involvement in, litigation;

 

   

announced or completed acquisitions of businesses or technologies by us or our competitors;

 

   

any major change in our management;

 

   

changes in accounting principles;

 

   

announcement or expectation of additional financing efforts;

 

   

future sales of our common stock by our executive officers, directors and other stockholders; and

 

   

general economic conditions and slow or negative growth of our markets.

In addition, the stock market in general, and the market for stock of life sciences companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Broad market and industry factors, as well as general economic, political and market conditions such as recessions or interest rate changes, may seriously affect the market price of our common stock, regardless of our actual operating performance. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. If the market price of our common stock after this offering does not exceed the initial public offering price, you may not realize any return on your investment in us and may lose some or all of your investment.

In addition, in the past, following periods of volatility in the overall market and the market price of a particular company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources. Any adverse determination in any such litigation or any amounts paid to settle any such actual or threatened litigation could require that we make significant payments.

Our failure to meet the continued listing requirements of the Nasdaq Global Market, or Nasdaq, could result in a delisting of our common stock.

If, after listing, we fail to satisfy the continued listing requirements of Nasdaq, such as the corporate governance requirements or the minimum closing bid price requirement, Nasdaq may take steps to delist our common stock. Such a delisting would likely have a negative effect on the price of our common stock and would impair your ability to sell or purchase our common stock when you wish to do so. In the event of a delisting, we can provide no assurance that any action taken by us to restore compliance with listing requirements would allow our common stock to become listed again, stabilize the market price or improve the liquidity of our common stock, prevent our common stock from dropping below the Nasdaq minimum bid price requirement or prevent future non-compliance with Nasdaq’s listing requirements.

 

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If securities or industry analysts issue an adverse opinion regarding our stock or do not publish research or reports about our company, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that equity research analysts publish about us and our business. Currently, we do not have any analyst coverage and we may not obtain analyst coverage in the future. In the event we obtain analyst coverage, we would not have any control over such analysts or the content and opinions included in their reports. Securities analysts may elect not to provide research coverage of our company after the completion of this offering, and such lack of research coverage may adversely affect the market price of our common stock. The price of our common stock could also decline if one or more equity research analysts downgrade our common stock or if those analysts issue other unfavorable commentary or cease publishing reports about us or our business. If one or more equity research analysts cease coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline.

Future sales of shares by existing stockholders could cause our stock price to decline.

If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline. Based on the number of shares of common stock outstanding as of June 30, 2019, upon the completion of this offering, we will have outstanding a total of                  shares of common stock, assuming the expected net exercise of the 2013 Warrants, no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options or warrants (other than the 2013 Warrants). Of these shares,                will be freely tradable, without restriction, in the public market immediately after the offering. Each of our directors and officers and substantially all of our other stockholders has entered into a lock-up agreement with the underwriters described in “Underwriting” elsewhere in this prospectus, which restricts their ability to sell or transfer their shares. The lock-up agreements pertaining to this offering will expire 180 days from the date of this prospectus. The underwriters, however, may, in their sole discretion, waive the contractual lock-up prior to the expiration of the lock-up agreements. After the lock-up agreements expire, based on shares outstanding as of June 30, 2019, up to an additional                  shares of common stock will be eligible for sale in the public market, of which                  shares are held by directors, executive officers and other affiliates and will be subject to volume limitations under Rule 144 under the Securities Act.

In addition,                  shares of common stock that are subject to outstanding options as of June 30, 2019 will become eligible for sale in the public market to the extent permitted by the provisions of various option agreements, the lock-up agreements and Rules 144 and 701 under the Securities Act. We intend to file a registration statement on Form S-8 under the Securities Act covering all of the shares of common stock subject to options outstanding and reserved for issuance under our employee benefit plans. This registration statement will become effective immediately upon filing, and shares covered by this registration statement will be eligible for sale in the public markets, subject to Rule 144 limitations applicable to affiliates, the terms of the applicable plan and the option agreements entered into with option holders, and any lock-up agreements described above. In addition, our directors and executive officers may establish programmed selling plans under Rule 10b5-1 of the Exchange Act for the purpose of effecting sales of our common stock. Any sales of securities by these stockholders, or the perception that those sales may occur, including the entry into such programmed selling plans, could have a material adverse effect on the trading price of our common stock.

In addition, the holders of                  shares of common stock and holders of warrants to purchase an aggregate of                  shares of common stock will be entitled to rights with respect to registration of such shares under the Securities Act pursuant to an investors’ rights agreement between such

 

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holders and us. See “Certain Relationships and Related Person Transactions—Investors’ Rights Agreement” below. If such holders, by exercising their registration rights, sell a large number of shares, they could adversely affect the market price for our common stock. If we file a registration statement for the purpose of selling additional shares to raise capital and are required to include shares held by these holders pursuant to the exercise of their registration rights, our ability to raise capital may be impaired.

We are an emerging growth company and a smaller reporting company, and the reduced disclosure requirements applicable to emerging growth companies and smaller reporting companies may make our common stock less attractive to investors.

We are an emerging growth company, as defined in the JOBS Act, and may remain an emerging growth company until the last day of the fiscal year following the fifth anniversary of the completion of this offering. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenue exceeds $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period. For so long as we remain an emerging growth company, we are permitted and intend to rely on exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. These exemptions include:

 

   

being permitted to provide only two years of audited financial statements, in addition to any required unaudited interim financial statements, with correspondingly reduced “Management’s discussion and analysis of financial condition and results of operations” disclosure;

 

   

not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting;

 

   

not being required to comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements;

 

   

reduced disclosure obligations regarding executive compensation; and

 

   

exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved.

We have taken advantage of reduced reporting burdens in this prospectus. In particular, in this prospectus, we have provided only two years of audited financial statements and have not included all of the executive compensation related information that would be required if we were not an emerging growth company. We cannot predict whether investors will find our common stock less attractive if we rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be reduced or more volatile. In addition, the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of these accounting standards until they would otherwise apply to private companies. We have elected to avail ourselves of this exemption and, therefore, we may not be subject to the same implementation timing for new or revised accounting standards as other public companies that are not emerging growth companies, which may make comparison of our financials to those of other public companies more difficult.

We are also a “smaller reporting company” as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an emerging growth company. We may take advantage of certain of the scaled disclosures available to smaller reporting companies and will be

 

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able to take advantage of these scaled disclosures for so long as our voting and non-voting common stock held by non-affiliates is less than $250.0 million measured on the last business day of our second fiscal quarter, or our annual revenue is less than $100.0 million during the most recently completed fiscal year and our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.

We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will be subject to the reporting requirements of the Exchange Act, which will require, among other things, that we file with the SEC annual, quarterly and current reports with respect to our business and financial condition. In addition, Sarbanes-Oxley, as well as rules subsequently adopted by the Securities and Exchange Commission, or the SEC, and Nasdaq to implement provisions of Sarbanes-Oxley, impose significant requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Further, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC has adopted additional rules and regulations in these areas, such as mandatory “say on pay” voting requirements that will apply to us when we cease to be an emerging growth company. Stockholder activism, the current political environment and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact the manner in which we operate our business in ways we cannot currently anticipate.

We expect the rules and regulations applicable to public companies to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly. If these requirements divert the attention of our management and personnel from other business concerns, they could have a material adverse effect on our business, financial condition and results of operations. The increased costs will decrease our net income or increase our net loss, and may require us to reduce costs in other areas of our business or increase the prices of our testing products or services. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain the same or similar coverage. We cannot predict or estimate the amount or timing of additional costs we may incur to respond to these requirements. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.

If we fail to maintain proper and effective internal control over financial reporting, our ability to produce accurate and timely financial statements could be impaired, investors may lose confidence in our financial reporting and the trading price of our common stock may decline.

Pursuant to Section 404 of Sarbanes-Oxley, our management will be required to report upon the effectiveness of our internal control over financial reporting beginning with the annual report for our fiscal year ending December 31, 2020. When we lose our status as an “emerging growth company” and reach an accelerated filer threshold, our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting. The rules governing the standards that must be met for management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. To comply with the requirements of being a reporting company under the Exchange Act, we will need to upgrade our information technology systems; implement additional financial and management controls, reporting systems and procedures; and hire additional accounting and finance staff. If we or, if required, our auditors are unable to conclude that our internal control over financial reporting is effective, investors may lose confidence in our financial reporting and the trading price of our common stock may decline.

 

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We cannot assure you that there will not be material weaknesses or significant deficiencies in our internal control over financial reporting in the future. Any failure to maintain internal control over financial reporting could severely inhibit our ability to accurately report our financial condition, results of operations or cash flows. If we are unable to conclude that our internal control over financial reporting is effective, or if our independent registered public accounting firm determines we have a material weakness or significant deficiency in our internal control over financial reporting once that firm begin its Section 404 reviews, investors may lose confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline, and we could be subject to sanctions or investigations by Nasdaq, the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, could also restrict our future access to the capital markets.

Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable and may lead to entrenchment of management.

Our amended and restated certificate of incorporation and amended and restated bylaws that will be in effect immediately prior to the consummation of this offering will contain provisions that could significantly reduce the value of our shares to a potential acquiror or delay or prevent changes in control or changes in our management without the consent of our board of directors. The provisions in our charter documents will include the following:

 

   

a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

 

   

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

   

the exclusive right of our board of directors, unless the board of directors grants such right to the stockholders, to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

 

   

the required approval of at least 66-2/3% of the shares entitled to vote to remove a director for cause, and the prohibition on removal of directors without cause;

 

   

the ability of our board of directors to authorize the issuance of shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;

 

   

the ability of our board of directors to alter our amended and restated bylaws without obtaining stockholder approval;

 

   

the required approval of at least 66-2/3% of the shares entitled to vote to adopt, amend or repeal our amended and restated bylaws or repeal the provisions of our amended and restated certificate of incorporation regarding the election and removal of directors;

 

   

a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

   

an exclusive forum provision providing that the Court of Chancery of the State of Delaware will be the exclusive forum for certain actions and proceedings;

 

   

the requirement that a special meeting of stockholders may be called only by the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; and

 

   

advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

 

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We are also subject to the anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Section 203, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other exceptions, the board of directors has approved the transaction.

Our amended and restated certificate of incorporation and amended and restated bylaws will provide that the Court of Chancery of the State of Delaware will be the exclusive forum for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.

Our amended and restated certificate of incorporation and amended and restated bylaws will provide that the Court of Chancery of the State of Delaware is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a breach of fiduciary duty, any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our amended and restated certificate of incorporation or our amended and restated bylaws, or any action asserting a claim against us that is governed by the internal affairs doctrine; provided, that, this provision would not apply to suits brought to enforce a duty or liability created by Securities Act or the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction. To the extent that any such claims may be based upon federal law claims, Section 27 of the Exchange Act creates exclusive federal jurisdiction over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all suits brought to enforce any duty or liability created by the Securities Act or the rules and regulations thereunder. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits against us and our directors, officers and other employees. By agreeing to this provision, however, the stockholders will not be deemed to have waived our compliance with the Federal Securities laws and rules and regulations thereunder. Furthermore, the enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that a court could find these types of provisions to be inapplicable or unenforceable. If a court were to find the choice of forum provisions in our amended and restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.

We have broad discretion to use the net proceeds from this offering and our investment of these proceeds may not yield a favorable return. We may allocate the net proceeds from this offering in ways that you and other stockholders may not approve.

Our management will have broad discretion in the application of the net proceeds from this offering, including for any of the purposes described in the section titled “Use of Proceeds.” Because of the number and variability of factors that will determine our use of the net proceeds from this offering, their ultimate use may vary substantially from their currently intended use. Our management might not apply our net proceeds in ways that ultimately increase the value of your investment, and the failure by our management to apply these funds effectively could harm our business. We may also use a portion of the net proceeds of this offering for acquisitions to bolster our product offerings. We have not entered into any agreements or commitments with respect to any specific acquisitions and have no understandings or agreements with respect to any such acquisition or investment at this time. Pending their use, we may invest the net proceeds from this offering in short- and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government. These investments may not yield a favorable return to our stockholders. If we do not invest or apply the net proceeds from this offering in ways that enhance stockholder value, we may fail to achieve expected results, which could cause our stock price to decline.

 

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Purchasers in this offering will experience immediate and substantial dilution in the book value of their investment.

The initial public offering price of our common stock is substantially higher than the net tangible book value per share of our common stock immediately after this offering. Therefore, if you purchase our common stock in this offering, you will incur immediate dilution of $        in the net tangible book value per share from the price you paid, based on the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus. In addition, new investors who purchase shares in this offering will contribute approximately     % of the total amount of equity capital raised by us through the date of this offering, but will only own approximately     % of the outstanding equity capital. The exercise of outstanding options and warrants will result in further dilution. In addition, if we raise additional funds by issuing equity securities, our stockholders may experience further dilution. For a detailed description of the dilution that you will experience immediately after this offering, see “Dilution.”

After this offering, our executive officers, directors and principal stockholders, if they choose to act together, will continue to have the ability to control or significantly influence all matters submitted to stockholders for approval.

Following the completion of this offering, our executive officers, directors and greater than 5% stockholders, in the aggregate, will own approximately     % of our outstanding common stock (assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options). As a result, such persons, acting together, will have the ability to control or significantly influence all matters submitted to our stockholders for approval, including the election and removal of directors and approval of any significant transaction, as well as our management and business affairs. This concentration of ownership may have the effect of delaying, deferring or preventing a change in control, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquiror from making a tender offer or otherwise attempting to obtain control of our business, even if such a transaction would benefit other stockholders.

We have never paid dividends on our capital stock, and we do not anticipate paying dividends in the foreseeable future. Your ability to achieve a return on your investment will depend on appreciation, if any, in the price of our common stock.

We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. We currently intend to retain any future earnings to fund the growth of our business. In addition, our loan agreement restricts our ability to pay cash dividends on our common stock and we may also enter into credit agreements or other borrowing arrangements in the future that will restrict our ability to declare or pay cash dividends on our common stock. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions and other factors that our board of directors may deem relevant. As a result, capital appreciation, if any, of our common stock will be the sole source of gain for the foreseeable future.

If an active, liquid trading market for our common stock does not develop, you may not be able to sell your shares quickly or at or above the initial offering price.

There has not been a public market for our common stock. An active and liquid trading market for our common stock may not develop or be sustained following this offering. The lack of an active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. The lack of an active market may also reduce the fair market value of your shares. An inactive market may also impair our ability to raise capital to continue to fund operations by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration. You may not be able to sell your shares quickly or at or above the initial

 

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offering price. The initial public offering price will be determined by negotiations with the representatives of the underwriters. This price may not be indicative of the price at which our common stock will trade after this offering, and our common stock could trade below the initial public offering price.

We could be subject to securities class action litigation.

In the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities. This risk is especially relevant for us because pharmaceutical companies have experienced significant stock price volatility in recent years. If we face such litigation, it could result in substantial costs and a diversion of management’s attention and resources, which could harm our business.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. All statements other than statements of historical facts contained in this prospectus, including statements regarding our future results of operations and financial position, business strategy, current and future product offerings, reimbursement and coverage, our ability to implement an integrated testing with therapeutics strategy, the expected benefits from our partnership or promotion arrangements with third parties, research and development costs, timing and likelihood of success and plans and objectives of management for future operations, are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this prospectus are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this prospectus and are subject to a number of risks, uncertainties and assumptions described under the sections in this prospectus entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this prospectus. Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified and some of which are beyond our control, you should not rely on these forward-looking statements as predictions of future events. The events and circumstances reflected in our forward-looking statements may not be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. Moreover, we operate in an evolving environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties. Except as required by applicable law, we undertake no obligation to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise. The forward-looking statements contained in this prospectus are excluded from the safe harbor protection provided by the Private Securities Litigation Reform Act of 1995 and Section 27A of the Securities Act. You should, however, review the factors and risks we describe in the reports we will file from time to time with the SEC after the date of this prospectus. See “Where You Can Find More Information.”

In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this prospectus, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and you are cautioned not to rely unduly upon these statements.

 

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MARKET AND INDUSTRY DATA

We obtained the industry, market and competitive position data used throughout this prospectus from our own internal estimates and research, as well as from independent market research, industry and general publications and surveys, governmental agencies and publicly available information in addition to research, surveys and studies conducted by third parties. Internal estimates are derived from publicly available information released by industry analysts and third-party sources, our internal research and our industry experience, and are based on assumptions made by us based on such data and our knowledge of our industry and market, which we believe to be reasonable. In some cases, we do not expressly refer to the sources from which this data is derived. In that regard, when we refer to one or more sources of this type of data in any paragraph, you should assume that other data of this type appearing in the same paragraph is derived from the same sources, unless otherwise expressly stated or the context otherwise requires. In addition, while we believe the industry, market and competitive position data included in this prospectus is reliable and based on reasonable assumptions, such data involves risks and uncertainties and is subject to change based on various factors, including those discussed in “Risk Factors.” These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties or by us.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the common stock that we are offering will be approximately $        million (or $        million if the underwriters exercise their option to purchase additional shares in full), assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share would increase (decrease) the net proceeds to us from this offering by approximately $        million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million in the number of shares offered by us at the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, by approximately $        million.

The principal purposes of this offering are to obtain additional capital to support our operations, to create a public market for our common stock and to facilitate our future access to the public equity markets.

We currently intend to use the net proceeds from this offering as follows:

 

   

approximately $         million for selling and marketing activities;

 

   

approximately $         million for research and development activities, including continued expansion of our AVISE® product portfolio, as well as clinical studies to demonstrate the utility of our AVISE® products and support reimbursement efforts; and

 

   

the remainder for working capital purposes and other general corporate purposes.

We may also use a portion of the net proceeds and our existing cash and cash equivalents, to in-license, acquire, or invest in complementary businesses, technologies, products or assets. However, we have no current commitments or obligations to do so.

We believe, based on our current operating plan, that the net proceeds from this offering and our existing cash and cash equivalents and anticipated future product revenue, will be sufficient to fund our operations for at least the next 12 months, although there can be no assurance in that regard. The amounts and timing of our actual expenditures will depend on numerous factors, including the timing and amount of our cash receipts from the sale of our testing products and promotion of SIMPONI®, the development efforts for our testing products and other factors described under “Risk Factors” in this prospectus, as well as the amount of cash used in our operations. For example, if our research and development of new testing products requires more time or resources than we currently anticipate or if we are required to conduct additional studies to help secure reimbursement for our testing products, we may allocate additional proceeds of this offering to our research and development efforts. If our research and development efforts progress faster than we currently expect, or if our sales and marketing needs expand faster than we currently expect, we may elect to reallocate a portion of the proceeds of this offering from research and development to sales and marketing activities to support our integrated promotion of testing products and therapeutics strategy. Therefore, our actual expenditures may differ materially from the estimates described above. We may find it necessary or advisable to use the net proceeds for other purposes, and we will have broad discretion in the application of the net proceeds.

Pending the uses described above, we plan to invest the net proceeds from this offering in short- and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

 

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DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We intend to retain future earnings, if any, to finance the operation of our business and do not anticipate paying any cash dividends in the foreseeable future. Any future determination related to dividend policy will be made at the discretion of our board of directors after considering our financial condition, results of operations, capital requirements, business prospects and other factors the board of directors deems relevant, and subject to the restrictions contained in any future financing instruments. In addition, our ability to pay cash dividends is currently prohibited by the terms of our loan agreement.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents, and our capitalization as of June 30, 2019 as follows:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect (i) the issuance of 479,967,595 shares of our Series H redeemable convertible preferred stock in July 2019 and the receipt of $11.0 million in gross proceeds therefrom (including the conversion of 148,928,337 shares of our Series G redeemable convertible preferred stock into 246,521,076 shares of our Series H redeemable convertible preferred stock in July 2019), (ii) the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 1,435,411,648 shares of our common stock (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019) and the resultant reclassification of (A) the carrying value of the redeemable convertible preferred stock to permanent equity and (B) our redeemable convertible preferred stock warrant liabilities to additional paid-in capital, a component of stockholder’s equity (deficit), in connection with such conversion, all of which will occur in connection with the completion of this offering, (iii) the issuance of              shares of our common stock as a result of the expected net exercise of the 2013 Warrants in connection with the completion of this offering, assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, which 2013 Warrants will terminate if not exercised prior to the completion of this offering and (iv) the filing and effectiveness of our amended and restated certificate of incorporation immediately prior to the completion of this offering; and

 

   

on a pro forma as adjusted basis to give further effect to the issuance and sale of                  shares of our common stock in this offering at the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

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The pro forma and pro forma as adjusted information below is illustrative only, and our capitalization following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this information in conjunction with our audited financial statements and the related notes included elsewhere in this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other financial information contained in this prospectus.

 

    As of June 30, 2019  
    Actual         Pro Forma          Pro Forma As
Adjusted(1)
 
    (unaudited, in thousands, except share data)  

Cash and cash equivalents

  $ 16,237     $                    $                
 

 

 

   

 

 

    

 

 

 

Redeemable convertible preferred stock warrant liabilities

  $ 1,036     $        $    

Borrowings, including current portion, net of discounts and debt issuance costs

    25,331       

Capital lease obligations, including current portion

    602       

Redeemable convertible preferred stock, $0.001 par value per share; 955,500,000 shares authorized; 681,534,421 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    121,026       

Stockholders’ equity (deficit):

      

Preferred stock, $0.001 par value per share; no shares authorized, issued or outstanding, actual; 10,000,000 shares authorized and no shares issued or outstanding, pro forma and pro forma as adjusted

          

Common stock, $0.001 par value per share; 1,675,200,000 shares authorized; 11,587,295 shares issued and outstanding, actual; 200,000,000 shares authorized, pro forma and pro forma as adjusted;              shares issued and outstanding, pro forma;              shares issued and outstanding, pro forma as adjusted

    12       

Additional paid-in capital

    36,307       

Accumulated deficit

    (158,053     
 

 

 

   

 

 

    

 

 

 

Total stockholders’ equity (deficit)

    (121,734     
 

 

 

   

 

 

    

 

 

 

Total capitalization

  $ 26,261     $        $    
 

 

 

   

 

 

    

 

 

 

 

(1)

Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, total stockholders’ equity (deficit) and total capitalization by approximately $        , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million in the number of shares offered by us at the assumed initial public offering price per share would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, total stockholders’ equity (deficit) and total capitalization by approximately $        , after deducting the estimated underwriting discounts and commissions and the estimated offering expenses payable by us.

The number of shares in the table above excludes:

 

   

121,756,380 shares of our common stock issuable upon exercise of stock options outstanding as of June 30, 2019, with a weighted-average exercise price of $0.01 per share;

 

   

149,097,864 shares of our common stock issuable upon the exercise of stock options to be granted under our 2019 Plan, contingent and effective upon the effectiveness of the

 

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registration statement of which this prospectus forms a part, with an exercise price that is equal to the initial public offering price;

 

   

             shares of our common stock issuable upon the exercise of outstanding warrants (which number does not include the 2013 Warrants) as of June 30, 2019, with a weighted-average exercise price of $        per share;

 

   

             shares of our common stock reserved for future issuance under our 2019 Plan, which will become effective in connection with the completion of this offering (which number includes              shares remaining available for issuance under our 2013 Plan, which will become available for issuance under the 2019 Plan upon its effectiveness, but does not include any potential annual evergreen increases pursuant to the terms of the 2019 Plan); and

 

   

             shares of our common stock reserved for future issuance under our ESPP, which will become effective in connection with the completion of this offering (which number does not include any potential annual evergreen increases pursuant to the terms of the ESPP).

 

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DILUTION

If you invest in our common stock in this offering, your ownership interest will be immediately diluted to the extent of the difference between the assumed initial public offering price per share and the pro forma as adjusted net tangible book value per share of our common stock after this offering.

As of June 30, 2019, we had a historical net tangible book deficit of $(127.2) million, or $(10.98) per share of common stock based on 11,587,295 shares of common stock outstanding as of such date. Our historical net tangible book deficit per share represents total tangible assets less total liabilities and redeemable convertible preferred stock, divided by the number of shares of common stock outstanding at June 30, 2019.

On a pro forma basis after giving effect to (i) the issuance of 479,967,595 shares of our Series H redeemable convertible preferred stock in July 2019 and the receipt of $11.0 million in gross proceeds therefrom (including the conversion of 148,928,337 shares of our Series G redeemable convertible preferred stock into 246,521,076 shares of our Series H redeemable convertible preferred stock in July 2019), (ii) the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 1,435,411,648 shares of our common stock, (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019), and the resultant reclassification of (A) the carrying value of the redeemable convertible preferred stock to permanent equity and (B) our redeemable convertible preferred stock warrant liabilities to additional paid-in capital, a component of stockholders’ equity (deficit), in connection with such conversion, all of which will occur in connection with the completion of this offering, and (iii) the issuance of              shares of our common stock as a result of the expected net exercise of the 2013 Warrants in connection with the completion of this offering, assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, which 2013 Warrants will terminate if not exercised prior to the completion of this offering, our pro forma net tangible book value (deficit) as of June 30, 2019 would have been approximately $         million, or approximately $        per share of common stock.

After giving further effect to the issuance and sale of              shares of our common stock that we are offering at the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of June 30, 2019 would have been approximately $        million, or approximately $        per share. This amount represents an immediate increase in pro forma net tangible book value of approximately $        per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of approximately $        per share to new investors purchasing shares of common stock in this offering.

 

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Dilution per share to new investors is determined by subtracting pro forma as adjusted net tangible book value per share after this offering from assumed initial public offering price per share paid by new investors. The following table illustrates this dilution:

 

Assumed initial public offering price per share

    $                

Historical net tangible book deficit per share as of June 30, 2019

  $ (10.98  

Pro forma increase in historical net tangible book value per share attributable to the pro forma transactions described above

   
 

 

 

   

Pro forma net tangible book value per share as of June 30, 2019

   

Increase in pro forma net tangible book value per share attributable to this offering

   
 

 

 

   

Pro forma as adjusted net tangible book value per share after this offering

   
   

 

 

 

Dilution per share to new investors in this offering

    $    
   

 

 

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the pro forma as adjusted net tangible book value per share after this offering by approximately $        , and dilution in pro forma net tangible book value per share to new investors by approximately $        , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and the estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million in the number of shares offered by us at the assumed initial public offering price would increase (decrease) our pro forma as adjusted net tangible book value per share after this offering by approximately $         and decrease (increase) the dilution to investors participating in this offering by approximately $        per share, after deducting the estimated underwriting discounts and commissions and the estimated offering expenses payable by us.

If the underwriters exercise their option to purchase additional shares in full in this offering, the pro forma as adjusted net tangible book value after the offering would be approximately $        per share, the increase in pro forma net tangible book value per share to existing stockholders would be approximately $        per share and the dilution per share to new investors would be approximately $        per share, in each case assuming an initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus.

The following table summarizes on the pro forma as adjusted basis described above, as of June 30, 2019, the differences between the number of shares purchased from us, the total consideration paid to us in cash and the weighted-average price per share paid by existing stockholders for shares issued prior to this offering and the price to be paid by new investors in this offering. The calculations below are based on the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of the prospectus, before deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

    Shares Purchased     Total Consideration     Weighted-
Average
Price

Per Share
 
    Number      Percent     Amount      Percent  

Existing stockholders before this offering

                               $                             $                

New investors participating in this offering

            $                
 

 

 

    

 

 

   

 

 

    

 

 

   

Total

       100   $                      100  
 

 

 

    

 

 

   

 

 

    

 

 

   

 

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The foregoing tables and calculations (other than the historical net tangible book value calculation) are based on              shares of our common stock outstanding as of June 30, 2019, after giving effect to the automatic conversion of all outstanding shares of our redeemable convertible preferred stock into 1,435,411,648 shares of our common stock (including the conversion of 479,967,595 shares of our Series H redeemable convertible preferred stock issued in July 2019) and the issuance of              shares of our common stock as a result of the expected net exercise of the 2013 Warrants in connection with the completion of this offering, assuming an initial public offering price of $         per share, the midpoint of the price range set forth on the cover page of this prospectus, which 2013 Warrants will terminate if not exercised prior to the completion of this offering, and excludes:

 

   

121,756,380 shares of our common stock issuable upon exercise of stock options outstanding as of June 30, 2019, with a weighted-average exercise price of $0.01 per share;

 

   

149,097,864 shares of our common stock issuable upon the exercise of stock options to be granted under our 2019 Plan, contingent and effective upon the effectiveness of the registration statement of which this prospectus forms a part, with an exercise price that is equal to the initial public offering price;

 

   

             shares of our common stock issuable upon the exercise of outstanding warrants (which number does not include the 2013 Warrants) as of June 30, 2019, with a weighted-average exercise price of $        per share;

   

             shares of our common stock reserved for future issuance under our 2019 Plan, which will become effective in connection with the completion of this offering (which number includes              shares remaining available for issuance under our 2013 Plan, which will become available for issuance under the 2019 Plan upon its effectiveness, but does not include any potential annual evergreen increases pursuant to the terms of the 2019 Plan); and

 

   

             shares of our common stock reserved for future issuance under our ESPP, which will become effective in connection with the completion of this offering (which number does not include any potential annual evergreen increases pursuant to the terms of the ESPP).

To the extent any outstanding options or warrants are exercised, there will be further dilution to new investors. If all of such outstanding options and warrants had been exercised as of June 30, 2019, the pro forma as adjusted net tangible book value per share after this offering would be $        , and total dilution per share to new investors would be $        .

If the underwriters exercise their option to purchase additional shares of our common stock in full:

 

   

the percentage of shares of common stock held by existing stockholders will decrease to approximately     % of the total number of shares of our common stock outstanding after this offering; and

 

   

the number of shares held by new investors will increase to             , or approximately     % of the total number of shares of our common stock outstanding after this offering.

 

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SELECTED FINANCIAL DATA

The following tables set forth our selected historical financial data as of, and for the periods ended on, the dates indicated. We have derived the selected statements of operations data for the years ended December 31, 2017 and 2018 and the balance sheet data as of December 31, 2017 and 2018 from our audited financial statements included elsewhere in this prospectus. The statements of operations data for the six months ended June 30, 2018 and 2019 and the balance sheet data as of June 30, 2019 have been derived from our unaudited financial statements included elsewhere in this prospectus. You should read this data together with our audited financial statements and the related notes included elsewhere in this prospectus and the section of this prospectus entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results for any prior period are not necessarily indicative of our future results.

 

    Years Ended December 31,     Six Months Ended
June 30,
 
    2017     2018(1)(3)     2018(1)     2019  
(in thousands, except share and per share data)         (As Revised)     (Unaudited)  

Statements of Operations Data:

       

Revenue

  $ 26,807     $ 32,440     $ 14,576     $ 19,734  

Operating expenses:

       

Costs of revenue (excluding amortization of purchased technology)

    14,137       15,379       7,524       9,434  

Selling, general and administrative expenses

    18,820       19,675       9,487       13,481  

Research and development expenses

    1,551     2,125       1,067       1,103  

Amortization of intangible assets

    186     141       94        

Change in fair value of acquisition-related liabilities

    (51                  
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    34,643     37,320       18,172       24,018  
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

    (7,836     (4,880     (3,596     (4,284

Interest expense

    (2,948     (2,868     (1,394     (1,811

Loss on extinguishment of share purchase rights and 2013 Term Loan

    (6,050                  

Change in fair value of financial instruments

    (9,391     (318           467  

Other income, net

    45     112       51       139  
 

 

 

   

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (26,180     (7,954     (4,939     (5,489

Income tax (benefit) expense

    (549 )     58              
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

    (25,631     (8,012     (4,939     (5,489

Accretion of redeemable convertible preferred stock

    (5,353     (9,318     (3,694     (4,302

Deemed dividend recorded in connection with financing transactions

    (1,790     (1,152     (1,152      
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss attributable to common stockholders

  $ (32,774   $ (18,482   $ (9,785   $ (9,791
 

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted(2)

  $ (2.83   $ (1.60   $ (0.85   $ (0.85
 

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average number of shares used to compute net loss per share attributable to common stockholders, basic and diluted(2)

    11,577,921       11,577,921       11,577,921       11,583,144  
 

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(2)

    $         $    
   

 

 

     

 

 

 

Pro forma weighted-average number of shares used to compute pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(2)

       
   

 

 

     

 

 

 

 

(1)

We adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as of January 1, 2018. See Note 3 to our audited financial statements included elsewhere in this prospectus for further discussion.

 

(2)

See Note 2 to our audited financial statements included elsewhere in this prospectus for an explanation of the method used to calculate the historical net loss and the historical and pro forma net loss per share attributable to common stockholders, basic and diluted, and the number of shares used in the computation of these per share amounts.

 

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(3)

See Note 16 to our audited financial statements included elsewhere in this prospectus for a summary of the amounts and financial statement line items impacted by the revision.

 

    December 31,     June 30,
2019
 
        2017         2018(1)(3)  
(in thousands)         (As Revised)     (Unaudited)  

Balance Sheet Data:

   

Cash and cash equivalents

  $ 11,241     $ 13,164     $ 16,237  

Working capital(2)

    8,270     12,360       18,210  

Total assets

    20,390     28,887       33,088  

Borrowings, non-current portion, net of discounts and debt issuance costs

    18,809     24,617       25,331  

Capital lease obligations, including current portion

    108       360       602  

Redeemable convertible preferred stock warrant liabilities

    896     1,503       1,036  

Redeemable convertible preferred stock

    92,046     105,232       121,026  

Total stockholders’ deficit

    (96,684     (111,966     (121,734

 

(1)

We adopted ASU 2014-09, Revenue from Contracts with Customers (Topic 606), as of January 1, 2018. See Note 3 to our audited financial statements included elsewhere in this prospectus for further discussion.

 

(2)

We define working capital as current assets less current liabilities. See our audited financial statements and the related notes included elsewhere in this prospectus for further details regarding our current assets and current liabilities.

 

(3)

See Note 16 to our audited financial statements included elsewhere in this prospectus for a summary of the amounts and financial statement line items impacted by the revision.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our audited financial statements and the related notes and other financial information included elsewhere in this prospectus. Some of the information contained in this discussion and analysis or set forth elsewhere in this prospectus, including information with respect to our plans and strategy for our business and future financial performance, includes forward-looking statements that are based on current beliefs, plans and expectations and involve risks, uncertainties and assumptions. You should review the “Risk Factors” section of this prospectus for a discussion of important factors that could cause our actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Please also see the section of this prospectus entitled “Special Note Regarding Forward-Looking Statements.”

Overview

We are dedicated to transforming the care continuum for patients suffering from debilitating and chronic autoimmune diseases by enabling timely differential diagnosis and optimizing therapeutic intervention. We have developed and are commercializing a portfolio of innovative testing products under our AVISE® brand, several of which are based on our proprietary CB-CAPs technology. Our goal is to enable rheumatologists to improve care for patients through the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases, including SLE and RA. Our strategy includes leveraging our portfolio of testing products to market therapeutics through our sales channel, targeting the approximately 5,000 rheumatologists across the United States. Our business model of integrating testing products and therapeutics positions us to offer targeted solutions to rheumatologists and, ultimately, better serve patients.

We currently market nine testing products under our AVISE® brand that allow for the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases. Our lead testing product, AVISE® CTD, enables differential diagnosis for patients presenting with symptoms indicative of a wide variety of CTDs and other related diseases with overlapping symptoms. We commercially launched AVISE® CTD in 2012 and revenue from this product comprised 82% of our revenue in the year ended December 31, 2018 and 83% of our revenue for the six months ended June 30, 2019. There is an unmet need for rheumatologists to add clarity in their CTD clinical evaluation, and we believe there is a significant opportunity for our tests that enable the differential diagnosis of these diseases, particularly for potentially life-threatening diseases such as SLE. In order to advance our integrated testing and therapeutics strategy, in December 2018 we entered into the Janssen agreement to exclusively promote SIMPONI® in the United States for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases. We began direct promotion of SIMPONI® in January 2019 and expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019. We expect our SIMPONI® promotion efforts to contribute incremental revenue in 2019 with our quarterly tiered promotion fee based on the incremental increase in total prescribed units above a predetermined average baseline of approximately 29,000 prescribed units per quarter.

We also have additional agreements with other leading pharmaceutical companies, including GSK, Horizon Therapeutics and Corrona, that leverage our testing products and the information generated from such tests. We plan to pursue additional strategic partnerships with a focus on the commercialization of therapeutics that are synergistic with our testing products.

We perform all of our AVISE® tests in our approximately 8,000 square foot clinical laboratory, which is certified by CLIA and accredited by CAP, and located in Vista, California. Our laboratory is

 

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certified for performance of high-complexity testing by CMS in accordance with CLIA. We are approved to offer our products in all 50 states. Our clinical laboratory reports all AVISE® testing product results within five business days.

We market our AVISE® testing products using our specialized salesforce. Unlike many diagnostic salesforces that are trained only to understand the comparative benefits of their tests, the specialized backgrounds of our salesforce coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified patient test reports and provide unique insights in a highly tailored discussion with rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote and sell targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and history using our portfolio of testing products.

Reimbursement for our testing services comes from several sources, including commercial third-party payers, such as insurance companies and health maintenance organizations, government payers, such as Medicare, and patients. Reimbursement rates vary by product and payer. We continue to focus on expanding coverage among existing contracted rheumatologists and to achieve coverage with commercial payers, laboratory benefit managers and evidence review organizations.

Since inception we have devoted substantially all our efforts developing and marketing products for the diagnosis, prognosis and monitoring of autoimmune diseases. Although our revenue has increased sequentially year over year, we have never been profitable and, as of June 30, 2019 we had an accumulated deficit of $158.1 million. We incurred net losses of $25.6 million, $8.0 million (as revised) and $5.5 million in the years ended December 31, 2017 and 2018 and the six months ended June 30, 2019, respectively. We expect to continue to incur operating losses in the near term as our operating expenses will increase to support the growth of our business, as well as additional costs associated with being a public company. We have funded our operations primarily through equity and debt financings and revenue from sales of our products. Since inception and through June 30, 2019, our operations have been financed primarily by net proceeds of approximately $161.1 million from sales of our common and redeemable convertible preferred stock and borrowings under various debt financings and revenue from the sales of our products. As of June 30, 2019 we had $16.2 million of cash and cash equivalents. In addition, in July 2019, we raised gross proceeds of approximately $11.0 million through the sale of our Series H redeemable convertible preferred stock.

Factors Affecting Our Performance

We believe there are several important factors that have impacted, and that we expect will impact, our operating performance and results of operations, including:

 

   

Continued Adoption Of Our Testing Products.    Since its launch in 2012, we have grown the number of our AVISE® CTD tests delivered at a compound annual growth rate of 87%, with limited incremental investment in our commercial infrastructure. Approximately 83,000 AVISE® CTD tests were delivered in 2018, representing 18% growth over 2017, and the number of ordering physicians reached 1,298 in the fourth quarter of 2018, representing 18% growth over the same quarter in 2017. In the first half of 2019, 50,792 AVISE® CTD tests were delivered, representing approximately 30% growth over the same period in 2018, and the number of ordering physicians in the first half of 2019 reached 1,711. More than 326,000 AVISE® CTD tests have been delivered since launch, and in the first half of 2019, we achieved a record number of 766 adopting physicians (defined as those who had previously prescribed at least 11 tests in a quarter) compared to 635 in the same period in 2018. Revenue growth for our testing products will depend on our ability to continue to expand our base of ordering physicians and increase our penetration with existing physicians.

 

   

Reimbursement For Our Testing Products.    Our revenue depends on achieving broad coverage and reimbursement for our tests from third-party payers, including both commercial

 

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and government payers such as Medicare. Payment from third-party payers differs depending on whether we have entered into a contract with the payers as a “participating provider” or do not have a contract and are considered a “non-participating provider.” Payers will often reimburse non-participating providers, if at all, at a lower amount than participating providers. We have received a substantial portion of our revenue from a limited number of third-party commercial payers, most of which have not contracted with us to be a participating provider. Historically, we have experienced situations where commercial payers proactively reduced the amounts they were willing to reimburse for our tests, and in other situations, commercial payers have determined that the amounts they previously paid were too high and have sought to recover those perceived excess payments by deducting such amounts from payments otherwise being made. When we contract to serve as a participating provider, reimbursements are made pursuant to a negotiated fee schedule and are limited to only covered indications. If we are not able to obtain or maintain coverage and adequate reimbursement from third-party payers, we may not be able to effectively increase our testing volume and revenue as expected. Additionally, retrospective reimbursement adjustments can negatively impact our revenue and cause our financial results to fluctuate.

 

   

Promotion of SIMPONI®.    We only recently began promoting SIMPONI® in the United States under the Janssen agreement. We may encounter difficulties in successfully promoting SIMPONI® and generating significant revenue under the agreement. Our ability to effectively promote SIMPONI® will require us to be successful in a range of activities, including training and deploying additional sales representatives and creating demand for SIMPONI® through our own sales activities as well as those of Janssen. Based on our estimate of the total U.S. addressable market for SIMPONI®’s approved indications of $28 billion, each incremental 1% market share we are able to capture for SIMPONI® above the predetermined baseline under the Janssen Agreement could result in incremental revenue to us of $84 million. However, it may take longer to generate meaningful revenue than we currently expect and we may not be successful in materially increasing market share, which would cause us to continue to rely on our existing testing products to drive revenue growth.

 

   

Development of Additional Testing Products.    We rely on sales of our AVISE® CTD test to generate the significant majority of our revenue. We recently launched AVISE® Anti-CarP and AVISE® PC4d. We expect to continue to invest in research and development in order to develop additional testing products and expect these costs to increase. Our success in developing new testing products will be important in our efforts to grow our business by expanding the potential market for our testing products and diversifying our sources of revenue.

 

   

Margin Expansion.    We believe growth in our promotion of therapeutics will meaningfully improve our margin profile and further support our goal of achieving profitability. We also expect an increase to our gross margins in January 2020 onwards upon the expiration of a 10% annual royalty on our CB-CAPs technology. In addition, we believe we are well positioned to drive further margin expansion through a continued focus on increasing operating leverage through the implementation of certain internal initiatives, such as conducting additional validation and reimbursement oriented clinical studies to facilitate payer coverage of our testing products, capitalizing on our growing reagent purchasing to negotiate improved volume-based pricing and automation in our clinical laboratory to reduce material and labor costs. However, these potential margin increases may be partially offset by expected decreases in Medicare reimbursement rates as a result of PAMA.

 

   

Timing of Our Research and Development Expenses.    Our spending on experiments and clinical studies may vary substantially from quarter to quarter. We also expend funds to secure clinical samples that can be used in discovery, product development, clinical validation, utility and outcome studies. The timing of these research and development activities is difficult to predict. If a substantial number of clinical samples are obtained in a given quarter or if a high-cost experiment is conducted in one quarter versus the next, the timing of these expenses will

 

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affect our financial results. We conduct clinical studies to validate our new testing products, as well as ongoing clinical and outcome studies to further expand the published evidence to support our commercialized AVISE® testing products. Spending on research and development for both experiments and studies may vary significantly by quarter depending on the timing of these various expenses.

 

   

How We Recognize Revenue.    Through December 31, 2017, we recognized revenue related to billings to payers on an accrual basis, net of contractual adjustments, only when we had established pricing with our payers as indicated by contractual pricing arrangements or when we had been able to demonstrate that a predictable pattern of payment for our services exists. For the year ended December 31, 2017, revenue was recognized on an accrual basis for one payer, Medicare, and totaled $8.2 million. In the absence of a predictable pattern of reimbursement or a contract with a payer, revenue was recognized upon cash receipt. Effective January 1, 2018, we began recognizing revenue in accordance with the provisions of Accounting Standards Codification, or ASC, Topic 606, Revenue from Contracts with Customers. We record revenue on an accrual basis based on our estimate of the amount that will be ultimately realized for each test upon delivery based on a historical analysis of amounts collected by test and by payer. Changes to such estimates may increase or decrease revenue recognized in future periods.

While each of these areas present significant opportunities for us, they also pose significant risks and challenges that we must address. We discuss many of these risks, uncertainties and other factors in the section entitled “Risk Factors.”

Janssen Promotion Agreement

In December 2018, we entered into a co-promotion agreement with Janssen, under which we are responsible for the costs associated with our sales force in promoting SIMPONI® in the United States. Janssen is responsible for all other costs associated with our promotion of SIMPONI® under the Janssen agreement. In exchange for our sales and co-promotional services, we are entitled to a quarterly tiered promotion fee ranging from $750 to $1,250 per prescription based on the incremental increase in total prescribed units of SIMPONI® for that quarter over a predetermined baseline. The predetermined average baseline for the initial term of 18 months is approximately 29,000 prescribed units per quarter, subject to adjustment under certain circumstances. The term of the agreement expires on June 30, 2020, unless extended by us for an additional 18 months upon 180 days written notice prior to the end of the initial term. Janssen can terminate the agreement at any time for any reason upon 30 days’ notice to us, and we can terminate the agreement for any reason at the end of any calendar quarter upon 30 days’ notice to Janssen. Either party may terminate the agreement in the event of the other party’s default of any of its material obligations under the agreement if such default remains uncured for a specified period of time following receipt of written notice of such default.

We recognized co-promotional revenue of approximately $404,000 during the six months ended June 30, 2019 and expect to continue to recognize revenue as we perform co-promotional services based on the number of total prescribed units of SIMPONI® over the predetermined baseline.

Financial Overview

Basis of Presentation

Revision of Previously issued Financial Statements for Correction of Immaterial Errors

During 2019, we identified immaterial misstatements in the financial statements for the year ended December 31, 2018 related to the carrying value of redeemable convertible preferred stock warrant liabilities. These amounts have been adjusted in the accompanying financial statements. See Note 16

 

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to our audited financial statements for a summary of the amounts and financial statement line items impacted by the revision. All amounts set forth in the discussion and year ended December 31, 2018 have been adjusted to reflect these revisions.

Revenue

To date, we have derived nearly all of our revenue from the sale of our testing products, most of which is attributable to our AVISE® CTD test. We primarily market our testing products to rheumatologists in the United States. The rheumatologists who order our testing products and to whom results are reported are generally not responsible for payment for these products. The parties that pay for these services, or payers, consist of healthcare insurers, government payers (primarily Medicare and Medicaid), client payers (i.e. hospitals, other laboratories, etc.), and patient self-pay. Our service is completed upon the delivery of test results to the prescribing rheumatologists which triggers billing for the service.

Through December 31, 2017, we recognized revenue related to billings to payers on an accrual basis, net of contractual adjustments, only when we had established pricing with our payers as indicated by contractual pricing arrangements or when we had been able to demonstrate that a predictable pattern of payment for our services exists. For the year ended December 31, 2017, revenue was recognized on an accrual basis for one payer, Medicare, and totaled $8.2 million. In the absence of a predictable pattern of reimbursement or a contract with a payer, revenue was recognized upon cash receipt.

Effective January 1, 2018, we began recognizing revenue in accordance with the provisions of ASC Topic 606, Revenue from Contracts with Customers. We record revenue on an accrual basis based on our estimate of the amount that will be ultimately realized for each test upon delivery based on a historical analysis of amounts collected by test and by payer. These assessments require significant judgment by management.

Our ability to increase our revenue will depend on our ability to further penetrate the market for our current and future testing products, and increase our reimbursement and collection rates for tests delivered, as well as our ability to successfully promote SIMPONI®.

Operating Expenses

Costs of Revenue (Excluding Amortization of Purchased Technology)

Costs of revenue represents the expenses associated with obtaining and testing patient specimens. The components of our costs of revenue include materials costs, direct labor, equipment and infrastructure expenses associated with testing specimens, shipping charges to transport specimens, blood specimen collections fees, royalties, depreciation and allocated overhead, including rent and utilities.

Each payer, commercial third-party, government, or individual, reimburses us at different amounts. These differences can be significant. As a result, our costs of revenue as a percentage of revenue may vary significantly from period to period due to the composition of payers for each month’s billings.

We expect that our costs of revenue will increase in absolute dollars as the number of tests we perform increases. However, we expect that the cost per test will decrease over time due to volume discounts on materials and shipping costs and other volume efficiencies we may gain as the number of tests we perform increases.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of personnel costs, including stock-based compensation expense, direct marketing expenses, accounting and legal expenses, consulting costs, and allocated overhead including rent, information technology, depreciation and utilities.

 

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We expect that our selling, general and administrative expenses will increase in absolute dollars as we expand our sales and sales support functions, including expansion activities related to our promotion of SIMPONI®. We also expect our selling, general and administrative expenses will increase because of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and Nasdaq, additional insurance, investor relations activities and other administrative and professional services such as accounting, legal, regulatory and tax.

Research and Development Expenses

Research and development expenses include costs incurred to develop our technology, testing products and product candidates, collect clinical specimens and conduct clinical studies to develop and support our testing products and product candidates. These costs consist of personnel costs, including stock-based compensation expense, materials, laboratory supplies, consulting costs, costs associated with setting up and conducting clinical studies and allocated overhead including rent and utilities. We expense all research and development costs in the periods in which they are incurred.

We expect that our research and development expenses will increase in absolute dollars as we continue to invest in research and development activities related to our existing testing products and product candidates.

Amortization of Intangible Assets

Amortization of intangible assets represents the total amortization expense for our purchased technologies.

The intangible assets recorded as of December 31, 2017 became fully amortized in 2018; accordingly, we do not expect any future amortization expense related to these assets.

Change in Fair Value of Acquisition-Related Liabilities

In connection with the acquisition of the medical diagnostics division of Cypress Bioscience, Inc., or Cypress, in 2010, we were assigned certain agreements with Royalty Pharma. We initially agreed to pay an additional amount not to exceed $9.0 million in the event specified revenue, contractual and product launch milestones were achieved. In February 2017, we amended two of the remaining agreements for which a contingent payment amount had been originally agreed to.

We do not expect any further fair value adjustments for these acquisition-related liabilities as the one remaining milestone is not expected to be achieved.

Interest Expense

Interest expense consists of cash and non-cash interest expense associated with our financing arrangements, including the borrowings under our current loan agreement with Innovatus and our prior term loan agreement, or the 2013 Term Loan, with Capital Royalty Partners II, L.P. and its affiliates, collectively referred to as Capital Royalty, which was repaid in September 2017.

We expect interest expense to increase in 2019 due to the draws we made under our loan agreement and to decrease in years thereafter due to lower interest rates and lower outstanding principal balances.

Loss on Extinguishment of Share Purchase Rights and 2013 Term Loan

In 2016 and 2017, we entered into agreements with existing stockholders of our redeemable convertible preferred stock that contained future purchase obligations that were required to be accounted for as liabilities and remeasured to fair value at each reporting date, with any change in the

 

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fair value reported as a component of other income (expense). In May 2017, we completed the first closing of the sale of our Series F redeemable convertible preferred stock which resulted in the conversion of all outstanding share purchase rights. We remeasured the share purchase right liabilities to fair value on the date of conversion and the difference between the fair value of the shares of Series F redeemable convertible preferred stock received and the sum of the cash proceeds received and the fair value of the outstanding share purchase and tranche participation rights resulted in the recognition of a loss on extinguishment of the outstanding share purchase rights.

In September 2017, we repaid our 2013 Term Loan with Capital Royalty and incurred a loss on the extinguishment of debt related to the unamortized portion of the of the placement fees and the capitalized value of the warrants associated with the notes.

We did not have any similar transactions in 2018 or the six months ended June 30, 2019 and accordingly, there were no similar charges in 2018 or the first half of 2019.

Change in Fair Value of Financial Instruments

As discussed above, we remeasured the share purchase right liabilities to fair value on the date of the conversion to shares of Series F redeemable convertible preferred stock and reclassified the liabilities to permanent equity.

In addition, we classify our outstanding warrants to purchase shares of our redeemable convertible preferred stock as liabilities on our balance sheets at their estimated fair value since the underlying redeemable convertible preferred stock was classified as temporary equity. At the end of each reporting period, changes in the estimated fair value during the period are recorded as a component of other income (expense).

The outstanding warrants to purchase shares of our Series D and E redeemable convertible preferred stock will terminate if not exercised prior to the completion of this offering and will no longer be subject to measurement once exercised or terminated. The outstanding warrants to purchase shares of our Series F redeemable convertible preferred stock will convert into warrants to purchase shares of our common stock in connection with the completion of this offering and will no longer be subject to measurement.

Other Income, Net

Other income, net, consists primarily of interest income earned on our cash and cash equivalents.

Income Tax (Benefit) Expense

Income taxes include federal and state income taxes in the United States.

 

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Results of Operations

Comparison of the Six Months Ended June 30, 2018 and 2019:

    Six Months Ended
June 30,
    Change  
          2018                 2019        
    (unaudited, in thousands)  

Revenue

  $ 14,576     $ 19,734     $ 5,158  

Operating expenses:

     

Costs of revenue (excluding amortization of purchased technology)

    7,524       9,434       1,910  

Selling, general and administrative expenses

    9,487       13,481       3,994  

Research and development expenses

    1,067       1,103       36  

Amortization of intangible assets

    94             (94
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    18,172       24,018       5,846  
 

 

 

   

 

 

   

 

 

 

Loss from operations

    (3,596     (4,284     (688

Interest expense

    (1,394     (1,811     (417

Change in fair value of financial instruments

          467       467  

Other income, net

    51       139       88  
 

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (4,939     (5,489 )       (550

Income tax expense

                 
 

 

 

   

 

 

   

 

 

 

Net loss

  $ (4,939   $ (5,489   $ (550
 

 

 

   

 

 

   

 

 

 

Revenue

Revenue increased $5.2 million, or 35.4%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018, primarily due to an increase in the number of diagnostic tests delivered and an increase in the average reimbursement per test. The number of AVISE® CTD tests, which accounted for 83% and 86% of revenue in the six months ended June 30, 2019 and 2018, respectively, increased to 50,792 tests delivered in the six months ended June 30, 2019 compared to 39,134 tests delivered in the same 2018 period. The increase is primarily due to the increased adoption of the AVISE® CTD test by rheumatologists as the number of ordering physicians increased to 1,711 in the six months ended June 30, 2019 as compared to 1,454 physicians in the same 2018 period. In addition, our average reimbursement per AVISE® CTD test increased to approximately $325 per test delivered in the six months ended June 30, 2019 from approximately $308 per test delivered in the same 2018 period, an increase of approximately 6%.

In addition, we began co-promoting SIMPONI® in early 2019 and recognized approximately $404,000 of revenue during the six months ended June 30,2019.

Costs of Revenue (excluding amortization of purchased technology)

Costs of revenue increased $1.9 million, or 25.4%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. This increase was primarily due to increased direct costs such as materials and supplies and royalties associated with the increase in test volume in 2019 compared to 2018.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $4.0 million, or 42.1%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. This increase was primarily due to increased employee related expenses as a result of increasing the size of our sales force from 29 at March 31, 2018 to 53 at June 30, 2019.

 

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Research and Development Expenses

Research and development expenses remained relatively consistent for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

Amortization of Intangible Assets

Our purchased intangible assets were fully amortized at December 31, 2018, therefore there is no amortization expense recorded for the six months ended June 30, 2019.

Interest Expense

Interest expense increased $0.4 million, or 29.9%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. This increase was primarily due to higher principal amounts outstanding at June 30, 2019 under our long-term borrowing arrangements.

Change in Fair Value of Financial Instruments

The change in the fair value of financial instruments was a benefit of $0.5 million for the six months ended June 30, 2019 and resulted from changes in the valuation of our redeemable convertible preferred stock warrant liabilities. There was no such change in valuation for the six months ended June 30, 2018.

Other Income, Net

Other income, net, remained relatively consistent for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.

Comparison of the Years Ended December 31, 2017 and 2018:

 

    Year Ended December 31,     Change  
          2017                 2018        
    (in thousands)  
    (As Revised)  

Revenue

  $ 26,807     $ 32,440     $ 5,633  

Operating expenses:

     

Costs of revenue (excluding amortization of purchased technology)

    14,137       15,379       1,242  

Selling, general and administrative expenses

    18,820       19,675       855  

Research and development expenses

    1,551       2,125       574  

Amortization of intangible assets

    186       141       (45

Change in fair value of acquisitions-related liabilities

    (51           51  
 

 

 

   

 

 

   

 

 

 

Total operating expenses

    34,643       37,320       2,677  
 

 

 

   

 

 

   

 

 

 

Loss from operations

    (7,836     (4,880     2,956  

Interest expense

    (2,948     (2,868     80  

Loss on extinguishment of share purchase rights and 2013 Term Loan

    (6,050           6,050  

Change in fair value of financial instruments

    (9,391     (318     9,073  

Other income, net

    45       112       67  
 

 

 

   

 

 

   

 

 

 

Loss before income taxes

    (26,180     (7,954     18,226  

Income tax (benefit) expense

    (549     58       607  
 

 

 

   

 

 

   

 

 

 

Net loss

  $ (25,631   $ (8,012   $ 17,619  
 

 

 

   

 

 

   

 

 

 

 

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Revenue

Revenue increased $5.6 million, or 21.0%, for the year ended December 31, 2018 compared to the year ended December 31, 2017, primarily due to an increase in the number of diagnostic tests delivered and the adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606), offset by a 5.7% decrease in the average reimbursement per test. The number of AVISE® CTD tests, which accounted for 82% and 89% of revenue in the year ended December 31, 2018 and 2017, respectively, increased to 82,657 tests delivered in the year ended December 31, 2018 compared to 70,138 tests delivered in the same 2017 period. The increase is primarily due to the increased adoption of our products by rheumatologists as the number of ordering physicians increased to 1,298 in the fourth quarter of 2018 as compared to 1,098 physicians in the same 2017 period.

The adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606), represented an increase in revenue for the year ended December 31, 2018 of approximately $1.5 million as this adoption resulted in an acceleration of revenue recognition since we were required to estimate consideration to which we expect to be entitled rather than record revenue on the cash basis as we had previously done for all but one customer.

Costs of Revenue (excluding amortization of purchased technology)

Costs of revenue increased $1.2 million, or 8.8%, in the year ended December 31, 2018 compared to the year ended December 31, 2017. This increase was primarily due to increased direct costs such as materials and supplies and royalties associated with the increase in test volume in 2018 compared to 2017.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $0.9 million, or 4.5%, in the year ended December 31, 2018 compared to the year ended December 31, 2017. This increase was primarily due to increased employee related expenses of $0.4 million, increased audit and legal fees of $0.4 million and increased facility related expenses of $0.1 million.

Research and Development Expenses

Research and development expenses increased $0.6 million, or 37.0%, in the year ended December 31, 2018 compared to the year ended December 31, 2017. This increase was primarily due to increased clinical trial expenses related to the initiation of our CARE for Lupus randomized multi-site study in 2018 of $0.4 million, increased employee related expenses of $0.1 million and increased professional service fees of $0.1 million.

Amortization of Intangible Assets

Amortization of intangible assets remained relatively consistent for the year ended December 31, 2018 compared to the year ended December 31, 2017.

Change in Fair Value of Acquisition-Related Liabilities

The change in fair value of acquisition-related liabilities remained relatively consistent for the year ended December 31, 2018 compared to the year ended December 31, 2017.

Interest Expense

Interest expense remained relatively consistent for the year ended December 31, 2018 compared to the year ended December 31, 2017.

 

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Loss on Extinguishment of Share Purchase Rights and 2013 Term Loan

The loss on extinguishment of share purchase rights and 2013 Term Loan decreased $6.1 million, or 100%, in the year ended December 31, 2018 compared to the year ended December 31, 2017, as there were no similar charges in 2018.

Change in Fair Value of Financial Instruments

The change in fair value of financial instruments decreased $9.1 million, or 96.6%, in the year ended December 31, 2018 compared to the year ended December 31, 2017. This decrease was primarily due to the conversion of all outstanding share purchase rights in the year ended December 31, 2017 thereby eliminating these items from being remeasured in the year ended December 31, 2018.

Other Income, Net

Other income, net, remained relatively consistent for the year ended December 31, 2018 compared to the year ended December 31, 2017.

Income Tax (Benefit) Expense

Income tax expense increased $0.6 million in the year ended December 31, 2018 compared to the year ended December 31, 2017. The income tax benefit in the year ended December 31, 2017 resulted from the impacts of The Tax Cuts and Job Act enacted in December 2017 with no additional impact in the year ended December 31, 2018.

Liquidity and Capital Resources

We have incurred net losses since our inception. For the years ended December 31, 2017 and 2018 and the six months ended June 30, 2019, we incurred a net loss of $25.6 million, $8.0 million (as revised) and $5.5 million, respectively, and we expect to incur additional losses and increased operating expenses in future periods. As of June 30, 2019, we had an accumulated deficit of $158.1 million. To date, we have generated only limited revenue, and we may never achieve revenue sufficient to offset our expenses.

Since inception and through June 30, 2019, our operations have been financed primarily by net proceeds of approximately $161.1 million from sales of our equity and borrowings under various debt financings and revenue from the sales of our products. As of June 30, 2019, we had $16.2 million of cash and cash equivalents. In addition, in July 2019, we raised gross proceeds of approximately $11.0 million through the sale of our Series H redeemable convertible preferred stock. Cash in excess of immediate requirements is invested in accordance with our investment policy, primarily with a view to liquidity and capital preservation. Currently, our funds are held in cash and money market funds.

In September 2017, we entered into the loan agreement with Innovatus, under which we immediately drew down $20.0 million. In December 2018, we borrowed an additional $5.0 million under the loan agreement. The loan term is for five years with a final maturity date of September 2022. The loan accrues interest at an annual rate of 11%, of which 2.5%, during the first 24 months, will be treated as paid in kind interest. Paid in kind interest is added to the principal balance each period. After the initial 24 months of the loan, the entire 11% will be paid in cash at the end of each period. We may, at our option, prepay the term loan borrowings by paying the lender a prepayment premium, which expires in October 2020.

Our obligations under the loan agreement are secured by a security interest in substantially all of our assets, including our intellectual property. The loan agreement contains customary conditions to borrowing, events of default, and covenants, including covenants requiring us to maintain certain levels

 

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of minimum liquidity (in specified instances, is either $2.0 million or the trailing four months of cash used to fund operating activities) and achieve certain minimum amounts of revenue and either gross margins or gross profits, and limiting our ability to dispose of assets, undergo a change in control, merge with or acquire other entities, incur debt, incur liens, pay dividends or other distributions to holders of our capital stock, repurchase stock and make investments, in each case subject to certain exceptions.

In connection with the execution of the loan agreement, we issued the lender a seven-year warrant to purchase 15,384,615 shares of our Series F redeemable convertible preferred stock at an exercise price of $0.078 per share, and in December 2018, in connection with the additional $5.0 million borrowed under the loan agreement, we issued to the lender a seven-year warrant to purchase 3,846,154 shares of our Series F redeemable convertible preferred stock at an exercise price of $0.078 per share. These warrants will become exercisable for an aggregate of 19,230,765 shares of our common stock upon the completion of this offering. If the loan agreement is repaid prior to September 7, 2019, we will be required to issue to the lender a warrant to purchase 3,000,000 shares of our Series F redeemable convertible preferred stock at an exercise price of $0.078 per share.

Funding Requirements

Our primary uses of cash are to fund our operations as we continue to grow our business. We expect to continue to incur operating losses in the near term as our operating expenses will be increased to support the growth of our business. We expect that our costs of revenue, selling, general and administrative expenses, and research and development expenses will continue to increase as we increase our test volume, expand our marketing efforts and increase our internal sales force to drive increased adoption of and reimbursement for our AVISE® testing products, promote SIMPONI®, prepare to commercialize new testing products, continue our research and development efforts and further develop our product pipeline. We expect that we will use a substantial portion of the net proceeds of this offering, in combination with our existing cash and cash equivalents, for these purposes and for the increased expenses associated with being a public company. We believe we have sufficient laboratory capacity to support increased test volume. Other than the addition of laboratory equipment, we expect that we will not need to make material capital expenditures in the near term related to our laboratory facilities. Cash used to fund operating expenses is impacted by the timing of when we pay expenses, as reflected in the change in our outstanding accounts payable and accrued expenses.

We expect that our near- and longer-term liquidity requirements will continue to consist of working capital and general corporate expenses associated with the growth of our business, including payments we may be required to make upon the achievement of previously negotiated milestones associated with intellectual property we have licensed. Based on our current business plan, we believe that the estimated net proceeds from this offering, together with our existing cash and cash equivalents and our anticipated future revenue, will be sufficient to meet our anticipated cash requirements for at least the next 12 months.

Our estimate of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including:

 

   

our ability to maintain and grow sales of our AVISE® testing products, as well as the costs associated with conducting clinical studies to demonstrate the utility of our products and support reimbursement efforts;

 

   

fluctuations in working capital;

 

   

the costs associated with our promotion of SIMPONI®, including the expansion of our sales capabilities, and the extent and timing of generating revenue from such promotion;

 

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the costs of developing our product pipeline, including the costs associated with conducting our ongoing and future validation studies;

 

   

our ability to achieve sufficient market acceptance, coverage and adequate reimbursement from third-party payers and adequate market share and revenue for our testing products;

 

   

the additional costs we may incur as a result of operating as a public company; and

 

   

the extent to which we establish additional partnerships or in-license, acquire or invest in complementary businesses or products.

Until such time, if ever, as we can generate revenue to support our costs structure, we expect to finance our operations through equity offerings, debt financings or other capital sources, including potentially collaborations, licenses and other similar arrangements. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders may be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. If additional funding is required or desired, there can be no assurance that additional funds will be available to us on acceptable terms on a timely basis, if at all, or that we will generate sufficient cash from operations to adequately fund our operating needs or achieve or sustain profitability. If we are unable to raise additional capital or generate sufficient cash from operations to adequately fund our operations, we will need to delay, reduce or eliminate some or all of our research and development programs, product portfolio expansion plans or commercialization efforts. Doing so will likely have an unfavorable effect on our ability to execute on our business plan and could have a negative impact on our relationships with parties such as Janssen. If we cannot expand our operations or otherwise capitalize on our business opportunities because we lack sufficient capital, our business, financial condition, and results of operations could be adversely affected.

Cash Flows

The following table summarizes our cash flows for the periods indicated:

 

    Years Ended December 31,      Six Months Ended June 30,  
          2017                  2018                  2018                  2019        
(in thousands)                 (unaudited)  

Net cash provided by (used in):

          

Operating activities

  $ (10,968    $ (9,301    $ (5,408    $ (4,118

Investing activities

    (510      (199      (2,068      (75

Financing activities

    19,156        11,423        2,706        7,266  
 

 

 

    

 

 

    

 

 

    

 

 

 

Increase (decrease) in cash, cash equivalents and restricted cash

  $ 7,678      $ 1,923      $ (4,770    $ 3,073  
 

 

 

    

 

 

    

 

 

    

 

 

 

Cash Flows from Operating Activities

Net cash used in operating activities for the six months ended June 30, 2018 was $5.4 million and primarily resulted from our net loss of $4.9 million adjusted for non-cash charges of $1.0 million for depreciation, amortization, stock-based compensation and non-cash interest and changes in our net operating assets of $1.5 million related to net decreases in accounts payable and accrued liabilities. Net cash used in operating activities for the six months ended June 30, 2019 was $4.1 million and primarily resulted from our net loss of $5.5 million adjusted for net non-cash charges of $0.8 million related to depreciation, amortization, stock- based compensation, non-cash interest and the revaluation of our preferred stock liabilities, and changes in our net operating assets of $0.6 million related to net increases in accounts payable, and accrued liabilities.

 

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Net cash used in operating activities for the year ended December 31, 2017 was $11.0 million and primarily resulted from our net loss of $25.6 million adjusted for non-cash charges of $9.4 million for remeasurements of financial instruments, $6.1 million for losses on extinguishment of the 2013 Term Loan and share purchase rights, and $1.7 million for depreciation, amortization and non-cash interest, all partially offset by a cash payment of accrued paid in-kind, or PIK, interest of $2.3 million associated with the extinguishment of the 2013 Term Loan. Net cash used in operating activities for the year ended December 31, 2018 was $9.3 million and primarily resulted from our net loss of $8.0 million (as revised) adjusted for non-cash charges of $0.3 million (as revised) for remeasurements of financial instruments and $1.8 million for depreciation, amortization and non-cash interest, partially offset by changes in our net operating assets consisting of a $2.3 million increase in accounts receivable primarily due to the adoption of ASC 606 and $1.3 million related to net increases in prepaid expenses and other current assets, accounts payable, and accrued liabilities.

Cash Flows from Investing Activities

Net cash used in investing activities for the six months ended June 30, 2018 was $2.1 million and was due to purchases of short-term investments of $2.0 million and purchases of property and equipment of $0.1 million. Net cash used in investing activities for the six months ended June 30, 2019 was $0.1 million and was due to net purchases of property and equipment.

Net cash used in investing activities for the years ended December 31, 2017 and 2018 was $0.5 million and $0.2 million, respectively, and were primarily due to purchases of property and equipment in both periods.

Cash Flows from Financing Activities

Net cash provided by financing activities for the six months ended June 30, 2018 and 2019 was $2.7 million and $7.3 million, respectively, and primarily resulted from net proceeds received from the issuance of our redeemable convertible preferred stock.

Net cash provided by financing activities was $19.2 million for the year ended December 31, 2017 and primarily resulted from $14.6 million of net proceeds received from the issuance of our redeemable convertible preferred stock and stock purchase rights and net proceeds of $4.5 million from refinancing our long-term borrowing arrangement. Net cash provided by financing activities was $11.4 million for the year ended December 31, 2018 and primarily resulted from $6.5 million of net proceeds received from the issuance of our redeemable convertible preferred stock and net proceeds of $5.0 million under our long-term borrowing agreement with Innovatus.

Contractual Obligations and Other Commitments

The following table summarizes our contractual obligations as of December 31, 2018:

 

    Payments Due by Period  
    Less
Than 1
Year
     1 to 3
Years
     3 to 5
Years
     More
Than 5
Years
     Total  
                  (in thousands)                

Contractual obligations:

             

Operating leases(1)

  $ 399      $ 445      $      $           –      $ 844  

Capital leases

    92        184        112           388  

2017 Term Loan(2)

    2,372        21,062        11,250               34,684  

Non-cancelable purchase obligations(3)

    3,250        3,250                      6,500  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations:

  $ 6,113      $ 24,941      $ 11,362      $      $ 42,416  
 

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

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(1)

We lease approximately 33,500 square feet of office and laboratory space in Vista, California, under leases that expire in 2021, with options to extend the leases for an additional 24-month or 36-month period.

 

(2)

We will make principal and interest payments to Innovatus in accordance with the required payment schedule for the 2017 Term Loan.

 

(3)

Represents the minimum annual purchase commitment for one supplier.

The contractual obligations table does not include any additional potential contingent payments upon the future achievement by us of specified sales-based and other milestones, or royalty payments we may be required to make under license agreements we have entered into pursuant to which we have in-licensed certain intellectual property, including our license agreements with the University of Pittsburgh, Prometheus and Dr. Dervieux. See the section entitled “Business—Intellectual Property Overview—License Agreements” and Note 8 to our audited financial statements included elsewhere in this prospectus for additional information. The timing of when these additional payments will actually be made is uncertain and the payments are contingent upon the completion of future activities.

Critical Accounting Policies and Significant Management Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our audited financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these audited financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the audited financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates.

Revenue Recognition

To date, substantially all of our revenue has been derived from sales of our testing products. We primarily market our testing products to rheumatologists and their physician assistants in the United States. The healthcare professionals who order our services and to whom test results are reported are generally not responsible for payment for these services. The parties that pay for these services consist of healthcare insurers, government payers (primarily Medicare and Medicaid), client payers (i.e. hospitals, other laboratories, etc.) and patient self-pays. Through December 31, 2017, we recognized revenue when the following criteria was met (i) persuasive evidence of an arrangement exists; (ii) delivery occurred or services have been rendered; (iii) the fee is fixed and determinable; and (iv) collectability is reasonably assured.

Our service is completed upon the delivery of test results to the prescribing rheumatologist which triggers billing for the service. Prior to January 1, 2018, we recognized revenue related to billings to payers on an accrual basis, net of contractual adjustments, only when we had established pricing with our third-party payers as indicated by contractual pricing arrangements or predictable patterns of payment for our services. In the absence of a predictable pattern of reimbursement or a contract with a payer, revenue was recognized upon cash receipt. For the year ended December 31, 2017, revenue was recognized on an accrual basis for one payer, Medicare, and totaled $8.2 million.

On January 1, 2018, we early adopted ASC Topic 606, Revenue from Contracts with Customers, and began recognizing revenue in accordance with the provisions thereof. Our service is a single

 

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performance obligation that is completed upon the delivery of test results to the prescribing physician which triggers revenue recognition.

Payers are billed at our list price. Net revenues recognized consist of amounts billed net of allowances for differences between amounts billed and the estimated consideration we expect to receive from such payers. We follow a standard process, which considers historical denial and collection experience, insurance reimbursement policies and other factors, to estimate allowances and implicit price concessions, recording adjustments in the current period as changes in estimates. Further adjustments to the allowances, based on actual receipts, is recorded upon settlement. The transaction price is estimated using an expected value method on a portfolio basis. Our portfolios are grouped per payer (i.e. each individual third party insurance, Medicare, client payers, patient self-pay, etc.) and per test basis.

Collection of our net revenues from payers is normally a function of providing complete and correct billing information to the healthcare insurers and generally occurs within 30 to 90 days of billing.

The process for estimating revenues and the ultimate collection of accounts receivable involves significant judgment and estimation by management.

In December 2018, we entered into the Janssen agreement to co-promote SIMPONI® in the United States. We are responsible for the costs associated with our sales force over the course of such co-promotion. Janssen is responsible for all other aspects of the commercialization of SIMPONI® under the Janssen agreement. In exchange for our sales and co-promotional services, we are entitled to a tiered promotion fee ranging from $750 to $1,250 per prescription based on the incremental increase in total prescribed units of SIMPONI® for that quarter over a predetermined baseline. The predetermined average baseline for the initial term of 18 months is approximately 29,000 prescribed units per quarter, subject to adjustment under certain circumstances.

Our obligations relating to sales and co-promotion services for SIMPONI® is a series of single performance obligations since Janssen simultaneously receives and consumes the benefits provided by our sales and co-promotional services. The method for measuring progress towards satisfying the performance obligations is based on prescribed units in excess of the contractual baseline at the contractual rate earned per unit since the agreement is cancelable. As of December 31, 2018, there were no performance obligations under the agreement and no consideration had been received. We began co-promoting SIMPONI® in early 2019 and recognized revenue of approximately $404,000 during the six months ended June 30, 2019.

Long-lived Assets

Our long-lived assets are comprised principally of our property and equipment, finite lived intangible assets, and goodwill.

We amortize all finite lived intangible assets over their respective estimated useful lives. In considering whether intangible assets are impaired, we combine our intangible assets and other long-lived assets (excluding goodwill), into groupings, a determination which we principally make on the basis of whether the assets are specific to a particular test offered by us or technology we are developing. If we identify events or circumstances indicate that the associated carrying amount of assets within a group may not be recoverable, we will consider the assets in the group impaired if the carrying value of the group’s assets and directly associated liabilities exceed the estimated cash flows expected to be generated over the estimated useful life of the assets in the group. Management’s estimates of future cash flows are impacted by projected levels of tests and levels of reimbursement, as well as expectations related to the future cost structure of the entity.

 

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Goodwill is not amortized but is tested for impairment at least annually or more frequently whenever a triggering event or change in circumstances occurs, at the reporting unit level. For our goodwill impairment analysis, we operate in a single reporting unit, and allocate all goodwill to this reporting unit. We are required to recognize an impairment charge if the carrying amount of the reporting unit exceeds its fair value. Management first assesses qualitative factors to determine whether it is more likely than not that the fair value of the reporting unit is less than the carrying amount as a basis for determining whether it is necessary to perform a quantitative assessment. If a quantitative assessment is deemed necessary, management uses all available information to make this fair value determination, including the present values of expected future cash flows using discount rates commensurate with the risks involved in the assets and observed market multiples of operating cash flows.

The judgments and estimates involved in identifying and quantifying the impairment of long-lived assets or goodwill involve inherent uncertainties, and the measurement of the fair value is dependent on the accuracy of the assumptions used in making the estimates and how those estimates compare to our future operating performance. No goodwill impairments were recorded during the years ended December 31, 2017 and 2018 or the six months ended June 30, 2019.

Following the completion of this offering, our stock price and associated market capitalization will also be considered in the determination of reporting unit fair value. A prolonged or significant decline in our share price could provide evidence of a need to record a material impairment of goodwill.

Stock-Based Compensation

We recognize compensation expense related to stock-based awards to employees and directors based on the estimated fair value of the awards on the date of grant over the requisite service period of the awards (usually the vesting period) on a straight-line basis. The grant date fair value, and the resulting stock-based compensation expense, is estimated using the Black-Scholes option pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the vesting period of the respective award.

We recorded stock-based compensation expense of approximately $187,000, $114,000, $90,000 and $23,000 for the years ended December 31, 2017 and 2018 and the six months ended June 30, 2018 and 2019, respectively. We expect to continue to grant stock options and other equity-based awards in the future, and to the extent that we do, our stock-based compensation expense recognized in future periods will likely increase.

The Black-Scholes option pricing model requires the use of highly subjective and complex assumptions, which determine the fair value of stock-based awards. If we had made different assumptions, our stock-based compensation expense, net loss and net loss per share attributable to common stockholders could have been significantly different. See Notes 2 and 12 to our audited financial statements included elsewhere in this prospectus for information concerning certain of the specific assumptions we used in applying the Black-Scholes option pricing model to determine the estimated fair value of our stock options granted in the years ended December 31, 2017 and 2018 and the six months ended June 30, 2018 and 2019.

Significant Factors, Assumptions and Methodologies Used in Determining Fair Value of Our Common Stock

We are also required to estimate the fair value of the common stock underlying our stock-based awards when performing the fair value calculations. Our board of directors, with the assistance of management, determined the fair value of our common stock on each grant date. All options to purchase shares of our common stock are intended to be granted with an exercise price per share no less than the fair value per share of our common stock underlying those options on the date of grant, based on the information known to us on the date of grant.

 

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Because there has been no public market for our common stock, the fair value of the common stock that underlies our stock options has historically been determined by our board of directors based upon information available to it at the time of grant, including the following:

 

   

contemporaneous valuations performed by independent third-party firms;

 

   

rights, preferences and privileges of our common stock compared to the rights, preferences and privileges of our other outstanding equity securities;

 

   

our current and projected operating and financial performance, including our levels of available capital resources;

 

   

trends and developments in our industry;

 

   

the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering or an acquisition of our company given prevailing market and sector conditions;

 

   

the illiquidity of our securities by virtue of being a private company;

 

   

the valuation of publicly traded companies in our sector, as well as recently completed initial public offerings and mergers and acquisitions of comparable companies;

 

   

stage of development; and

 

   

U.S. and global economic and capital market conditions.

The valuations of our common stock were prepared in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid, which prescribes several valuation approaches for setting the value of an enterprise, such as the cost, income and market approaches, and various methodologies for allocating the value of an enterprise to its common stock. The cost approach establishes the value of an enterprise based on the cost of reproducing or replacing the property less depreciation and functional or economic obsolescence, if present. The income approach establishes the value of an enterprise based on the present value of future cash flows that are reasonably reflective of our company’s future operations, discounting to the present value with an appropriate risk adjusted discount rate or capitalization rate. The market approach is based on the assumption that the value of an asset is equal to the value of a substitute asset with the same characteristics. Each valuation methodology was considered in our valuations. In determining a fair value for our common stock, we estimated the enterprise value of our business using either the market approach or income approach. In 2017 and 2018, we concluded that the market approach was the most appropriate. In accordance with the Practice Aid, we considered the various methods for allocating the enterprise value across our classes and series of capital stock to determine the fair value of our common stock at each valuation date. Until December 2018, we concluded that the Option Pricing Method, or OPM, was most appropriate for each of the valuations of our common stock performed by independent third-party valuation specialists. We believed the OPM was the most appropriate given the expectation of various potential liquidity outcomes and the difficulty of selecting and supporting appropriate enterprise values given our early stage of development. Under the OPM, shares are valued by creating a series of call options with exercise prices based on the liquidation preferences and conversion terms of each equity class. The values of the preferred and common stock are inferred by analyzing these options. In December 2018, we changed to a Probability-Weighted Expected Return Method, or PWERM, for estimating enterprise value given the increased probability of an initial public offering liquidity scenario. The PWERM is a scenario-based analysis that estimates the value per share based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to us, as well as the economic and control rights of each share class.

If we had made different assumptions than those used, the amount of our stock-based compensation expense, net loss and net loss per share attributable to common stockholders could have been significantly different. Following the completion of this offering, the fair value per share of

 

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our common stock for purposes of determining stock-based compensation expense will be the closing price of our common stock as reported on the applicable grant date on the primary stock exchange on which our common stock is traded.

Based on the assumed initial public offering price of $        per share, the midpoint of the price range set forth on the cover page of this prospectus, the intrinsic value of stock options outstanding as of June 30, 2019 would be $        , of which $        and $        would have been related to stock options that were vested and unvested, respectively, at that date.

Estimated Fair Value of Share Purchase Rights, Redeemable Convertible Preferred Stock Warrants and Other Financial Instruments

From time to time, we enter into agreements with existing stockholders of our redeemable convertible preferred stock that contain future purchase obligations of redeemable convertible preferred stock at a fixed price. We evaluate these share purchase right agreements and assess whether they meet the definition of a freestanding instrument and, if so, determine the fair value of the share purchase right liability and record it on the balance sheet. The share purchase right liability is revalued at each reporting period with changes in the fair value of the liability recorded as a component of other income (expense) in the statement of operations. The share purchase right liability is revalued at settlement and the resultant fair value is then reclassified to redeemable convertible preferred stock at that time. The estimated fair value of the share purchase right liability is determined using valuation models that consider the probability of achieving the requisite milestones, our cost of capital, the estimated time period the preferred stock right would be outstanding, consideration received for the convertible preferred stock, the number of shares to be issued to satisfy the preferred stock purchase right and at what price, and probability of the consummation of an initial public offering, as applicable.

We account for our redeemable convertible preferred stock warrant liabilities as freestanding instruments for shares that are puttable or redeemable. These warrants are classified as liabilities on our balance sheet and are recorded at their estimated fair values. At the end of each reporting period, changes in estimated fair value during the period are recorded as a component of other income (expense), net in the accompanying statement of operations. We will continue to re-measure the fair value of the warrant liabilities until: (i) exercise; (ii) expiration of the related warrant; or (iii) conversion of the preferred stock underlying the security into common stock, which will occur in connection with the completion of this offering. We estimate the fair values of our warrant liabilities using an option pricing model based on inputs as of the valuation measurement dates, including the fair value of our redeemable convertible preferred stock, the estimated volatility of the price of our redeemable convertible preferred stock, the expected term of the warrants and the risk-free interest rates.

There are significant judgments and estimates inherent in the determination of the fair values of our preferred stock purchase right liabilities and redeemable convertible preferred stock warrant liabilities. If we had made different assumptions, the carrying value of these liabilities, net loss and net loss per share attributable to common stockholders could have been significantly different.

Acquisition-Related Liabilities

In connection with the acquisition of the medical diagnostics division of Cypress in 2010, we initially agreed to pay an additional amount not to exceed $9.0 million in the event specified revenue, contractual and product launch milestones are achieved. This contingent liability required the use of inputs which were not observable in the market to assess its fair value at the end of each reporting period. For this liability, fair value was determined based on probabilities assigned to the milestones being achieved, revenue projections, and interest rates. Changes in fair value were recorded in the statement of operations and comprehensive loss. In February 2017, we amended two of the remaining agreements for which a contingent payment amount had been originally agreed to. One contingent payment amount remains outstanding.

 

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Income Taxes

We operate in, and are subject to tax authorities in, various tax jurisdictions in the United States. To date, we have not been audited by the Internal Revenue Service or any state income tax authority, however all tax years remain open for examination by federal tax authorities.

At December 31, 2018, our deferred tax assets are primarily comprised of federal and state tax net operating loss carryforwards. We have performed an analysis to determine whether an “ownership change” occurred from inception to December 31, 2013. Based on this analysis, we determined that we did experience a historical ownership change of greater than 50% in 2008. Therefore, our ability to utilize our net operating losses incurred prior to this date is limited.

We are required to reduce our deferred tax assets by a valuation allowance if it is more likely than not that some or all of our deferred tax assets will not be realized. We must use judgment in assessing the potential need for a valuation allowance, which requires an evaluation of both negative and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. In determining the need for and amount of our valuation allowance, if any, we assess the likelihood that we will be able to recover our deferred tax assets using historical levels of income, estimates of future income and tax planning strategies. As a result of historical cumulative losses and uncertainties surrounding our ability to generate future taxable income and, based on all available evidence, we believe it is more likely than not that our recorded net deferred tax assets will not be realized. Accordingly, we have recorded a valuation allowance against all of our net deferred tax assets at December 31, 2018. We will continue to maintain a full valuation allowance on our deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of this allowance.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Please see our audited financial statements and notes thereto included elsewhere in this prospectus, which contain accounting policies and other disclosures required by GAAP.

Recently Adopted Accounting Standards

In May 2014, the FASB issued Accounting Standards Update, or ASU, 2014-09, Revenue from Contracts with Customers, which, along with subsequent amendments and addenda to this standard, provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We elected to early adopt this guidance on January 1, 2018 using a cumulative-effect adjustment to the opening balance of accumulated deficit and accounts receivable of $3.1 million. The cumulative-effect adjustment was the result of an acceleration of revenue recognition since we are required to estimate consideration to which we expect to be entitled rather than record revenue on a cash basis.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The amendments in this update require that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, companies will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents in the statement of cash flows. We adopted this guidance for our fiscal year beginning January 1, 2018 and adjusted the presentation of our Statement of Cash Flows to include our restricted cash balance with

 

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our non-restricted cash balances. Our restricted cash balance consists of a federally insured certificate of deposit held with an affiliate of a large publicly traded financial institution that secures our corporate credit card program. Due to the duration of this certificate of deposit, the amounts restricted as to use have been classified outside of cash and cash equivalents. The adoption of this guidance did not have a material impact on our financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. This guidance is intended to simplify the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today’s two-step impairment test under the guidance contained in ASC 350. Specifically, this guidance eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. We adopted this guidance on January 1, 2018 and the adoption did not have a material impact on our financial statements since we completed a qualitative assessment as of December 31, 2018.

Recent Accounting Pronouncements Not Yet Adopted

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The new topic supersedes Topic 840, Leases, and increases transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and requires disclosures of key information about leasing arrangements. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, which provides narrow amendments to clarify how to apply certain aspects of the new lease standard, and ASU 2018-11, Leases: Targeted Improvements, which was issued to provide relief to companies from restating comparative periods. Pursuant to this ASU, in the period of adoption we will not restate comparative periods presented in our financial statements. The effective date of this guidance for public companies is for reporting periods beginning after December 15, 2018, and periods beginning after December 15, 2019 for private companies. ASU 2016-02 mandates a modified retrospective transition method. We intend to adopt this new standard using a cumulative effect adjustment to accumulated deficit and will elect the package of practical expedients, which among other things will allow us to carry forward our historical lease classification. We are currently evaluating the impact of ASU 2016-02 on our financial statements.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement: Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which adds and modifies certain disclosure requirements for fair value measurements. Under the new guidance, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, or valuation processes for Level 3 fair value measurements. However, public companies will be required to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and related changes in unrealized gains and losses included in other comprehensive income. This update is effective for annual periods beginning after December 15, 2019, and interim periods within those periods, and early adoption is permitted. We are currently evaluating the impact of ASU 2018-13 on our financial statements.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements, as defined under the rules and regulations of the SEC.

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily relate to interest rates. As of June 30, 2019, we had cash and cash equivalents of $16.2 million, which consist of bank deposits and money market funds. Such interest-bearing instruments carry a degree of

 

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risk; however, we have not been exposed to, nor do we anticipate being exposed to, material risks due to changes in interest rates. A hypothetical 10% change in interest rates during any of the periods presented would not have had a material impact on our audited financial statements. Our long-term debt bears interest at a fixed rate.

JOBS Act Accounting Election

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an “emerging growth company.” The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to use this extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our audited financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.

We will remain an emerging growth company until the last day of our fiscal year following the fifth anniversary of the date of the first sale of our common equity securities pursuant to an effective registration statement under the Securities Act, which such fifth anniversary will occur in 2024. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer” as defined in Rule 12b-2 under the Exchange Act, our annual gross revenues exceed $1.07 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period.

 

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BUSINESS

Company Overview

Exagen is dedicated to transforming the care continuum for patients suffering from debilitating and chronic autoimmune diseases by enabling timely differential diagnosis and optimizing therapeutic intervention. We have developed and are commercializing a portfolio of innovative testing products under our AVISE® brand, several of which are based on our proprietary Cell-Bound Complement Activation Products, or CB-CAPs, technology. CB-CAPs assess the activation of the complement system, a biological pathway that is widely implicated across many autoimmune and autoimmune-related diseases, including systemic lupus erythematosus, or SLE. Our goal is to enable rheumatologists to improve care for patients through the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases, including SLE and rheumatoid arthritis, or RA. Our strategy includes leveraging our portfolio of testing products to market therapeutics through our sales channel, targeting the approximately 5,000 rheumatologists across the United States. Our business model of integrating testing products and therapeutics positions us to offer targeted solutions to rheumatologists and, ultimately, better serve patients.

We currently market nine testing products under our AVISE® brand, which we are leveraging to establish partnerships with leading pharmaceutical companies. In December 2018, we entered into a co-promotion agreement with Janssen Biotech, Inc., or the Janssen agreement, to exclusively promote SIMPONI® (golimumab), a subcutaneous, once-per-month, anti-tumor necrosis factor, or anti-TNF, biologic prescribed in combination with methotrexate, in the United States for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases. Combined U.S. sales of SIMPONI® and SIMPONI ARIA®, an intravenous formulation, were approximately $1.0 billion in 2018, of which we estimate approximately 50% was from sales of SIMPONI®. We began direct promotion of SIMPONI® in January 2019 and expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019 to support these promotion efforts. Unlike many diagnostic salesforces that are trained only to understand the comparative benefits of their tests, the specialized backgrounds of our salesforce coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified patient test reports and provide unique insights in a highly tailored discussion with rheumatologists. We therefore believe our strategy of integrating the promotion of testing products and therapeutics uniquely positions us to expand SIMPONI®’s U.S. market share. We expect our SIMPONI® promotion efforts to contribute incremental revenue in 2019 with our quarterly tiered promotion fee based on the incremental increase in total prescribed units above a predetermined average baseline of approximately 29,000 prescribed units per quarter.

We believe our strategy of integrating the promotion of testing products and therapeutics differentiates us from other diagnostic and pharmaceutical companies, and provides our specialized salesforce greater access to rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and who have a history using our portfolio of testing products.

Our lead testing product, AVISE® CTD, enables differential diagnosis for patients presenting with symptoms indicative of a wide variety of connective tissue diseases, or CTDs, and other related diseases with overlapping symptoms. The comprehensive nature of AVISE® CTD allows for the testing of a number of relevant biomarkers in one convenient blood draw, as opposed to testing serially for individual biomarkers, which adds time and cost to the diagnostic process. We believe AVISE® CTD may provide clinical utility for over 23 million patients in the United States suffering from these diseases, which include SLE, RA, Sjögren’s syndrome, antiphospholipid syndrome, or APS, other

 

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autoimmune-related diseases such as autoimmune thyroid, and other disorders that mimic these diseases, such as fibromyalgia. There is an unmet need for rheumatologists to add clarity in their CTD clinical evaluation, and we believe there is a significant opportunity for our tests that enable the differential diagnosis of these diseases, particularly for potentially life-threatening diseases such as SLE.

We have demonstrated a strong track record of developing innovative testing products that meet the needs of diagnosing, prognosing and monitoring CTDs, as illustrated below:

 

 

LOGO

AVISE® CTD leverages our proprietary CB-CAPs technology to enable the differential diagnosis SLE. AVISE® CTD provides rheumatologists and their patients with sensitive and specific results that allow for potentially faster and more accurate differential diagnosis of SLE as compared to other currently-marketed testing methods. Beyond SLE, AVISE® CTD allows rheumatologists to accurately diagnose other overlapping autoimmune and autoimmune-related diseases, including RA, with the same blood sample.

Our AVISE® SLE Monitor testing product also leverages our proprietary CB-CAPs technology by measuring two CB-CAPs biomarkers that offer insight into a patient’s disease activity. This test is designed to enable rheumatologists to effectively assess and optimize therapeutic intervention in patients diagnosed with SLE. Depending on disease severity, AVISE® SLE Monitor may be utilized by patients multiple times a year throughout their lives.

Our RA-focused testing products include AVISE® MTX and AVISE® Anti-CarP. AVISE® MTX is a drug monitoring test designed to aid in the optimization of methotrexate therapy, the standard of care and first-line therapy for patients with RA. AVISE® MTX is based on our proprietary methotrexate polyglutamate, or MTXPG, technology that measures blood levels of MTXPGs, the active metabolite of methotrexate linked to disease control in RA patients. Measuring MTXPGs allows rheumatologists to identify patients presenting with inadequate exposure to methotrexate enabling them to optimize dosing and achieve therapeutic levels commensurate with adequate disease control. AVISE® Anti-CarP, which measures anti-carbamylated protein antibody, or anti-CarP, was developed by the Leiden

 

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University Medical Center, and we recently introduced it as a biomarker-driven RA prognostic test through a distribution agreement with Inova Diagnostics, Inc. with the goal of identifying patients prone to more severe disease.

We market our AVISE® testing products using our specialized salesforce. Since the launch of AVISE® CTD in 2012 through December 31, 2018, we have delivered over 326,000 of these tests, representing a compound annual growth rate of 87%, with limited incremental investment in our commercial infrastructure. Approximately 83,000 AVISE® CTD tests were delivered in 2018, representing 18% growth over 2017, and the number of ordering physicians in the fourth quarter of 2018 reached 1,298, representing 18% growth over the same period in 2017. In the first half of 2019, 50,792 AVISE® CTD tests were delivered, representing approximately 30% growth over the same period in 2018, and the number of ordering physicians in the first half of 2019 reached 1,711. In the first half of 2019, we achieved a record number of 766 adopting physicians, which we classify as those who had previously prescribed at least 11 tests in a quarter, compared to 635 in the same period in 2018. Nearly 100% of adopting physicians continue to order tests in subsequent quarters. From launch of our direct promotion of SIMPONI® in January 2019 to the end of the second quarter of 2019, weekly ordering from healthcare providers increased by approximately 10% and total weekly prescriptions increased by approximately 17%.

In addition, we continue to populate a growing proprietary database of over 300,000 de-identified patient test results. We believe the insight emerging from these results has the potential to unlock value for pharmaceutical and biotechnology companies in the commercialization of therapeutics. We believe we also have the ability to further leverage our database to optimize patient selection in clinical trials for companies developing therapeutics for autoimmune and autoimmune-related diseases. We plan to collaborate with our existing and future pharmaceutical and biotechnology partners to help maximize the full value of our in-house database.

We believe our strategy of integrating the promotion of testing products and therapeutics differentiates us from other diagnostic and pharmaceutical companies, and provides our specialized salesforce greater access to rheumatologists. Unlike many diagnostic salesforces that are trained only to understand the comparative benefits of their tests, the specialized backgrounds of our salesforce coupled with our comprehensive training enables our sales representatives to interpret results from our de-identified test reports and provide unique insights in a highly tailored discussion with rheumatologists. Our integrated testing and therapeutics strategy results in a unique opportunity to promote and sell targeted therapies in patient focused sales calls with rheumatologists, including those with whom we have a longstanding relationship and who have a history using our portfolio of testing products.

We recently entered into the Janssen agreement for the promotion of SIMPONI® in order to advance our integrated testing and therapeutics strategy. To support the co-promotion of SIMPONI®, we expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019. This will enable us to conduct approximately 60,500 calls annually to rheumatologists, which we believe will enable us to achieve the optimal reach and frequency with rheumatologists. We also have agreements with other leading pharmaceutical companies, including GlaxoSmithKline LLC, or GSK, and Horizon Pharma USA, Inc., or Horizon Therapeutics, and Corrona, LLC, that leverage our testing products and the data generated from such tests. We provide GSK, a leader in lupus therapeutics, our test result data to provide market insight into and help increase awareness of the benefits of an early and accurate diagnosis of SLE. Our agreement with Horizon Therapeutics entails utilizing our AVISE® MTX test to report on levels of MTXPG in patients undergoing methotrexate therapy in combination with its anti-gout product KRYSTEXXA® in an ongoing Phase 4 clinical trial. We also provide Corrona, the operator of the largest real world observational database in RA containing data from over 40,000 patients, with testing services and support. We plan to pursue additional partnerships with a focus on integrating therapeutics that are synergistic with our evolving portfolio of testing products.

 

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We are led by an experienced management team with unique capabilities to execute on our strategy of integrating the promotion of testing products and therapeutics. Our senior management has an average of over 20 years of experience in the healthcare industry and many were previously involved with successfully building Prometheus Laboratories Inc., or Prometheus, which was focused on integrating diagnostics and therapeutics, prior to its acquisition by Nestlé Health Science S.A. in 2011.

Our Strategy

We develop and commercialize next-generation testing products and promote synergistic therapeutics to ultimately improve the continuum of care for patients suffering from debilitating and chronic autoimmune diseases. The key tenets of our business strategy include:

 

   

Drive additional market penetration for our testing products.    Our portfolio of testing products enables the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases. We have demonstrated a strong track record of commercial growth from our testing products, leveraging our specialized salesforce and expansive network of relationships with rheumatologists across the United States. We believe we are uniquely positioned to continue expanding our commercial presence within the autoimmune disease market and plan to continue to invest in our salesforce in order to achieve the optimal reach and frequency with rheumatologists. This will support our strategy of integrating the promotion of testing products and therapeutics. In addition, we will continue to expand our efforts in the targeted promotion and education of rheumatologists and payers as to the clinical and cost benefits of our testing products. We believe these efforts will position us to capture additional market share for our portfolio of testing products.

 

   

Integrate the promotion of testing products and therapeutics for autoimmune and autoimmune-related diseases.    Our integrated testing and therapeutics strategy leverages our sales and marketing efforts, targeting rheumatologists for the commercialization of our testing products to promote therapeutics. This establishes a compelling synergy compared to traditional pharmaceutical sales resulting in greater access to rheumatologists and positions us to potentially create value for pharmaceutical partners. In January 2019, we began our exclusive promotion of SIMPONI® in the United States, leveraging our integrated testing and therapeutics strategy, for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases.

 

   

Continue our track record of developing innovative testing products.    Since inception, we have demonstrated a strong track record of developing testing products that address the challenges in the differential diagnosis, prognosis and monitoring of patients with autoimmune and autoimmune-related diseases. We are leveraging our proprietary CB-CAPs and MTXPG technologies to develop additional testing products designed to have superior clinical utility for CTDs. We believe our commitment to innovating our portfolio of testing products will further strengthen our relationships with rheumatologists and our value proposition to our existing and future pharmaceutical and biotechnology partners.

 

   

Establish additional therapeutic partnerships.    We believe our agreements with Janssen Biotech, Inc., or Janssen, and other leading pharmaceutical companies validate our unique value proposition to pharmaceutical companies seeking a competitive edge for commercializing therapeutics for autoimmune and autoimmune-related diseases. We intend to leverage our integrated testing and therapeutics strategy to establish additional partnerships with a focus on the commercialization of therapeutics that are synergistic with our testing products.

 

   

Achieve meaningful margin expansion.    We believe growth from the promotion of therapeutics will meaningfully improve our margin profile and further support our goal of achieving profitability. We also expect an increase to our gross margins in January 2020

 

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onwards upon the expiration of a 10% annual royalty on our CB-CAPs technology. In addition, we believe we are well positioned to drive further margin expansion through a continued focus on increasing operating leverage through the implementation of certain internal initiatives, such as conducting additional validation and reimbursement oriented clinical studies to facilitate payer coverage of our testing products, capitalizing on our growing reagent purchasing to negotiate improved volume-based pricing and automation in our clinical laboratory to reduce material and labor costs.

Autoimmune and Connective Tissue Diseases

Autoimmune diseases encompass a broad range of serious, chronic and debilitating conditions in which a person’s immune system creates antibodies that mistakenly react against normal healthy tissues causing inflammation and irreversible tissue damage. These antibodies are called autoantibodies and their detection through blood tests can help diagnose, prognose and monitor the course of autoimmune diseases. However, knowing when and which autoantibody to test for is challenging due to the vagueness of symptoms, the unexplained flaring and remission of symptoms, and the many conditions which can mimic autoimmune disease. Early and accurate diagnosis of the conditions causing these overlapping symptoms is critical as an incorrect diagnosis can lead to toxicity from inappropriate medications, irreversible tissue damage and other comorbidities associated with uncontrolled disease. There is no known cause or cure for these chronic conditions and current treatment interventions are targeted at managing symptoms and limiting disease progression.

CTDs are a sub-category of autoimmune diseases involving inflammation of the joints, tissues and internal organs. Persons with CTDs often present to their rheumatologist with complaints of joint pain, fatigue, unexplained fever, inflammation, rash, stiffness and muscle aches. These symptoms overlap among numerous CTDs, including SLE, one of the most severe CTDs and historically difficult to rule out, as well as other autoimmune-related diseases and other disorders that mimic these diseases, such as fibromyalgia. Based on a study we commissioned in 2014, we estimate that there are approximately 23 million undiagnosed patients in the United States who are symptomatic of these conditions and who may benefit from the differential diagnosis of CTDs. Of these patients, we estimate approximately seven million are potentially referable to rheumatologists and would be candidates for an AVISE® CTD test, representing a total addressable market of approximately $3.7 billion, based on the current Medicare allowable reimbursement rate. We estimate the total addressable market for our AVISE® testing products to be approximately $5 billion, based on estimated patient populations, the current Medicare allowable reimbursement rate and testing frequencies.

Systemic Lupus Erythematosus

SLE, the most common and severe form of lupus, is a chronic, inflammatory disorder that can damage any part of the body, including the skin, joints and internal organs. The blood of a person afflicted with SLE contains autoantibodies, which are the cause of the inflammation and organ damage and are one indicator of immune system abnormalities. SLE is characterized by a rise in symptoms and/or abnormal laboratory test results. SLE varies in severity, from mild cases to those in which significant and potentially fatal damage occurs to vital organs such as the brain, heart, kidneys and lungs. Detection of these autoantibodies can assist rheumatologists in the diagnosis of SLE. Diagnosis of SLE allows rheumatologists to initiate the most appropriate therapy to minimize irreversible organ damage and reduce morbidity and mortality. Current treatment for SLE involves the use of antimalarials, corticosteroids, immunosuppressants and biologic agents to prevent or suppress active disease or flares.

Standard laboratory tests for diagnosing SLE include measuring immunological biomarkers, such as antinuclear antibodies, or ANA, anti-double stranded DNA, or anti-dsDNA, and other autoantibody tests. ANA are a group of autoantibodies produced by a person’s immune system when it fails to

 

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adequately distinguish between self and non-self. The ANA test detects these autoantibodies in the blood and is a useful screening tool for SLE and other autoimmune and autoimmune-related diseases. The vast majority of SLE patients test positive for ANA. However, the high sensitivity of ANA for SLE is counterbalanced by somewhat poor specificity. Sensitivity measures the proportion of patients who are correctly identified as having a particular condition, while specificity measures the proportion of patients who are correctly identified as not having a particular condition. Therefore, the majority of individuals who test positive for ANA do not have SLE. Only approximately 11-13% of individuals with a positive ANA test have SLE. This lack of specificity leads to many inappropriate non-autoimmune referrals to the rheumatologist from primary care physicians. For example, it has been reported that 30% of fibromyalgia patients may test positive for ANA, potentially generating as many as four million inappropriate rheumatology referrals. In addition, a study published in 2012 reported the estimated prevalence of a positive ANA test in the normal, healthy, U.S. population to be 13.8%, or 32 million people, indicating a significant need for a highly-specific test for this disease.

Anti-dsDNA are autoantibodies that target a person’s double stranded DNA. The anti-dsDNA antibody test is a very specific test for SLE as anti-dsDNA antibodies are rarely found in autoimmune diseases other than SLE. A strongly positive anti-dsDNA antibody test makes it very likely that a person has SLE, although if the test is negative it does not necessarily rule out SLE. Approximately 30-70% of people with SLE have a negative anti-dsDNA antibody test, reaffirming the need for an effective testing product which adds clarity to the rheumatologist’s clinical assessment.

Activation of the complement system is an integral part of the disease process of SLE. Thus, rheumatologists measure components of the complement system, including serum levels of C3 and C4, to help diagnose SLE and monitor SLE disease activity. In 2012, the Systemic Lupus Collaborating Clinics added low C3 and low C4 as immunologic criteria for classifying SLE. In active SLE, C3 and C4 complement proteins are consumed and broken down to fragments, known as complement activation products. Therefore, low levels of C3 and C4 suggest a diagnosis of SLE and that the disease is active. However, variability in the levels of C3 and C4 can occur due to factors unrelated to SLE disease presence or disease activity, making them less reliable as biomarkers for SLE. For example, C3 and C4 are acute phase reactants and produced during inflammation. As a result, many SLE patients have normal complement levels even when the disease is active. Although relatively specific for SLE, low complement levels can also be seen in certain chronic infections, including non-lupus related kidney inflammation, severe liver disease and other autoimmune diseases. CB-CAPs are formed when the fragments of complement activation products from C4 bind permanently to circulating cells such as red blood cells, b-cells and platelets. This binding lasts for the life of the cell and represents a more stable and reliable indicator of complement activation than measuring C3 and C4 alone.

In March 2011, the first new biologic drug targeting treatment of SLE in over 50 years, GSK’s Benlysta®, was approved by the U.S. Food and Drug Administration, or the FDA. It is the only approved biologic for the treatment of SLE. Since its approval, there have been a number of drug development programs that have failed in SLE, which may suggest that guidelines for classifying SLE patients and the endpoints used to determine clinical effectiveness have not adequately addressed the complexity of the disease process and its heterogeneous population. We believe biopharmaceutical companies would benefit from the differential diagnosis enabled by our AVISE® testing products in order to better identify sub-populations of SLE patients for targeted therapies.

Rheumatoid Arthritis

RA is a chronic, systemic autoimmune disease in which the immune system attacks the joints and can also affect other organ systems. The annual incidence and prevalence of RA in the United States is estimated to be 75,000 and 1.75 million, respectively. Patients suffering from RA develop joint damage that is associated with painful inflammation which often progresses to irreversible damage of

 

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cartilage and bone leading to significant disability and a reduction in quality of life and the ability to work. Early diagnosis and effective treatment of RA is critically important to prevent erosive bone or joint damage and disability. Rheumatologists are compelled to reach a definitive diagnosis quickly and administer effective treatment.

Diagnosis of RA involves performing a complete medical history with physical and/or radiographic examination of the number and distribution of swollen, tender and painful joints that have persisted for more than six weeks. Laboratory testing for rheumatoid factor, or RF, anti-cyclic citrullinated peptide, or CCP, antibodies, and testing for general, nonspecific inflammation with erythrocyte sedimentation rate, or the ESR, and C-reactive protein tests are used to assist in the diagnosis.

The standard of care for the treatment for RA involves the use of Disease Modifying Anti-Rheumatic Drugs, or DMARDs, which have shown, in clinical studies, the ability to slow or stop disease progression. Methotrexate remains the most commonly used DMARD, due to its low cost, effectiveness, and the extensive clinical experience with its use. It is estimated that approximately 74% of RA patients in the United States, or 1.3 million patients, are treated with methotrexate, either as a monotherapy or in combination with another DMARD.

Biologics DMARDs are proteins that have been genetically modified to target cellular components of the immune system that attack healthy tissues causing the symptoms of RA. They are a targeted form of therapy, which makes them different from traditional RA treatments, such as methotrexate. The first FDA approved biologics for RA were the anti-TNFs. ENBREL® was approved for RA in 1998 and the latest, SIMPONI®, was approved in 2009. The anti-TNFs dominate the therapy for RA and generally are the first biologics chosen to augment methotrexate when patients are not achieving a satisfactory response.

Our Solution

We currently market nine testing products under our AVISE® brand that allow for the differential diagnosis, prognosis and monitoring of complex autoimmune and autoimmune-related diseases, including SLE and RA. Our product portfolio integrates our proprietary CB-CAPs technology, which is a stable and reliable method for differentially diagnosing SLE. We focus on leveraging our portfolio of testing products to promote therapeutics through our sales channel targeting the approximately 5,000 rheumatologists across the United States. In December 2018, we entered into the Janssen agreement to exclusively promote SIMPONI® in the United States for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases. In January 2019, we began direct promotion of SIMPONI® with our specialized salesforce.

Our Proprietary Technologies

We have two core proprietary technologies, CB-CAPs and MTXPGs, which form the backbone of several of our testing products.

CB-CAPs

Our proprietary CB-CAPs technology determines the blood levels of complement activation proteins permanently deposited on hematopoeitic cells. The determination of complement proteins in a patient’s blood is a mainstay in clinical laboratory science, and state-of-the-art methods traditionally rely on measurement of serum or plasma levels of soluble complements. C3 and C4 are the most commonly determined complement proteins in the blood and the precursors to activation of complement proteins into biologically active breakdown products. However, there are limitations with measuring C3 and C4 blood levels as indicators of complement activation. For example, increased synthesis of C3 and C4 by the liver can offset increased C3 and C4 breakdown during activation of the complement cascade, resulting in no change in serum levels. While the limitations and drawbacks of

 

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measuring standard components of the complement system, such as C3 and C4, are well recognized by the medical community, these laboratory biomarkers are part of international guidelines for the classification of SLE.

We believe the availability of novel complement biomarkers supporting or replacing standard C3 and C4 measures will be of great value for rheumatologists and ultimately their patients. Our CB-CAPs technology directly measures protein products of complement activation, such as C4d, the product of C4 activation. These complement activation products become stably attached to surfaces of circulating blood cells to become CB-CAPs. As such, the determination of CB-CAPs in the blood provides benefits when compared to the traditional complement measurement. These include the stable, accurate and unequivocal information of complement activation that enable consistent measurement and an improved ability to assess and monitor changes in biological activity related to activation of the complement system. In a head-to-head study published in 2014, CB-CAPs (EC4d or BC4d) showed 22% higher sensitivity (66%) than C3 and C4 (44%) in diagnosing SLE, with specificity fixed at 91%.

MTXPGs

Methotrexate is the standard of care and first-line treatment of many autoimmune diseases including RA and psoriatic arthritis. Our proprietary technology measures blood levels of MTXPGs, which are the active metabolite of methotrexate. The technology uses a dried capillary blood-based collection method coupled with liquid chromatographic tandem mass spectrometry and quantifies nanomolar concentrations of MTXPG using at least two orders of magnitude lower blood volume than venipuncture. MTXPG blood levels are actionable clinical utility checkpoints and can help clinicians identify causes for a lack of response to methotrexate, such as poor activation to active metabolites, underexposure secondary to poor absorption or poor compliance, all of which are limiting factors to the achievement of a robust clinical response with this first-line treatment. We believe we can leverage this technology to optimize anti-TNF treatment by reducing the formation of anti-drug antibodies that are known to impact the clinical efficacy of these drugs.

Testing Products

Since inception, we have been committed to developing and commercializing innovative testing products that address the challenges rheumatologists face in differentially diagnosing, prognosing and monitoring complex autoimmune and autoimmune-related diseases. We estimate the total addressable market for our AVISE® testing products to be approximately $5 billion, based on estimated patient populations, the current Medicare allowable reimbursement rate and testing frequencies.

Diagnosis

AVISE® CTD

Our lead testing product, AVISE® CTD, is a comprehensive test that aids in the differential diagnosis of SLE versus other common CTDs. The SLE portion of the test employs our proprietary CB-CAPs technology and specifically measures activation of the complement system by quantifying the level of two CB-CAPs biomarkers in the patient’s blood, B-cell C4d, or BC4d, and erythrocyte bound C4d, or EC4d, which are higher in patients with SLE compared to patients with other CTDs. In addition, the comprehensive nature of AVISE® CTD enables testing for a series of 22 biomarkers in one convenient blood draw to further aid in the differential diagnosis of a wide variety of CTDs and other diseases which can be challenging to diagnose as a result of overlapping symptoms. These diseases include SLE, RA, Sjögren’s syndrome, APS, other autoimmune-related diseases such as autoimmune thyroid, and other disorders that mimic these diseases, such as fibromyalgia. Our test’s ability to allow rheumatologists to effectively rule out SLE and differentially diagnose other CTDs such as RA adds clarity to the rheumatologist’s assessment, thereby making the evaluation process more efficient and accurate. The clinical performance of our proprietary biomarkers and the convenience of a single blood draw make AVISE® CTD an attractive choice among rheumatologists.

 

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AVISE® Lupus

The AVISE® Lupus test employs our proprietary CB-CAPs technology and is the cornerstone of the SLE assessment within our more comprehensive AVISE® CTD testing product. AVISE® Lupus measures activation of the complement system by quantifying the level of BC4d and EC4d in the patient’s blood. Rheumatologists choose to order the comprehensive AVISE® CTD test or the more focused AVISE® Lupus test based on medical necessity, which is determined by each patient’s symptoms and medical history.

AVISE® APS

AVISE® APS consists of a specialized panel of eight autoantibody tests. This test aids in both the diagnosis and management of APS, a hyper-coagulation state leading to thrombosis, pregnancy complications, and even death. Rheumatologists would typically request the AVISE® APS test in patients who initially tested positive for one or more APS biomarkers contained in AVISE® CTD, or in the management of patients experiencing a high-risk pregnancy.

Prognosis

AVISE® SLE Prognostic

AVISE® SLE Prognostic is a ten-biomarker panel of autoantibodies that have established predictive value for assessing the potential for complications affecting the kidney, brain and cardiovascular system, including lupus nephritis and lupus psychosis. Rheumatologists rely on insights from the AVISE® SLE Prognostic test to help tailor their treatment approach.

AVISE® Anti-CarP

We were the first commercial laboratory to make testing for anti-CarP available in the United States with the introduction of AVISE® Anti-CarP in 2018. This test uniquely addresses two major challenges facing rheumatologists today – (1) patients presenting with RA symptoms but lacking the common confirmatory blood tests for anti-RF or anti-CCP, known as sero-negative patients, and (2) the lack of a serologic indicator, which indicates a poor prognosis and helps guide treatment decisions. Anti-CarP can be positive in up to 26% of RA patients who are negative for anti-CCP. Furthermore, RA patients positive for Anti-CarP have an increased risk for more severe RA disease, including permanent joint damage.

AVISE® PC4d

AVISE® PC4d is one of our newest offerings, which reflects over 10 years of research efforts and employs our proprietary CB-CAPs technology. This proprietary CB-CAP biomarker measures platelet- bound C4d, or PC4d, and has been shown in clinical studies to have significant association with thrombosis and ischemic stroke in SLE. These thrombotic events can be among the most damaging and deadly forms of lupus flares and often strike without warning. Because of its strong association with thrombosis, we believe AVISE® PC4d promises to be a valuable tool for SLE disease monitoring.

Monitoring

AVISE® SLE Monitor

AVISE® SLE Monitor is a six-biomarker blood test that employs our proprietary CB-CAPs technology and is intended to assess the condition of a patient that has been diagnosed with SLE. It offers a unique combination of biomarkers that measure for EC4d, which has shown greater accuracy in tracking disease activity than C3 and C4, and PC4d, which is associated with thrombosis risk in SLE. AVISE® SLE Monitor offers additional insight into a patient’s disease activity as well as possible adverse events. Rheumatologists have limited methods for evaluating the extent of disease activity

 

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taking place inside the body of an SLE patient. They rely on imperfect biomarkers, overt symptoms or flares, and patient reported history, all of which leave the rheumatologists looking for greater insights. In surveys conducted with SLE patients, it has been reported that patients tend to under report their symptoms and over 70% of physicians are unaware of this bias. AVISE® SLE Monitor demonstrates correlation to SLE disease activity and is therefore designed to enable rheumatologists to effectively assess and optimize therapeutic intervention in patients diagnosed with SLE. Depending on disease severity, our AVISE® SLE Monitor testing product may be utilized by patients multiple times a year and throughout their lives. We believe AVISE® SLE Monitor will play an increasingly important role in the management of SLE patients and further solidify the role and relationship of AVISE® testing products for these patients.

AVISE® MTX

AVISE® MTX is a patented and validated blood test that precisely measures levels of MTXPG, the active form of methotrexate, in the patient’s blood. There is large variability in the way patients absorb and metabolize methotrexate, leaving rheumatologists unsure of what steps to take when a patient has an inadequate response. Methotrexate is the most widely prescribed drug by rheumatologists in the treatment of RA. When faced with a patient who is not responding to methotrexate therapy, the options include increasing the dose, switching to a parenteral delivery method and/or advancing to a more costly biologic therapy. AVISE® MTX provides crucial information as to whether a patient has achieved MTXPG blood levels consistent with an appropriate response to methotrexate, also known as the therapeutic level, or if the MTXPG blood levels are too low to produce adequate effects. The rheumatologists can then make informed therapeutic decisions to optimize methotrexate therapy and give patients their best chance at achieving an optimal response.

AVISE® MTX is compatible with AVISE® Touch, our low-volume test sample collection method that allows for a micro-volume blood sample to be collected anywhere from a simple fingerstick. AVISE® Touch has a number of advantages, including empowering rheumatologists to collect and submit samples without full phlebotomy services, convenience for patients who have trouble with venipuncture and potential patient self-collection.

AVISE® HCQ

AVISE® HCQ is a blood test designed to help rheumatologists objectively monitor levels of hydroxychloroquine, or HCQ, in whole blood as they treat patients with SLE and other CTDs, including RA. HCQ is typically prescribed to patients to control SLE disease activity and prevent flares. However, there is large variability in the response to HCQ therapy, the drug can sometimes take weeks or months to have a therapeutic effect and compliance has been documented to be an issue in CTD patients. We believe measuring HCQ makes the patient accountable, and also helps to determine whether HCQ blood levels are adequate and consistent with clinical efficacy. The addition of new and costly biologic therapies approved for the treatment of SLE may drive interest by all healthcare stakeholders, especially payers, to adopt an approach that optimizes a generic drug before advancing to a costlier alternative. AVISE® HCQ is also compatible with AVISE® Touch.

Test Reports

We provide the results of our AVISE® testing products in a comprehensive and easy-to-understand test report typically sent to rheumatologists within five business days following receipt of the blood specimen. As shown below, the result of the AVISE® Lupus portion of the AVISE® CTD report displays a gradient illustrating the likelihood of the presence of lupus, which facilitates interpretation and discussion of the result with the patient versus only reporting a numerical value.

 

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In addition, all biomarker results for AVISE® CTD are reported and organized by disease state, providing clarity and convenience for the rheumatologists. A sample of the full AVISE® CTD report is shown below:

AVISE® CTD Report

 

 

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Order ID 200432 Provider Example Provider MD Specimen Collected 05/30/2016 Received 05/16/2016 Test Order Created 06/01/2016 Reported 06/02/2016 Patient Sample, Nancy S Gender - DOB Female - 01/25/1974 Identifier Received Exagen ID 300955 AVISE lupus Test Report AVISE Lupus Result: Positive- Index: 1.4 Tier1Tier 1 AnalytesValueInterpretationReference RangeAssessmentAnti-dsDNA lgG20IU/mlNegative<302- Negative I e 302 - PositiveConfirmation by Crithidia luciliaeN/AAnti-Smith lgG<1U/mlNegative<5- Negative I 5-10 - Equivocal I >10- PositiveNegativeCB-CAP: EC4d - Erythrocyte-bound C4d25Net MFIPOSITIVE<15- Negative 15 -75- Positive I >75- Strong PositiveCB-CAP: BC4d- B-lymphocyte-bound C4d100Net MFIPOSITIVE<61- Negative I 61-200- Positive I >200- Strong PositiveNote:Criteria for Tier 1 Positive not met.Tier 2Tier 2 AnalytesValueInterpretationReference RangeAssessmentANA igG40 UnitsPOSITIVE<20- Negative I 2O-59- Positive I e60- Strong PositiveCB-CAP: EC4d - Erythrocyte-bound C4d25Net MFIPOSITIVE<15- Negative I 15-75- Positive I >75 - Strong PositiveCB-CAP: BC4d - B-lymphocyte-bound C4d100Net MFIPOSITIVE<61- Negative 161-200- Positive I >200 - Strong PositiveAnti-SS-B/La lgG1U/mlNegative<7 - Negative I 7-10 - Equivocal I >10 -PositivePositiveAnti-Scl-70 lgG<1U/mlNegative<7 - Negative I 7-10 - Equivocal I >10 -PositiveAnti-CENP lgG<1U/mlNegative<7 - Negative I 7-10 - Equivocal I >10 -PositiveAnti-Jo- I1gG<1U/mlNegative<7 - Negative I 7-10 - Equivocal I >10 -PositiveAnti-CCP lgG2U/mlNegative<7 - Negative I 7-10 - Equivocal I >10 - PositiveNote:This assessment is associated with an increased likelihood of SLE.Test Method Description Results were obtained using flow cytometry for complement C4d fragment bound to erythrocytes (EC4d) and B-lymphocytes (BC4d). Autoantibodies were determined using solid phase immunoassays. ANA was determined by Indirect lmmunofluorescence and solid phase assays. ANA by solid phase assays was used for the Index calculation. in a study of 794 subjects comprising 304 SLE patients, 285 patients with other rheumatic diSeases and 205 normal healthy controls, positivity for Tier 1 markers (anti-dsDNA, confirmed using Crithidia, anti-Sm or elevated EC4d and BC4d) was associated with a sensitivity of 46% and a specificity of 97%. Among the 440 subjects negative In Tier 1, a positive index score composite of ANA (by ELISA), EC4d/BC4d and positivity for anti-citrullinated peptide antibodies, SS-B/La, CENP, Jo-1 or Scl-70 resulted in sensitivity of 62% for SLE and specificity of 89%. Two tier combination yielded 80% sensitivity for SLE and 86% specificity for other rheumatic diseases (98% specificity vs. healthy). Page 1 of 2

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Order ID 200402 Provider Example Provider MD Specimen Collected 09/29/2016 Received 09/30/2016 Test Order Created 09/30/2016 Reported 10/02/2016 patient sample, susan s gender DOB Female -01/24/1974 identifier received Exagen id 300955 SLE- associated analytes value interpretation reference range + ANA igG 40 Units positive ELISA: <20- Negative I 20-59 - Positive I e60-Strong Positive + HEp-2 cell fluorescence Titer: 1:320 POSITIVE IFA: <1:80- Negative I e1:80- Positive Nuclear Pattern: Speckled Cytoplasmic Pattern: Not Observed Anti-dsDNA- lgG 20 IU/mL Negative ELISA: <302-positive :Anti-dsDNA- confirmatory N/A IFA- using Crithidia luciliae Anti-Smith lgG 1 U/mL Negative ELISA: <5- Negative I 5-10- Equivocal I >10- Positive + CB-CAP: EC4d- + Erythrocyte-bound C4d 25 Net MFI positive FACS: <15- Negative / 15-75- Positive I >75- Strong Positive CB-CAP: BC4d - B-lymphocyte-bound C4d 100 Net MFI POSITIVE FACS: <61- Negative I 61-200- Positive I >200- Strong Positive other autoimmune disease auto-antibodies value interpretation reference range Anti-U1RNP lgG 20 U/mL POSITIVE ELISA: <7- Negative I 7-10- Equivocal I >10 - Positive Anti-RNP70 lgG 3 U/mL Negative ELISA: <7- Negative I 7-10- Equivocal I >10 - Positive Anti-Ss-A/Ro lgG 2 U/mL Negative ELISA: <7- Negative I 7-10 - Equivocal I >10 - Positive Anti-ss-B/la lgG 1 U/mL Negative ELISA: <7- Negative I 7-10- Equivocal I >10 - Positive Anti-Scl-70 lgG <1 U/mL Negative ELISA: <7- Negative | 7-10- Equivocal 1 >10 - Positive Anti-CENP lgG 1 U/mL Negative ELISA: <7- Negative I 7-10- Equivocal I >10 - Positive Anti-Jo-1 lgG <1 U/mL Negative ELISA: <7- Negative I 7-10- Equivocal I >10 -Positive Rheumatoid Arthritis auto-Antibodies value interpretation reference range Rheumatoid Factor lgM 2.0 U/mL Negative ELISA: <3.5- Negative I 3.5-5- Equivocal I >5- Positive Rheumatoid Factor lgA 1 U/mL Negative ELISA: <14- Negative I 14-20- Equivocal I >20- Positive Anti-CCP lgG 2 U/mL Negative ELISA: <7- Negative I 7-10 - Equivocal I >10 Positive+ Anti-Carbamylated Protein (CarP) lgG 22 U/mL POSITIVE ELISA: <20 - Negative I >20 .P0sitive Antiphospholipid Syndrome Auto-Antibodies Value lnterpretation Reference Range Anti-Cardiolipin lgM 2 cu Negative ELISA: <20 - Negative I >20- Positive Anti-Cardiolipin lgG <6 cu Negative ELISA: <20 - Negative I >20- Positive anti-b2 Glycoprotein 1lgG <6 cu Negative ELISA: <21 - Negative I >21 - Positive Anti-b2 Glycoprotein 11gG <6 cu Negative ELISA: <21- Negative I ~21- Positive Thyroid Auto-Antibodies Value lnterpretation reference range Anti-Thyroglobulin lgG <12 IU/mL Negative ELISA: <40- Negative I 40-60- Equivocal I >60- Positive Anti-Thyroid Peroxidase lgG <4 IU/mL Negative ELISA: <25- Negative I 25-35 -Equivocal I >35 -Positive NOTES: in the context of suspected RA, elevated anti-CarP antibodies are associated with more aggressive disease. The significance of a positive anti-CarP value In the absence of RA has not been established. References 1. Thermo Fisher/Connective Tissue Marker references and results (Phadia product inserts). 2. Manzi 5 et al. Measurement of erythrocyte C4d and complement receptor 1 in systemic lupus erythematosus. Arthritis Rheum. 50(11):3596-604.2004. 3. Kalunian et al. Measurement of cell-bound complement activation products enhances diagnaostic performance in systemic lupus erythematosus Arthritis Rheum .2012 dec; 64 (12): 4040-7Putterman et al. An Assay panel Combining Cell Bound Complement Activation Products With Autoantibodies To Extractable Nuclear antigens and mutated citrullinated vimentin helps with the differential diagnosis of systemic lupus erythematosus. Arthristis rheumatism 2013 suppl (s2525). Page 2 of 2 1261 Liberty Way, Vista CA CLIA #05D1075048 CAP # 7201051 I PFI #8369 Laboratory Directors: Richard Safrin. MD Thierry dervieux, PhD, dABCC Provider Relations: 888.452.1522 Exagen, AVISE and the AVISE the and exagen logos are registered trademarks of exagen diagnostics,inc2018 all rights reserved This test is used for clinical purposes, though results are not intended to be used as the sole means for clinical diagnosis or patients management decisions. It should not be regarded as investigational or for research. IT HAS NOT BEEN CLEARED or approved by the FDa. Exagen is regulated under the CLIA as qualified to perform high-complex testing. Sa1049 (8/18)

 

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Therapeutics

In December 2018, we entered into the Janssen agreement to exclusively promote SIMPONI® in the United States for the treatment of adult patients with moderate to severe RA and for other indicated rheumatic diseases. Combined U.S. sales of SIMPONI® and SIMPONI ARIA® were approximately $1.0 billion in 2018, of which we estimate approximately 50% was from sales of SIMPONI®.

We began direct promotion of SIMPONI® with our specialized salesforce in January 2019 and expanded our salesforce from 31 representatives as of December 31, 2018 to 55 representatives in August 2019. This will enable us to deliver approximately 60,500 calls annually to rheumatologists, which we believe will enable us to achieve the optimal reach and frequency, and support our strategy of integrating the promotion of testing products and therapeutics. We believe that educating providers regarding SIMPONI® has and will continue to facilitate greater acceptance of SIMPONI®. From the date we began our promotion of SIMPONI® through June 30, 2019, SIMPONI® unit prescriptions increased by approximately 17%.

Our AVISE® MTX test can identify methotrexate patients with inadequate methotrexate exposure who are potential candidates for SIMPONI® therapy. Our AVISE® Anti-CarP test can identify RA patients with more severe disease requiring more aggressive therapy, such as anti-TNF biologics like SIMPONI®. We believe our strategy of integrating the promotion of testing products and therapeutics, combined with our specialized salesforce, uniquely position us to expand SIMPONI®’s U.S. market share. We will receive a quarterly tiered promotion fee ranging from $750 to $1,250 per prescription based on incremental total prescribed units above a predetermined average baseline of approximately 29,000 prescribed units per quarter for an initial term of 18 months. We estimate the total U.S. addressable market for SIMPONI’s ® approved indications, including RA, psoriatic arthritis and ankylosing spondylitis, to be approximately $28 billion. Based on this estimated market size, each incremental 1% market share we are able to capture for SIMPONI® above the predetermined baseline could result in incremental revenue to us of $84 million. For more information regarding the Janssen agreement, see “—Agreements with Pharmaceutical Companies.”

In recent years, advancements in the understanding of the autoimmune and autoimmune-related disease process have led to a significant number of novel biologic drugs and drug development initiatives, especially in RA and SLE, and we intend to leverage our integrated testing and therapeutics strategy to establish additional partnerships with a focus on the commercialization of therapeutics that are synergistic with our testing products.

Our Pipeline and Growth Opportunities

We believe there is significant potential to capitalize on our proprietary CB-CAPs and MTXPG technologies by integrating those technologies with commercially validated biomarkers to develop testing products with superior clinical utility. The complement pathway is widely implicated in the pathogenesis of a variety of conditions, including autoimmune diseases and organ transplant rejection, and emerging data suggests its implication in cancer development. We believe that our proprietary CB-CAPs technology, owing to its stability and reliability, will allow us to produce meaningful and differentiated proprietary solutions for rheumatologists. For example, we are focused on leveraging our proprietary CB-CAPs technology by developing a thrombosis risk score with PC4d in prognosing cardiovascular events in SLE. We plan to initiate proof of concept studies to develop alternatives to biopsy in the monitoring of transplant rejection and the differential diagnosis of fibromyalgia in the primary care physician setting. In addition, we are developing a panel of antibody systems that we believe may have high prognostic value in patients with RA, Sjögren’s, fibromyalgia and autoimmune thyroid, and we continue to evaluate the use of AVISE® Touch and microfluidics for our broader portfolio of testing products to increase convenience and cost-effectiveness.

Sales and Marketing

Our specialized salesforce is focused on targeting the approximately 5,000 rheumatologists across the United States. Our sales representatives generally have extensive experience in healthcare sales

 

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with backgrounds in rheumatology, biologics, specialty therapeutics and/or testing. In addition, our sales representatives complete a comprehensive disease-level sales training program and are required to participate in regular, ongoing training activities and certifications.

Our sales model involves integrating the promotion of testing products and therapeutics in a unique approach that will enable our sales representatives to gain greater access and time with rheumatologists. The test information available to our sales representatives creates a different dynamic as compared to a traditional drug sales representative’s product detail. It enables a timely, extended, patient-focused discussion that naturally transitions to a therapeutic discussion during the same sales call. Our goal is for our sales representative to be viewed as a collaborative consultant versus a traditional drug sales representative. We intend to capitalize on our established reputation, market presence and expertise to sell additional products and services into the autoimmune and autoimmune-related disease market. We believe that a collaborative relationship with rheumatologists helps build a lasting sales channel through which additional products and services can be introduced.

As of June 30, 2019, our overall sales team consisted of approximately 64 members, including 53 sales representatives, six regional sales directors, two vice presidents and three managed care professionals. In connection with the promotion of SIMPONI®, we expanded the number of sales representatives from 31 representatives as of December 31, 2018 to 55 representatives in August 2019, who will be managed by a team of six regional sales directors. Our increased salesforce will allow for expansion into markets not previously covered by us. In addition, this salesforce expansion is estimated to double the number of sales calls made per year, helping us to cultivate a strong collaborative relationship with rheumatologists through increased interactions. To further support our promotional efforts, we have a centralized, dedicated client services department with a high level of technical training that augments our specialized salesforce and marketing activities and enhances sales efficiency and customer satisfaction by providing personalized customer support.

Right Doctor, Right Message, Right Frequency

We believe our sales model of integrating the promotion of testing products and therapeutics will be complemented by our focused “high-touch” selling approach that emphasizes execution in three core areas: targeting, messaging and call frequency. We strategically target the highest-potential practices by utilizing various data sources (e.g., market analytics, demographic data, historical biologic and diagnostic product usage trends). Furthermore, we believe the increased access afforded by our testing products will allow for patient-focused messaging, including safety and efficacy data for SIMPONI® and the increased accuracy of our testing products over current standard of care diagnostic methodologies. Finally, we execute a high-frequency promotional strategy for our top targeted rheumatologists and their office personnel to build knowledge, understanding and retention of the benefits of SIMPONI® and our testing products.

We plan to leverage core channels for building awareness and adoption including our participation with multiple patient advocacy organizations, such as the Lupus Foundation of America, or LFA, and medical societies, such as the American College of Rheumatology, or ACR. We have also established strong relationships with multiple rheumatology care management organizations, or super groups, which can be key in influencing favorable reimbursement. Our AVISE® MTX testing product has been included in the clinical guidelines for two of these groups. We believe our experience with advancing a testing product from initial development through clinical adoption differentiates us and uniquely positions us to replicate success with our other testing products. Beyond working with these groups, we intend to continue to augment field selling activity with a balanced marketing mix including print and digital advertising, direct marketing, continuing medical education programs and working with key opinion leaders to support peer-to-peer educational events.

 

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Reimbursement, Clinical Validation and Clinical Utility

Reimbursement

We seek reimbursement for our testing products from several sources, including commercial third-party payers, government payers and patients. Payment from commercial third-party payers differs depending on whether we have entered into a contract with the payer as a participating provider or do not have a contract and are considered to be an out-of-network provider. When we contract to serve as a participating provider, reimbursements are made pursuant to a percentage of our charges or a negotiated fee schedule amount. Currently, we are reimbursed on an out-of-network basis, at various rates that can be higher or lower than participating providers. Where we are not reimbursed in full, we may elect to appeal the insurer’s underpayment or denial of payment or seek payment from the patient. We continue to focus on expanding coverage among existing contracted providers and achieving coverage with commercial payers, laboratory benefit managers and evidence review organizations. We employ a multi-pronged strategy designed to achieve broad coverage and reimbursement for our AVISE® testing products:

 

   

Meet the evidence standards necessary to be consistent with leading clinical guidelines.    We believe inclusion in leading clinical guidelines plays a critical role in payers’ coverage decisions. In order to change clinical guidelines, tests must carry a high level of published evidence demonstrating analytical validity, clinical validity, clinical utility and cost effectiveness. When studies with such evidence are published in peer-reviewed journals, the authors of clinical guidelines may assess the level of evidence and determine whether modifying existing guidelines to include new technology is warranted. For example, we previously conducted peer-reviewed, published clinical studies for AVISE® MTX which helped us secure favorable coverage for that testing product from the MolDx Program, Noridian and various commercial Medicare Advantage plans. The two largest rheumatology super groups have included AVISE® MTX in their respective RA patient pathway guidelines for physician adoption of AVISE® MTX. In addition, UpToDate, a leading evidence-based clinical decision support resource for physicians and payers, recommends the measurement of polyglutamate levels as done by AVISE® MTX. We have conducted, and continue to conduct, clinical validation and clinical utility studies for AVISE® Lupus, which we believe will provide a basis for the ACR and/or UpToDate to consider inclusion of AVISE® Lupus in their respective guidelines. In the future, we also intend to conduct similar studies in order to develop similar supporting literature with respect to our other testing products.

 

   

Execute an internal managed care policy and claims adjudication function as part of our core business operations.    We employ a team of in-house claims processing and reimbursement specialists who work with patients and payers to obtain maximum reimbursement. In parallel, a managed care team collaborates with our reimbursement specialists to ensure our payer outreach strategy reacts and anticipates the changing needs of our customer base. Our customer service team is an integral part of our reimbursement strategy, working with patients and rheumatologists to navigate the claims process.

 

   

Cultivate a network of key opinion leaders.    Key opinion leaders are able to influence clinical practice by publishing research and determining whether new tests should be integrated into clinical guidelines. We collaborate with key opinion leaders early in the development process to ensure our clinical studies are designed and executed in a way that clearly demonstrates the benefits of our testing products to physicians and payers.

Clinical Validation

We demonstrated the clinical validity of AVISE® Lupus in a study of 794 patients conducted from 2010 to 2014 across multiple leading academic centers. The primary endpoint of the study was the specificity and sensitivity of AVISE® Lupus compared to common autoantibodies used to diagnose SLE

 

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and other CTDs, such as ANA and anti-dsDNA. The final results of this study showed that AVISE® Lupus demonstrated 86% specificity and 80% sensitivity in distinguishing SLE from other CTDs and fibromyalgia, was 33% more specific than ANA (53% specificity/89% sensitivity) and was 48% more sensitive than anti-dsDNA (32% sensitivity/97% specificity).

Clinical Utility

We have collaborated with both academic and community clinicians to demonstrate the clinical utility of AVISE® Lupus versus standard diagnostic tests in physician diagnosis, impact on patient management decisions, patient reported outcomes and health economics.

We sponsored a longitudinal, case-control, retrospective review of medical charts in 2016 to assess the value and clinical utility of AVISE® Lupus to rheumatologists. The results of this study were published in the Open Rheumatology Journal in 2016 and suggested that a positive AVISE® Lupus test aids in the diagnosis of SLE versus standard diagnostic tests.

In early 2018, we initiated CARE for Lupus, a prospective, randomized, multi-site study to assess the performance of AVISE® Lupus versus a number of other standard diagnostic tests. We submitted the Care for Lupus manuscript for publication in July 2019. We also plan to initiate the CLEAR study in conjunction with CareFirst by late-2019 to further evaluate the clinical utility of AVISE® Lupus by collecting and analyzing applicable claims data. In addition, we collaborated with leading health economic experts and clinicians to conduct a health economics study. The results of that health economics study were presented at the ACR conference in 2018, demonstrated the cost savings to a payer associated with AVISE® Lupus over a one to four year time horizon and were submitted for publication in April 2019. We are updating the manuscript with the findings from the CARE for Lupus study for anticipated publication in late-2019. The above referenced studies are included in the AVISE® Lupus Dossier, which was completed in May 2019. Formal coverage determinations meetings are expected to take place in the first half of 2020 following publications of studies.

We believe our reimbursement strategy, including establishing the clinical validation, clinical utility and health economics of our testing products will allow us to drive an expansion in reimbursement coverage for our testing products.

Laboratory Operations

We perform all of our AVISE® tests in our approximately 8,000 square foot clinical laboratory, which is certified by the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and accredited by the College of American Pathologists, or CAP, and located in Vista, California. Our laboratory is certified for the performance of high-complexity testing by the Centers for Medicare and Medicaid Services, or CMS, in accordance with CLIA. We are approved to offer our products in all 50 states. Our clinical laboratory reports all AVISE® testing product results within five business days. We believe that our existing laboratory facilities are adequate to meet our business needs for at least the next 12 months and that additional laboratory space will be available on commercially reasonable terms, if required.

Quality Assurance

Our quality assurance function oversees the quality of our laboratory as well as research and development, client services, billing, sales and marketing operations. We have established oversight for systems implementation and maintenance procedures, document control processes, supplier qualification, preventive or corrective actions, and employee training processes that we believe achieves excellence in operations. We continuously monitor and improve our processes and procedures and believe this high-quality service leads to customer satisfaction and retention.

 

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Competition

Our principal competition for our AVISE® testing products is traditional methods used by healthcare providers to test patients with CTD disease-like symptoms. Such traditional methods include testing for a broad range of diagnostic, immunology and chemistry biomarkers, such as ANA and anti-dsDNA, and serum complement, such as C3 and C4. We also face competition from commercial laboratories, such as Laboratory Corporation of America Holdings, Quest Diagnostics Incorporated, ARUP Laboratories, Inc. and Mayo Clinic, all of which have existing infrastructures to support the commercialization of diagnostic services. Large, multispecialty group medical clinics, health systems and academic medical university-based clinics may provide in-house clinical laboratories offering autoimmune and autoimmune-related disease testing services. Additionally, we compete against regional clinical laboratories providing testing in the autoimmune and autoimmune-related disease field, including Rheumatology Diagnostics Laboratories, Inc. Other potential competitors include companies that might develop diagnostic or disease or drug monitoring products, such as Myriad Genetics, Inc., Progentec Diagnostics Inc., Kypha, LLC, Genalyte Inc., Protagen AG, DxTerity Diagnostics Inc., HealthTell, Inc. and Immunovia AB. In the future, we may also face competition from companies developing new products or technologies.

Direct competition for the promotion of SIMPONI® includes all other companies with anti-TNF biologics and the marketing companies supporting their distribution and promotion. These products include HUMIRA® and RINVOQTM from Abbvie Inc., ENBREL® from Amgen Inc., CIMZIA® from UCB, INFLECTRA® from Pfizer Inc., or Pfizer, (biosimilar REMICADE®) and RENFLEXIS® from Merck & Co. (biosimilar REMICADE®). Additional competitors include companies with other biologic drugs indicated for RA that have significant sales or sales potential. Specifically, these include ORENCIA® from Bristol-Myers Squibb Company, ACTEMRA® from Roche Holding AG, or Roche, RITUXAN® from Roche, XELJANZ® from Pfizer, KEVZARA® from Sanofi S.A. and OLUMIANT® from Eli Lilly and Company. There are also several late-stage RA drug and biosimilar development programs and several additional RA products that have minimal sales to date or that are indicated for other rheumatic indications competitive to SIMPONI® such as psoriatic arthritis and ankylosing spondylitis.

We believe the principal competitive factors in our target market include: quality and strength of clinical and analytical validation data; confidence in diagnostic results; safety and efficacy with respect to promoted therapeutics; sales and marketing capabilities; the extent of reimbursement; inclusion in clinical guidelines; cost-effectiveness; and ease of use.

Many of our potential competitors have widespread brand recognition and substantially greater financial, technical and research and development resources and selling and marketing capabilities than we do. Others may develop products with prices lower than ours that could be viewed by rheumatologists and payers as functionally equivalent to our solution or offer solutions at prices designed to promote market penetration, which could force us to lower the list price of our products and affect our ability to achieve profitability. If we are unable to change clinical practice in a meaningful way or compete successfully against current and future competitors, we may be unable to increase market acceptance and sales of our products, which could prevent us from increasing our revenue or achieving profitability and could cause the market price of our common stock to decline.

Agreements with Pharmaceutical Companies

Janssen Agreement

In December 2018, we and Janssen entered into the Janssen agreement to co-promote SIMPONI® in the United States. We are responsible for the costs associated with our salesforce over the course of such co-promotion. Janssen is responsible for all other aspects of the commercialization of SIMPONI® under the Janssen agreement. In exchange for our sales and co-promotional services,

 

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we are entitled to a quarterly tiered promotion fee ranging from $750 to $1,250 per prescription based on the incremental increase in total prescribed units of SIMPONI® for that quarter over a predetermined baseline. The predetermined average baseline for the initial term of 18 months is approximately 29,000 prescribed units per quarter, subject to adjustment under certain circumstances.

The term of the Janssen agreement expires on June 30, 2020, unless extended by us for an additional 18 months upon 180 days’ written notice prior to the end of the initial term. Janssen can terminate the agreement at any time for any reason upon 30 days’ notice to us, and we can terminate the agreement for any reason at the end of any calendar quarter upon 30 days’ notice to Janssen. Either party may terminate the agreement in the event of the other party’s default of any of its material obligations under the agreement if such default remains uncured for a specified period of time following receipt of written notice of such default.

Collaboration Agreement with GSK

In January 2018, we entered into a collaboration agreement with GSK, pursuant to which we provide GSK with our test result data to provide market insight into and help increase awareness on the benefits of an early and accurate diagnosis of SLE. The agreement was amended in November 2018 to, among other things, include data from our AVISE® Prognostic and AVISE® HCQ testing products and extend the term of the agreement through December 31, 2019.

Under the agreement, we are required to deliver weekly de-identified data files to GSK covering all data obtained from the performance of certain AVISE® testing products, subject to applicable requirements under the Federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, internal policy requirements and other applicable laws. During the term of the agreement, the data we provide to GSK may not be provided, directly or through a third party, to any other pharmaceutical company that is marketing or developing a product for the treatment of SLE. GSK made a single upfront payment in exchange for the right to receive the applicable data files. In addition, GSK has agreed to create a joint steering committee to cooperate with us in order to raise awareness and physician support for our AVISE® testing products, including through the development and delivery of approved promotional materials and the implementation of a related training plan for each party’s sales personnel.

The joint committee will meet at least 120 days prior to the end of the term of the agreement in order to discuss renewal options. Either party may terminate the agreement for breach and, in certain cases, such breach must remain uncured for a certain period of time following receipt of written notice of such breach. In addition, GSK may terminate the agreement immediately if we become insolvent or for convenience upon 60 days’ prior written notice.

Master Services Agreement with Horizon Therapeutics

In August 2018, we entered into a master services agreement with Horizon Therapeutics, pursuant to which Horizon Therapeutics utilizes our AVISE® MTX test to report on levels of MTXPG in patients undergoing methotrexate therapy in combination with its anti-gout product KRYSTEXXA® in an ongoing Phase 4 clinical trial. Under the agreement, Horizon Therapeutics paid an initial one time set-up cost and now pays an incremental fee for each specimen processed. We provide, among other things, specimen collection kits, customized test requisition, pre-paid shipping, specimen storage and individual reports for each study subject. Either party can terminate the agreement for convenience upon 30 days’ prior written notice to the other party. Absent early termination, the agreement will run through August 2020.

Intellectual Property Overview

We strive to protect and enhance the proprietary technologies that we believe are important to our business and seek to obtain and maintain patents for any patentable aspects of our testing products

 

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and services and any other inventions that are important to the development of our business. Our success will depend on our ability to obtain and maintain patent and other proprietary protection for commercially important technology, inventions and know-how related to our business, to defend and enforce our patents, to maintain our licenses to use intellectual property owned by third parties, to preserve the confidentiality of our trade secrets and to operate without infringing the valid and enforceable patents and other proprietary rights of third parties. We also rely on continuing technological innovation and in-licensing opportunities to develop, strengthen, and maintain our proprietary position in the fields targeted by our testing products and services.

We are the owner or licensee of a portfolio of patents and patent applications and possess substantial know-how and trade secrets which protect various aspects of our business. The patent families comprising our patent portfolio are primarily focused on our AVISE® testing products for the diagnosis, prognosis and monitoring of autoimmune and autoimmune-related diseases, and are generally directed to CB-CAPs, red blood cell MTXPG exposure assessments, and anti-MCV antibodies. We intend to leverage the intellectual property surrounding our AVISE® testing products as an important component of our business strategy.

Patent Protection for our AVISE® Testing Products

Our portfolio of patents and patent applications related to our AVISE® testing products generally relates to three aspects: CB-CAPs, red blood cell MTXPG exposure assessments, and anti-MCV antibodies. The patent families which we believe are important for the protection of AVISE® are summarized below in the section entitled “—License Agreements.”

CB-CAPs.

We are the exclusive licensee of five patent families related to CB-CAPs technology from the University of Pittsburgh, or UPitt. We expect that these patent families (U.S. Patent Nos. 7,361,517; 7,390,631; 7,585,640; 7,588,905; 8,080,382; and 8,126,654) will expire in 2024 or 2025. A foreign patent corresponding to U.S. Patent No. 7,361,517 has issued in Europe (EP 1,756,571). Foreign patents corresponding to U.S. Patent No. 7,390,631 have issued in Japan (JP 4570872 and JP 4906898). Foreign patents corresponding to U.S. Patent No. 7,585,640 have issued in Australia (AU 2005242719) and Canada (CA 2,564,492). A foreign patent corresponding to U.S. Patent Nos. 7,588,905 and 8,126,654 has issued in Japan (JP 4550051). We also own one issued patent (US 10,132,813) and two pending patent application families that relate to our AVISE® Lupus products. Foreign patents corresponding to US 10,132,813 have issued in Europe (EP 2,673,644) and Japan (JP 5,990,542). In order to manage our foreign filing costs and focus on the U.S. market, we made the decision to cease the prosecution and maintenance of several of our foreign patents and patent applications related to our CB-CAPs technology, including EP 1,432,731; EP 1,618,379; EP 1,635,692; EP 1,745,287; EP 2,214,014; EP 2,216,650, and certain of their corresponding family members.

MTX Exposure Assessment Products and Services

We are the exclusive licensee of four patents that relate to our AVISE® MTX product and methods for monitoring methotrexate therapy using red blood cell MTXPG exposure assessments. These patents and patent applications are owned by Prometheus and are exclusively licensed to us for all uses except for use in gastrointestinal diseases. These patents include U.S. Patent Nos. 6,921,667; 7,563,590; 7,582,282 and 7,695,908, which are expected to expire between 2023 and 2027. We also are the exclusive licensee of two issued US patents (US 9,261,509 and US 9,822,391) that relate to our AVISE® MTX product.

Proprietary Rights and Processes

We may rely, in some circumstances, on proprietary technology and processes (including trade secrets) to protect our technology. However, these can be difficult to protect. We seek to protect our

 

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proprietary technology and processes, in part, by entering into confidentiality agreements with those who have access to our confidential information, including our employees, consultants, scientific advisors and contractors. We also seek to preserve the integrity and confidentiality of our proprietary technology and processes by maintaining physical security of our premises and physical and electronic security of our information technology systems. While we have confidence in these individuals, organizations and systems, agreements or security measures may be breached, and we may not have adequate remedies for any such breach. In addition, our proprietary technology and processes may otherwise become known or be independently discovered by competitors. To the extent that our employees, consultants, scientific advisors, contractors, or any future collaborators use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions. For this and more comprehensive risks related to our proprietary technology and processes, please see “Risk Factors—Risks Related to our Intellectual Property.”

License Agreements

Amended and Restated Exclusive License Agreement with the University of Pittsburgh

In August 2011, we entered into an amended and restated exclusive license agreement with UPitt, to amend and restate the exclusive license agreement we obtained by our purchase of the medical diagnostics division of Cypress Bioscience, Inc., or Cypress, in 2010, or the Cypress Purchase, and to obtain an exclusive license to UPitt’s patent rights in certain inventions, or the UPitt Patent Rights, related to the use of CB-CAPs technology in the diagnosis, prognosis and monitoring of diseases, including certain patents related to our AVISE® testing products. The agreement was amended three times, once in May 2012 to, among other things, limit the territory of the license to the United States and exclude certain foreign patents and applications from the agreement, once in September 2013 to add (1) an additional U.S. patent to the UPitt Patent Rights licensed under the agreement and (2) the field of monitoring of organ transplantation and organ rejection to the scope of the license, and once in June 2016 to, among other things, clarify the definition of combination products for determining royalties due under the license.

Under the agreement, we are permitted to make, use and sell products and services utilizing the UPitt Patent Rights in the field of SLE and the field of monitoring of organ transplantation and organ rejection, and to sublicense such rights. UPitt retained the right to practice under the UPitt Patent Rights and to use such rights for non-commercial education and research purposes. In addition, this agreement is subject to the rights of the United States government, if any, as set forth in 35 U.S.C. §200, et seq. Pursuant to this law, the U.S. government may have acquired a nonexclusive, nontransferable, paid up license to practice or have practiced for or on behalf of the U.S. government the inventions described in the UPitt Patent Rights throughout the world.

In consideration for the rights granted to us under the agreement, we made certain upfront payments to UPitt on the first and second anniversaries of the agreement that increased on the third and subsequent anniversaries of the agreement until the first sale of products or services utilizing the UPitt Patent Rights. We are required to pay UPitt a low single-digit royalty on net sales of products or services utilizing the UPitt Patent Rights sold by us or our affiliates, subject to minimum annual royalty payments and other adjustment in certain circumstances. We also made a $0.2 million milestone payment to UPitt with the achievement of certain levels of net sales which we met in 2014. Our royalty obligations continue for each licensed product or service on a country-by-country basis until the expiration of the last licensed patent covering the applicable licensed product or service in such country.

In the event we sublicense any of the UPitt Patent Rights, we are obligated to pay UPitt a low single-digit percentage sublicense royalty on net sales of products or services sold by our sublicensees that utilize the sublicensed UPitt Patent Rights and a low double-digit percentage of all non-royalty sublicensing income received by us.

 

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The agreement requires that we diligently develop and commercialize products that are covered by the UPitt Patent Rights, and we have agreed to meet certain development and commercial milestones. UPitt may terminate the agreement if we fail to meet such milestones. In addition, if we fail to meet a milestone relating to development of the UPitt Patent Rights in the monitoring of organ transplantation and organ rejection field, UPitt may remove that field from our licensed rights. We are currently in compliance with these milestone requirements.

We may terminate the agreement upon six months’ written notice to UPitt. UPitt may terminate the agreement in the event of our nonperformance of any of our obligations under the agreement if such nonperformance remains uncured for a certain period of time following our receipt of written notice of such nonperformance or in the event of our insolvency. Absent early termination, the agreement will continue until the expiration date of the longest-lived patent right included in the UPitt Patent Rights.

Exclusive License Agreement with the University of Pittsburgh

We made an economic decision to cease the maintenance and licensing of UPitt Patent Rights outside the United States, which led to such rights returning to UPitt. We subsequently made the determination to re-license these foreign patent rights from UPitt, but at the time of re-licensing these patent rights, a number of the foreign patent rights had permanently lapsed. Accordingly, in September 2013, we entered into an exclusive license agreement with UPitt to obtain an exclusive license to UPitt’s remaining ex-U.S. patent rights in certain inventions, or the ex-U.S. UPitt Patent Rights, related to the use of CB-CAPs technology in the diagnosis, prognosis and monitoring of diseases, including certain patents related to our AVISE® testing products.

Under the agreement, we are permitted to make, use and sell products and services utilizing the ex-U.S. UPitt Patent Rights in the field of SLE and the field of monitoring of organ transplantation and organ rejection outside of the United States, and to sublicense such rights. UPitt retained the right to practice under the ex-U.S. UPitt Patent Rights and to use such rights for non-commercial education and research purposes. In addition, this agreement is subject to the rights of the U.S. government, if any, as set forth in 35 U.S.C. §200, et seq.

In consideration for the rights granted to us under the agreement, we paid an initial license fee to UPitt. We are also required to pay UPitt a low single-digit royalty on net sales of products or services utilizing the ex-U.S. UPitt Patent Rights sold by us or our affiliates, subject to adjustment in certain circumstances. Our royalty obligations continue for each licensed product or service on a country-by-country basis until the expiration of the last licensed patent covering the applicable licensed product or service in such country.

In the event we sublicense any of the ex-U.S. UPitt Patent Rights, we are obligated to pay UPitt a low single-digit percentage sublicense royalty on net sales of products or services sold by our sublicensees that utilize the sublicensed ex-U.S. UPitt Patent Rights and a low double-digit percentage of all non-royalty sublicensing income received by us.

The agreement requires that we diligently develop and commercialize products that are covered by the ex-U.S. UPitt Patent Rights, and we have agreed to meet certain commercial milestones. UPitt may terminate the agreement if we fail to meet such milestones. We are currently in compliance with these milestone requirements.

We may terminate the agreement upon six months’ written notice to UPitt. UPitt may terminate the agreement in the event of our nonperformance of any of our obligations under the agreement if such nonperformance remains uncured for a certain period of time following our receipt of written notice of such nonperformance or in the event of our insolvency. Absent early termination, the agreement will continue until the expiration date of the longest-lived patent right included in the UPitt Patent Rights.

 

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License Agreement with Prometheus Laboratories, Inc.

In connection with the Cypress Purchase, we acquired a license agreement, dated September 2007, between Prometheus Laboratories, Inc., or Prometheus, and Proprius Pharmaceuticals, Inc., or Proprius, a company which had been previously acquired by Cypress. Pursuant to this agreement, we obtained an exclusive, worldwide license to Prometheus’s patent rights in certain inventions, or the Prometheus Patent Rights, related to the diagnosis, prognosis and monitoring of diseases, including certain patents related to our AVISE® testing products and services. This agreement was subsequently amended in October 2013.

Under the agreement, we are permitted to research, develop, manufacture and commercialize products utilizing the Prometheus Patent Rights and to sublicense such rights; provided, however, that any such sublicenses may only be granted with Prometheus’s consent. We are not permitted to develop or commercialize products utilizing the Prometheus Patent Rights for use in diagnosing or treating any gastrointestinal diseases or to promote any such products to gastroenterologists. Pursuant to the agreement, we are obligated to use reasonable commercial efforts to undertake certain development activities with respect to products utilizing the Prometheus Patent Rights, including the completion of certain clinical studies. In addition, in the event that we do not timely complete these studies or approved substitute studies, we will become obligated to pay to Prometheus a one-time payment of $50,000.

We are required to make a milestone payment of $2.0 million upon the achievement of certain net sales. In addition, we are required to pay Prometheus tiered royalties in the mid-single-digit range on sales of any products utilizing the Prometheus Patent Rights by us, our affiliates or our sublicensees. Our royalty obligations continue on a licensed-product-by-licensed-product and country-by-country basis until the expiration, lapse or invalidation of the last valid claim in a licensed patent covering the applicable licensed product in such country.

In the event we sublicense any of the Prometheus Patent Rights, we are obligated to pay to Prometheus a fee based on a percentage of sublicense fees received by us, which percentage is in the mid-twenties. In addition, we are also required to pay to Prometheus a percentage of the royalty payments we receive from our sublicensees, which may not be less than a certain low single-digit percentage of net sales of products or services sold by our sublicensees that utilize the sublicensed Prometheus Patent Rights, nor more than a certain mid-single digit percentage of such net sales.

We may unilaterally terminate the agreement for any reason upon 60-days’ written notice to Prometheus. Either party may terminate the agreement in the event of the other party’s material breach of the agreement if such breach remains uncured for a certain period of time following receipt of written notice of such breach or in the event of the other party’s insolvency. Absent early termination, the agreement will continue until the expiration date of the longest-lived patent right included in the Prometheus Patent Rights.

Asset Purchase Agreement with Cypress (Royalty Pharma) and Proprius

In October 2010, we completed the Cypress Purchase pursuant to an asset purchase agreement with Cypress and its wholly-owned subsidiary, Proprius, under which we obtained certain assets related to our AVISE® testing products and services. The agreement was amended six times, once in March 2011 to change certain obligations relating to certain accounts receivable we acquired from Cypress, once in August 2012 to convert a one-time payment obligation to a payment plan over four years with interest, once in February 2013 to convert a one-time contingent milestone payment obligation concerning a CB-CAPs monitoring assay to a payment plan over two years with interest, once in October 2013 to, among other things, provide consent for Exagen to use its IP as collateral on a financing round, once in January 2016 to restate an annual sales milestone, and once in February 2017 to restate specifics of the monitoring assay royalty.

 

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In 2011, Royalty Pharma Collection Trust, or Royalty Pharma, acquired Cypress and became its successor-in-interest under the agreement. In consideration for the acquisition, we made certain initial cash payments to Cypress and we are currently making payments to Royalty Pharma, as a successor-in-interest to Cypress, pursuant to the August 2012 amendment, which payments are subject to acceleration in certain circumstances. Under our agreements with Royalty Pharma, we are required to pay Royalty Pharma a low double-digit royalty on the world wide net sales of CB-CAPs products and a low double-digit royalty on the net sales of certain new products in each case, for a period of eight years.

In addition, we are required to make certain one-time contingent milestone payments for two third-party commercial programs, for the launch of a CB-CAPs monitoring assay, and for the achievement of an annual, worldwide net sales level for CB-CAPs products. Our agreement with Royalty Pharma requires that we use commercially reasonable efforts to cause each of the milestones to be achieved. In December 2015, we achieved the specified annual world-wide nets sales of CB-CAPs products which required us to make a $2.0 million milestone payment to Royalty Pharma. We paid the applicable $2.0 million milestone payment in 2016. In February 2017, we amended our agreements with Royalty Pharma relating to the launch of a monitoring product using CB-CAPs technology. As a result of this amendment, a prior obligation to make a one-time payment of $1.0 million upon the launch of a monitoring product incorporating CB-CAPs technology was replaced with an agreement to pay Royalty Pharma a one-time payment of $100,000 upon the launch of such a product, plus a 2.5% royalty based on future cash collections from sales of that product which incorporate the licensed technology. Future royalties under this arrangement are limited to the lesser of $1,200,000 (including the upfront payment of $100,000) or the total royalty earned through January 1, 2024.

Asset Purchase Agreement With Cellatope

In connection with the Cypress Purchase, we acquired an asset purchase agreement, dated February 2009 and amended December 2012 and again in January 2017, between Cypress and Cellatope Corporation, or Cellatope. Pursuant to the amended agreement, we obtained assets related to our AVISE® testing products. In connection with one launch of our AVISE® SLE Monitor testing product, we paid an upfront payment of $100,000 and we are required to pay Cellatope a low-single digit royalty on net sales up to a maximum of $3.0 million.

Dr. Thierry Dervieux and De Novo Diagnostics, Inc.

In September 2011, we entered into a license agreement with Dr. Thierry Dervieux, our Chief Scientific Officer, and his company De Novo Diagnostics, Inc., under which we obtained an exclusive, worldwide (except for Australia and New Zealand) license to Dr. Dervieux’s patent rights and know-how in certain inventions, or the Dervieux Patent Rights, related to the diagnosis, prognosis and monitoring of diseases, including certain patents related to our AVISE® testing products and services.

Under the agreement, we are permitted to develop, manufacture and commercialize products utilizing the Dervieux Patent Rights in the human healthcare market, and to sublicense such rights.

In considerations for the rights granted to us under the agreement, we are required to make milestone payments, up to an aggregate of $600,000, upon achievement of certain sales milestones. In addition, we are required to pay Dr. Dervieux a mid-single-digit royalty on net sales by us or our affiliates of any products utilizing the Dervieux Patent Rights, subject to adjustment in certain circumstances. We are also obligated to pay Dr. Dervieux a percentage in the mid-twenties of sublicense fees and royalties received by us.

The agreement requires that we diligently develop and commercialize products that are covered by the Dervieux Patent Rights, and we have agreed to use commercially reasonable efforts to bring technology covered by the Dervieux Patent Rights to market as soon as practicable.

 

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We may unilaterally terminate the agreement upon 12 months’ written notice to Dr. Dervieux. Either party may terminate this agreement in the event of the other party’s nonperformance of any of its obligations under the agreement if such nonperformance remains uncured for a specified period of time following receipt of written notice of such nonperformance or in the event of the other party’s insolvency. Absent early termination, the agreement will continue until the expiration date of the longest-lived patent right included in the Dervieux Patent Rights.

Regulations

Clinical Laboratory Improvement Amendments of 1988

As a clinical reference laboratory, we are required to hold certain federal, state and local licenses, certifications and permits to conduct our business. Under CLIA, we are required to hold a certificate applicable to the type of laboratory tests we perform and to comply with standards applicable to our operations, including test processes, personnel, facilities administration, equipment maintenance, recordkeeping, quality systems and proficiency testing. We must maintain CLIA compliance and certification to be eligible to bill for diagnostic services provided to Medicare beneficiaries.

We have current certification under CLIA to perform testing at our Vista facility. To renew our CLIA certificate, we are subject to survey and inspection every two years to assess compliance with program standards. The regulatory and compliance standards applicable to the testing we perform may change over time, and any such changes could have a material effect on our business.

Penalties for non-compliance with CLIA requirements include suspension, limitation or revocation of the laboratory’s CLIA certificate, as well as directed plan of correction, state on-site monitoring, civil money penalties, civil injunctive suit or criminal penalties.

State Laboratory Licensing

In addition to federal certification requirements of laboratories under CLIA, licensure is required and maintained for our Vista clinical reference laboratory under California law. Such laws establish standards for the day-to-day operation of a clinical reference laboratory, including the training and skills required of personnel and quality control. In addition, California laws mandate proficiency testing, which involves testing of specimens that have been specifically prepared for the laboratory.

Because we receive specimens from New York, our clinical reference laboratory is required to be licensed by New York, under New York laws and regulations, which establish standards for:

 

   

day-to-day operation of a clinical laboratory, including training and skill levels required of laboratory personnel;

 

   

physical requirements of a facility;

 

   

equipment; and

 

   

validation and quality control.

New York law also mandates proficiency testing for laboratories licensed under New York state law, regardless of whether such laboratories are located in New York. If a laboratory is out of compliance with New York statutory or regulatory standards, the New York Department of Health, or NYDOH, may suspend, limit, revoke or annul the laboratory’s New York license, censure the holder of the license or assess civil money penalties. Statutory or regulatory noncompliance may result in a laboratory’s operator being found guilty of a misdemeanor under New York law. NYDOH also must approve the LDT before the test is offered in New York. We have received written approval from NYDOH to offer our products in New York.

 

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In addition to New York and California, other states, including Maryland, Pennsylvania and Rhode Island, require licensing of out-of-state laboratories under certain circumstances.

Federal Oversight of Laboratory Developed Tests

The laws and regulations governing the marketing of diagnostic products are evolving, extremely complex, and in many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. Clinical laboratory tests like AVISE® CTD, AVISE® SLE Prognostic and AVISE® MTX are regulated under CLIA, as administered by CMS, as well as by applicable state laws. In addition, the Federal Food, Drug and Cosmetic Act, or FDCA, defines a medical device to include any instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including a component part, or accessory, intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals. Our in vitro testing products are considered by the FDA to be subject to regulation as medical devices. Among other things, pursuant to the FDCA and its implementing regulations, the FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, pre-market clearance or approval, marketing and promotion, and sales and distribution of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates the export of medical devices manufactured in the United States to international markets.

Although the FDA has statutory authority to assure that medical devices are safe and effective for their intended uses, the FDA has generally exercised its enforcement discretion and not enforced applicable regulations with respect to in vitro diagnostics that are designed, manufactured, and used within a single laboratory for use only in that laboratory. These tests are referred to as laboratory developed tests, or LDTs. We believe that the AVISE® CTD and AVISE® MTX are LDTs, as are our near-term pipeline candidate tests. As a result, we believe many of our diagnostic services are currently subject to the FDA’s enforcement discretion and are not subject to the FDA’s oversight. However, reagents, instruments, software or components provided by third parties and used to perform LDTs may be subject to regulation.

In recent years, FDA has stated its intention to modify its enforcement discretion policy with respect to LDTs. For example, on July 31, 2014, the FDA notified Congress of its intent to modify, in a risk-based manner, its policy of enforcement discretion with respect to LDTs. On October 3, 2014, the FDA issued two draft guidance documents entitled “Framework for Regulatory Oversight of Laboratory Developed Tests (LDTs),” or the Framework Guidance, and “FDA Notification and Medical Device Reporting for Laboratory Developed Tests (LDTs),” or the Reporting Guidance. The Framework Guidance states that FDA intends to modify its policy of enforcement discretion with respect to LDTs in a risk-based manner consistent with the classification of medical devices generally in Classes I through III. The FDA further states its intention in the Framework Guidance to publish general LDT classification guidance within 18 months of date on which the Framework Guidance is finalized. The Reporting Guidance would further enable FDA to collect information regarding the LDTs currently being offered for clinical use through a notification process, as well as to enforce its regulations for reporting safety issues and collecting information on any known or suspected adverse events related to the use of an LDT.

Although the FDA halted finalization of the guidance in November 2016 to allow for further public discussion on an appropriate oversight approach to LDTs and to give congressional authorizing committees the opportunity to develop a legislative solution, the FDA could ultimately modify its current approach to LDTs in a way that would subject our products marketed as LDTs to the enforcement of regulatory requirements. Moreover, legislative measures have recently been proposed in Congress that, if ultimately enacted, could provide the FDA with additional authority to require premarket review of and regulate LDTs.

 

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Medical Device Regulatory Framework

Although we currently market our proprietary testing products as LDTs, which are currently subject to enforcement discretion, we could be subject to more onerous FDA compliance obligations in the future. Specifically, if the FDA begins to actively regulate LDTs, then, unless an exemption applies, each new or significantly modified medical device we seek to commercially distribute in the U.S. will require either a premarket notification to the FDA requesting permission for commercial distribution under Section 510(k) of the FDCA, also referred to as a 510(k) clearance, or approval from the FDA of a premarket approval, or PMA, application. Both the 510(k) clearance and PMA processes can be resource intensive, expensive, and lengthy, and require payment of significant user fees.

Device Classification

Under the FDCA, medical devices are classified into one of three classes-Class I, Class II or Class III depending on the degree of risk associated with each medical device and the extent of control needed to provide reasonable assurances with respect to safety and effectiveness.

Class I includes devices with the lowest risk to the patient and are those for which safety and effectiveness can be reasonably assured by adherence to a set of FDA regulations, referred to as the General Controls for Medical Devices, which require compliance with the applicable portions of the FDA’s quality system regulation, or QSR, facility registration and product listing, reporting of adverse events and malfunctions, and appropriate, truthful and non-misleading labeling and promotional materials. Some Class I devices also require premarket clearance by the FDA through the 510(k) premarket notification process described below. Most Class I products are exempt from the premarket notification requirements.

Class II devices are those that are subject to the General Controls, and special controls as deemed necessary by the FDA to ensure the safety and effectiveness of the device. These special controls can include performance standards, patient registries, FDA guidance documents and post-market surveillance. Most Class II devices are subject to premarket review and clearance by the FDA. Premarket review and clearance by the FDA for Class II devices is accomplished through the 510(k) premarket notification process.

Class III devices include devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to those deemed novel and not substantially equivalent following the 510(k) process. The safety and effectiveness of Class III devices cannot be reasonably assured solely by the General Controls and Special Controls described above. Therefore, these devices are subject to the PMA application process, which is generally more costly and time-consuming than the 510(k) process. Through the PMA application process, the applicant must submit data and information demonstrating reasonable assurance of the safety and effectiveness of the device for its intended use to the FDA’s satisfaction. Accordingly, a PMA typically includes, but is not limited to, extensive technical information regarding device design and development, pre-clinical and clinical trial data, manufacturing information, labeling and financial disclosure information for the clinical investigators in device studies. The PMA application must provide valid scientific evidence that demonstrates to the FDA’s satisfaction a reasonable assurance of the safety and effectiveness of the device for its intended use.

The Investigational Device Process

In the U.S., absent certain limited exceptions, human clinical trials intended to support medical device clearance or approval require an IDE application. Some types of studies deemed to present “non-significant risk” are deemed to have an approved IDE once certain requirements are addressed and IRB approval is obtained. If the device presents a “significant risk” to human health, as defined by the FDA, the sponsor must submit an IDE application to the FDA and obtain IDE approval prior to

 

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commencing the human clinical trials. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate IRBs at the clinical trial sites. Submission of an IDE will note necessarily result in the ability to commence clinical trials, and although the FDA’s approval of an IDE allows clinical testing to go forward for a specified number of subjects, it does not bind the FDA to accept the results of the trial as sufficient to prove the product’s safety and efficacy, even if the trial meets its intended success criteria.

All clinical trials must be conducted in accordance with the FDA’s IDE regulations that govern investigational device labeling, prohibit promotion and specify an array of recordkeeping, reporting and monitoring responsibilities of study sponsors and study investigators. Clinical trials must further comply with the FDA’s good clinical practice regulations for IRB approval and for informed consent and other human subject protections. Required records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable, or, even if the intended safety and efficacy success criteria are achieved, may not be considered sufficient for the FDA to grant marketing approval or clearance of a product. The commencement or completion of any clinical trial may be delayed or halted, or be inadequate to support approval of a PMA application, for numerous reasons, including, but not limited to, the following:

 

   

the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;

 

   

patients do not enroll in clinical trials at the rate expected;

 

   

patients do not comply with trial protocols;

 

   

patient follow-up is not at the rate expected;

 

   

patients experience adverse events;

 

   

patients die during a clinical trial, even though their death may not be related to the products that are evaluated during the trial;

 

   

device malfunctions occur with unexpected frequency or potential adverse consequences;

 

   

side effects or device malfunctions of similar products already in the market that change the FDA’s view toward approval of new or similar PMAs or result in the imposition of new requirements or testing;

 

   

institutional review boards and third-party clinical investigators may delay or reject the trial protocol;

 

   

third-party clinical investigators decline to participate in a trial or do not perform a trial on the anticipated schedule or consistent with the clinical trial protocol, investigator agreement, investigational plan, good clinical practices, the IDE regulations or other FDA or IRB requirements;

 

   

third-party investigators are disqualified by the FDA;

 

   

we or third-party organizations do not perform data collection, monitoring and analysis in a timely or accurate manner or consistent with the clinical trial protocol or investigational or statistical plans, or otherwise fail to comply with the IDE regulations governing responsibilities, records and reports of sponsors of clinical investigations;

 

   

third-party clinical investigators have significant financial interests related to us or our study such that the FDA deems the study results unreliable, or we or investigators fail to disclose such interests;

 

   

regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials;

 

   

changes in government regulations or administrative actions;

 

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the interim or final results of the clinical trial are inconclusive or unfavorable as to safety or efficacy; or

 

   

the FDA concludes that our trial designs are unreliable or inadequate to demonstrate safety and efficacy.

The 510(k) Clearance Process

Under the 510(k) clearance process, the manufacturer must submit to the FDA a premarket notification, demonstrating that the device is “substantially equivalent” to a legally marketed predicate device. A predicate device is a legally marketed device that is not subject to a PMA, i.e., a device that was legally marketed prior to May 28, 1976 (pre-amendments device) and for which a PMA is not required, a device that has been reclassified from Class III to Class II or I, or a device that was previously found substantially equivalent through the 510(k) process. To be “substantially equivalent,” the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data is sometimes required to support substantial equivalence.

After a 510(k) premarket notification is submitted, the FDA determines whether to accept it for substantive review. If it lacks necessary information for substantive review, the FDA will refuse to accept the 510(k) notification. If it is accepted for filing, the FDA begins a substantive review. By statute, the FDA is required to complete its review of a 510(k) notification within 90 days of receiving the 510(k) notification. As a practical matter, clearance often takes longer, and clearance is never assured. Although many 510(k) premarket notifications are cleared without clinical data, the FDA may require further information, including clinical data, to make a determination regarding substantial equivalence, which may significantly prolong the review process. If the FDA agrees that the device is substantially equivalent, it will grant clearance to commercially market the device.

If the FDA determines that the device is not “substantially equivalent” to a predicate device, or if the device is automatically classified into Class III, the device sponsor must then fulfill the much more rigorous premarketing requirements of the PMA approval process, or seek reclassification of the device through the de novo process. The de novo classification process is an alternate pathway to classify medical devices that are automatically classified into Class III but which are low to moderate risk. A manufacturer can submit a petition for direct de novo review if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk. De novo classification may also be available after receipt of a “not substantially equivalent” letter following submission of a 510(k) to FDA.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, could require a PMA application. The FDA requires each manufacturer to determine whether the proposed change requires a new submission in the first instance, but the FDA can review any such decision and disagree with a manufacturer’s determination. Many minor modifications are accomplished by a letter-to-file in which the manufacture documents the change in an internal letter-to-file. The letter-to-file is in lieu of submitting a new 510(k) to obtain clearance for such change. The FDA can always review these letters to file in an inspection. If the FDA disagrees with a manufacturer’s determination regarding whether a new premarket submission is required for the modification of an existing 510(k)-cleared device, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or approval of a PMA application is obtained. In addition, in these circumstances, the FDA can impose significant regulatory fines or penalties for failure to submit the requisite application(s).

 

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The PMA Approval Process

Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If it is, the FDA will accept the application for filing and begin the review. The FDA has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period of time. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant’s response to deficiencies communicated by the FDA.

Before approving or denying a PMA, an FDA advisory committee may review the PMA at a public meeting and provide the FDA with the committee’s recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions.

Prior to approval of a PMA, the FDA may conduct inspections of the clinical trial data and clinical trial sites, as well as inspections of the manufacturing facility and processes. Overall, the FDA review of a PMA application generally takes between one and three years, but may take significantly longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:

 

   

the device may not be shown safe or effective to the FDA’s satisfaction;

 

   

the data from pre-clinical studies and/or clinical trials may be found unreliable or insufficient to support approval;

 

   

the manufacturing process or facilities may not meet applicable requirements; and

 

   

changes in FDA approval policies or adoption of new regulations may require additional data.

If the FDA evaluation of a PMA is favorable, the FDA will issue either an approval letter, or an approvable letter, the latter of which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA approval letter authorizing commercial marketing of the device, subject to the conditions of approval and the limitations established in the approval letter. If the FDA’s evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional tests or clinical trials are necessary, in which case the PMA approval may be delayed for several months or years while the trials are conducted and data is submitted in an amendment to the PMA, or the PMA is withdrawn and resubmitted when the data are available. The PMA process can be expensive, uncertain and lengthy and a number of devices for which the FDA approval has been sought by other companies have never been approved by the FDA for marketing.

New PMA applications or PMA supplements are required for modification to the manufacturing process, equipment or facility, quality control procedures, sterilization, packaging, expiration date, labeling, device specifications, ingredients, materials or design of a device that has been approved through the PMA process. PMA supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the approved PMA application and may or may not require as extensive technical or clinical data or the convening of an advisory panel, depending on the nature of the proposed change.

In approving a PMA application, as a condition of approval, the FDA may also require some form of post-approval study or post-market surveillance, whereby the applicant conducts a follow-up study or

 

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follows certain patient groups for a number of years and makes periodic reports to the FDA on the clinical status of those patients when necessary to protect the public health or to provide additional or longer term safety and effectiveness data for the device. The FDA may also approve a PMA application with other post-approval conditions intended to ensure the safety and effectiveness of the device, such as, among other things, restrictions on labeling, promotion, sale, distribution and use. New PMA applications or PMA supplements may also be required for modifications to any approved diagnostic tests, including modifications to our manufacturing processes, device labeling and device design, based on the findings of post-approval studies.

Federal and State Physician Self-Referral Prohibitions

We are subject to the federal physician self-referral prohibitions, commonly known as the Stark Law, and to similar state law restrictions, such as California’s Physician Ownership and Referral Act, or PORA, and other comparable state laws. Together these restrictions generally prohibit us from billing a patient or any governmental or private payer for certain designated health services, including clinical laboratory services, when the physician ordering the service, or any member of such physician’s immediate family, has a financial interest, such as an ownership or investment interest in or compensation arrangement with us, unless the arrangement meets an exception to the prohibition.

Sanctions for a Stark Law violation include the following:

 

   

denial of payment for the services provided in violation of the prohibition;

 

   

refunds of amounts collected by an entity in violation of the Stark Law;

 

   

a civil penalty of up to $24,748 for each bill or claim for a service arising out of the prohibited referral;

 

   

the imposition of up to three times the amounts for each item or service wrongfully claimed;

 

   

possible exclusion from federal healthcare programs, including Medicare and Medicaid; and

 

   

a civil penalty of up to $164,992 for each arrangement or scheme that the parties know (or should know) has the principal purpose of circumventing the Stark Law’s prohibition.

These prohibitions apply regardless of any intent by the parties to induce or reward referrals or the reasons for the financial relationship and the referral. In addition, knowing violations of the Stark Law may also serve as the basis for liability under the Federal False Claims Act, which can result in additional civil and criminal penalties.

Further, a violation of PORA is a misdemeanor and could result in civil penalties and criminal fines. Other states also have self-referral restrictions with which we have to comply, some of which differ from those imposed by the Stark Law or California law.

Federal and State Anti-Kickback Laws

The Federal Anti-kickback Statute makes it a felony for a person or entity, including a clinical laboratory, to knowingly and willfully offer, pay, solicit or receive any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in order to induce business that is reimbursable under any federal health care program. A violation of the Anti-kickback Statute may result in imprisonment for up to ten years and fines of up to $100,000 for each violation and administrative civil money penalties of $100,000 plus up to three times the amount of the remuneration paid. Convictions under the Anti-kickback Statute result in mandatory exclusion from federal health care programs for a minimum of five years. In addition, The U.S. Department of Health and Human Services, or HHS, has the authority to impose civil assessments and fines and to exclude health care providers and others engaged in prohibited activities from Medicare, Medicaid and other federal health care programs. In addition, the government may assert that a claim that includes items or services resulting from a violation of the

 

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Anti-kickback Statute constitutes a false or fraudulent claim under the Federal False Claims Act, which is discussed in greater detail below. Additionally, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation.

Although the Anti-kickback Statute applies only to items and services reimbursable under any federal health care program, a number of states, including California, have passed statutes substantially similar to the Anti-kickback Statute that apply to all third-party payers, including commercial insurers, and in some states, to patients without insurance. The California Attorney General and courts have interpreted the California anti-kickback and fee-splitting laws in substantially the same way as HHS and the courts have interpreted the Anti-kickback Statute. Penalties of such state laws include imprisonment and significant monetary fines.

Federal and state law enforcement authorities scrutinize arrangements between health care providers and potential referral sources to ensure that the arrangements are not designed as a mechanism to induce patient care referrals or induce the purchase or prescribing of particular products or services. Generally, courts have taken a broad interpretation of the scope of the Anti-kickback Statute, holding that the statute may be violated if merely one purpose of a payment arrangement is to induce referrals or purchases.

In addition to statutory exceptions to the Anti-kickback Statute, regulations provide for a number of safe harbors. If an arrangement meets the provisions of a safe harbor, it is deemed not to violate the Anti-kickback Statute. An arrangement must fully comply with each element of an applicable safe harbor in order to qualify for protection.

Failure to meet the requirements of the safe harbor, however, does not render an arrangement illegal. Rather, the government may evaluate such arrangements on a case-by-case basis, taking into account all facts and circumstances. There are no regulatory safe harbors under California laws.

Other Federal and State Health Care Laws

In addition to the requirements discussed above, several other health care fraud and abuse laws could have an effect on our business. For example, provisions of the Social Security Act permit Medicare and Medicaid to exclude an entity that charges the federal health care programs substantially in excess of its usual charges for its services. The terms “usual charge” and “substantially in excess” are subject to varying interpretations.

The Federal False Claims Act prohibits, among other things, a person from knowingly presenting, or causing to be presented, a false or fraudulent claim for payment or approval and from, making, using, or causing to be made or used, a false record or statement material to a false or fraudulent claim in order to secure payment or retaining an overpayment by the federal government. In addition to actions initiated by the government itself, the statute authorizes actions to be brought on behalf of the federal government by a private party having knowledge of the alleged fraud. Because the complaint is initially filed under seal, the action may be pending for some time before the defendant is even aware of the action. If the government intervenes and is ultimately successful in obtaining redress in the matter or if the plaintiff succeeds in obtaining redress without the government’s involvement, then the plaintiff will receive a percentage of the recovery. Finally, the Social Security Act includes its own provisions that prohibit the filing of false claims or submitting false statements in order to obtain payment. Violation of these provisions may result in fines, imprisonment or both, and possible exclusion from Medicare or Medicaid programs. Several states, including California, have enacted comparable false claims laws which may be broader in scope and may apply regardless of payer.

The civil monetary penalties statute imposes penalties against any person or entity that, among other things, is determined to have presented or caused to be presented a claim to a federal health

 

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program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent. A person who offers or provides to a Medicare or Medicaid beneficiary any remuneration, including waivers of co-payments and deductible amounts (or any part thereof), that the person knows or should know is likely to influence the beneficiary’s selection of a particular provider, practitioner or supplier of Medicare or Medicaid payable items or services may be liable for civil monetary penalties of up to $20,000 for each wrongful act and up to three times the amount improperly claimed. Moreover, in certain cases, providers who routinely waive copayments and deductibles for Medicare and Medicaid beneficiaries can also be held liable under the Anti-Kickback Statute and False Claims Act. One of the statutory exceptions to the prohibition is non-routine, unadvertised waivers of copayments or deductible amounts based on individualized determinations of financial need or exhaustion of reasonable collection efforts. The Office of Inspector General of HHS, or OIG, emphasizes, however, that this exception should only be used occasionally to address special financial needs of a particular patient. Although this prohibition applies only to federal healthcare program beneficiaries, applicable state laws related to, among other things, unlawful schemes to defraud, excessive fees for services, tortious interference with patient contracts and statutory or common law fraud, may also be implicated for similar practices offered to patients covered by commercial payers.

HIPAA created new federal criminal statutes that prohibit, among other actions, knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private third-party payers, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. Like the Anti-kickback Statute, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation.

The Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, collectively the Affordable Care Act, or ACA, among other things, also imposed annual reporting requirements on manufacturers of certain devices, drugs and biologics for certain payments and transfers of value by them and in some cases their distributors to physicians and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members. Any failure to comply with these reporting requirements could result in significant fines and penalties. Because we manufacture our own LDTs solely for use by or within our own laboratory, we believe that we are exempt from these reporting requirements. We cannot assure you, however, that the government will agree with our determination, and a determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business, prospects, results of operations or financial condition.

If our operations are found to be in violation of any of the fraud and abuse laws described above or any other laws that apply to us, we may be subject to penalties, including potentially significant criminal and civil and/or administrative penalties, damages, fines, disgorgement, imprisonment, exclusion from participation in government healthcare programs, contractual damages, reputational harm, administrative burdens, diminished profits and future earnings, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our results of operations.

International Regulations

Many countries in which we may offer any of our testing products in the future have anti-kickback regulations prohibiting providers from offering, paying, soliciting or receiving remuneration, directly or indirectly, in order to induce business that is reimbursable under any national health care program. In situations involving physicians employed by state-funded institutions or national health care agencies,

 

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violation of the local anti-kickback law may also constitute a violation of the U.S. Foreign Corrupt Practices Act, or FCPA, and/or other applicable anti-corruption laws.

The FCPA prohibits any U.S. individual, business entity or employee of a U.S. business entity from offering or providing, directly or through a third party, including any potential distributors we may rely on in certain markets, anything of value to a foreign official with corrupt intent to influence an award or continuation of business or to gain an unfair advantage, whether or not such conduct violates local laws. In addition, it is illegal for a company that reports to the SEC to have false or inaccurate books or records or to fail to maintain a system of internal accounting controls. We will also be required to maintain accurate information and control over sales and distributors’ activities that may fall within the purview of the FCPA, including its books and records provisions and its anti-bribery provisions.

The standard of intent and knowledge under the FCPA’s anti-bribery provisions is minimal intent and knowledge are usually inferred from the fact that bribery took place. The FCPA’s accounting provisions do not require intent. Violations of the FCPA’s anti-bribery provisions for corporations and other business entities are subject to a fine of up to $2 million and officers, directors, stockholders, employees, and agents are subject to a fine of up to $100,000 and imprisonment for up to five years. Other countries, including the United Kingdom and other OECD Anti-Bribery Convention members, have similar anti-corruption regulations, such as the UK Bribery Act.

When marketing our testing products outside of the U.S., we may be subject to foreign regulatory requirements governing human clinical testing, prohibitions on the import of tissue necessary for us to perform our testing products or restrictions on the export of tissue imposed by countries outside of the U.S. or the import of tissue into the U.S., and marketing approval. These requirements vary by jurisdiction, differ from those in the U.S. and may in some cases require us to perform additional pre-clinical or clinical testing. In many countries outside of the U.S., coverage, pricing and reimbursement approvals are also required.

Privacy and Security Laws

Health Insurance Portability and Accountability Act; California Consumer Privacy Act of 2018, or the CCPA

Under the Federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH Act, HHS has issued regulations to protect the privacy and security of protected health information used or disclosed by certain entities including health care providers, such as us. HIPAA also regulates standardization of data content, codes and formats used in certain health care transactions and standardization of identifiers for health plans and providers. Penalties for violations of HIPAA and HITECH laws and regulations include civil and criminal penalties.

Three standards have been promulgated under HIPAA’s and HITECH’s regulations: the Standards for Privacy of Individually Identifiable Health Information, which restrict the use and disclosure of certain individually identifiable health information, the Standards for Electronic Transactions, which establish standards for common healthcare transactions, such as claims information, plan eligibility, payment information and the use of electronic signatures, and the Security Standards for the Protection of Electronic Protected Health Information, or Security Standards, which require covered entities and