S-1 1 d567346ds1.htm FORM S-1 Form S-1
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As filed with the Securities and Exchange Commission on September 23, 2013

Registration No. 333-             

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

BIOCEPT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   8071   80-0943522

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

5810 Nancy Ridge Drive

San Diego, CA 92121

(858) 320-8200

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

 

 

Michael W. Nall

Chief Executive Officer and President

Biocept, Inc.

5810 Nancy Ridge Drive

San Diego, CA 92121

(858) 320-8200

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

 

 

Copies to:

 

Michael J. Brown, Esq.

Hayden J. Trubitt, Esq.

Michael L. Lawhead, Esq.

Stradling Yocca Carlson & Rauth, P.C.

4365 Executive Drive, Suite 1500

San Diego, CA 92121

(858) 926-3000

 

William G. Kachioff

Senior Vice-President, Finance and

Chief Financial Officer

Biocept, Inc.

5810 Nancy Ridge Drive

San Diego, CA 92121

(858) 320-8200

 

Ivan K. Blumenthal, Esq.

Merav Gershtenman, Esq.

Mintz, Levin, Cohn, Ferris, Glovsky

and Popeo, P.C.

666 Third Avenue

New York, NY 10017

(212) 935-3000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes 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, please 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.  ¨


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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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   x

 

 

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, $0.0001 par value per share(3)

  $23,000,000   $3,137.20

Representative’s Warrants to Purchase Common Stock(3)(4)

  —     —  

Common Stock Underlying Representative’s Warrants(3)(5)

  $1,250,000   $170.50

Total Registration Fee

  $24,250,000   $3,307.70

 

 

(1) Estimated solely for the purpose of calculating the Registration Fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended. Includes the offering price of shares of common stock the underwriters have the option to purchase to cover over-allotments, if any.
(2) Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price.
(3) Pursuant to Rule 416 under the Securities Act, the shares of common stock registered hereby also include an indeterminate number of additional shares of common stock as may from time to time become issuable by reason of stock splits, stock dividends, recapitalizations or other similar transactions.
(4) No registration fee pursuant to Rule 457(g) under the Securities Act.
(5) Estimated solely for the purposes of calculating the registration fee pursuant to Rule 457(g) under the Securities Act. The warrants are exercisable at a per share exercise price equal to 125% of the public offering price.

 

 

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 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary 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 it is not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

 

PRELIMINARY PROSPECTUS   SUBJECT TO COMPLETION     DATED SEPTEMBER    , 2013   

 

            Shares

Common Stock

 

LOGO

 

 

This is the initial public offering of shares of common stock of Biocept, Inc. No public market currently exists for our shares. We are offering all of the shares of common stock offered by this prospectus. We expect the public offering price of our shares of common stock to be between $[    .    ] and $[    .    ] per share.

We expect to implement a 1-for-10 reverse stock split of our outstanding common stock just before the effective time of this prospectus; all common share and per-common-share figures in this prospectus have been adjusted to reflect this reverse stock split. We have applied to list our common stock on The NASDAQ Capital Market under the symbol “BIOC.” No assurance can be given that our application will be approved.

We are an “emerging growth company” as that term is used in the Jumpstart Our Business Startups Act of 2012, and, as such, we have elected to take advantage of certain reduced public company reporting requirements for this prospectus and future filings.

Investing in our common stock involves a high degree of risk. See “Risk Factors ” beginning on page 12 of this prospectus for a discussion of information that should be considered in connection with an investment in our common stock.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

     Per Share      Total  

Public offering price

   $                    $                

Underwriting discounts and commissions(1)

   $                    $                

Offering proceeds to us, before expenses

   $                    $                

 

(1)

See “Underwriting” beginning on page 131 of this prospectus for a description of compensation payable to the underwriters.

We have granted a 45-day option to the underwriters to purchase up to              additional shares of common stock to cover over-allotments, if any.

The underwriters expect to deliver the shares against payment therefor on or about                         , 2013.

Aegis Capital Corp

The date of this prospectus is                     , 2013.


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TABLE OF CONTENTS

 

     Page  

SUMMARY

     1   

SUMMARY FINANCIAL DATA

     10   

RISK FACTORS

     12   

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

     41   

USE OF PROCEEDS

     42   

DIVIDEND POLICY

     42   

CAPITALIZATION

     43   

DILUTION

     44   

SELECTED HISTORICAL FINANCIAL DATA

     45   

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     49   

DESCRIPTION OF THE BUSINESS

     61   

MANAGEMENT

     95   

EXECUTIVE COMPENSATION

     100   

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

     115   

PRINCIPAL STOCKHOLDERS

     120   

DESCRIPTION OF CAPITAL STOCK

     123   

SHARES ELIGIBLE FOR FUTURE SALE

     129   

UNDERWRITING

     131   

LEGAL MATTERS

     140   

EXPERTS

     140   

WHERE YOU CAN FIND MORE INFORMATION

     140   

GLOSSARY OF SCIENTIFIC AND HEALTHCARE-RELATED ACRONYMS

     141   

INDEX TO FINANCIAL STATEMENTS

     F-1   

Neither we nor the underwriters have authorized anyone to provide you with information that is different from that contained in this prospectus or in any free writing prospectus we may authorize to be delivered or made available to you. When you make a decision about whether to invest in our common stock, you should not rely upon any information other than the information in this prospectus or in any free writing prospectus that we may authorize to be delivered or made available to you. Neither the delivery of this prospectus nor the sale of our common stock means that the information contained in this prospectus or any free writing prospectus is correct after the date of this prospectus or such free writing prospectus. This prospectus is not an offer to sell or the solicitation of an offer to buy the shares of common stock in any circumstances under which the offer or solicitation is unlawful.

 

 

Unless otherwise indicated, information contained in this prospectus concerning our industry and the markets in which we operate, including our general expectations and market position, market opportunity and market share, is based on information from our own management estimates and research, as well as from industry and general publications and research, surveys and studies conducted by third parties. Management estimates are derived from publicly available information, our knowledge of our industry and assumptions based on such information and knowledge, which we believe to be reasonable. Our management estimates have not been verified by any independent source, and we have not independently verified any third-party information. In addition, assumptions and estimates of our and our industry’s future performance are necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors.” These and other factors could cause our future performance to differ materially from our assumptions and estimates. See “Special Note Regarding Forward-Looking Statements.”


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We use in this prospectus our BIOCEPT LABORATORIES logo, for which we hold a registered United States trademark, our mark CEE, which is a registered United States trademark, and our marks OncoCEE-BR, OncoCEE-LU, CEE-Selector, CEE-Cap, CEE-Enhanced, CEE-Sure, OncoCEE-GA, OncoCEE-PR, OncoCEE-ME, OncoCEE-CR and OncoCEE, which in the United States are unregistered trademarks. This prospectus also includes trademarks, tradenames and service marks that are the property of other organizations. Solely for convenience, trademarks and tradenames referred to in this prospectus appear (after the first usage) 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.


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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 “Risk Factors” section of this prospectus and the financial statements and related notes appearing at the end of this prospectus before making an investment decision.

Unless the context provides otherwise, all references in this prospectus to “Biocept,” “we,” “us,” “our,” the “Company,” or similar terms, refer to Biocept, Inc. We reincorporated from California to Delaware in July 2013. Except where otherwise expressly stated, no distinction is made in this prospectus between historic activities and results of the California and Delaware corporations.

Our Company

We are a cancer diagnostics company that develops and commercializes proprietary circulating tumor cell, or CTC, and circulating tumor DNA, or ctDNA, tests utilizing a standard blood sample. These tests (including our OncoCEE-BRTM breast cancer CTC test, which is already on the market) are designed to provide information to oncologists to enable them to select appropriate treatment for their patients due to better, timelier and more-detailed data on the characteristics of tumors. Our marketed test and our tests in development for the detection and analysis of CTCs utilize our Cell Enrichment and Extraction, or CEE®, technology, and our tests in development for the detection and analysis of ctDNA utilize our CEE-Selector™ technology, each performed on a standard blood sample. CEE is an internally invented and developed, microfluidics-based CTC capture and analysis platform, with enabling features that change how CTC testing can be used by clinicians by providing real-time biomarker monitoring with only a standard blood sample. The CEE-Selector technology enables mutation detection with enhanced sensitivity and specificity and is applicable to nucleic acid from CTCs or other sample types, such as blood plasma for ctDNA.

At our corporate headquarters facility located in San Diego, California, we operate a clinical laboratory that is certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and accredited by the College of American Pathologists, or CAP. We also manufacture our CEE microfluidic channels, related equipment and certain reagents to perform our tests at this facility.

We are in the process of commercializing our first proprietary test, OncoCEE-BR. The OncoCEE-BR is a breast cancer CTC test that is performed on a standard blood sample. It detects CTCs, which are typically very rare, and determines the patient’s human epidermal growth factor receptor 2, or HER2, status by fluorescence in situ hybridization, or FISH. Pursuant to an agreement that we entered into with Clarient Diagnostic Services, Inc., or Clarient, a GE Healthcare Company, Clarient is cooperating with us on a nonexclusive basis to market, sell and otherwise commercialize OncoCEE-BR tests.

We anticipate launching OncoCEE-LUTM, a proprietary test performed on a standard blood sample for non-small cell lung cancer, or NSCLC, in the first half of 2014. The OncoCEE-LU test’s biomarker analysis would include FISH for echinoderm microtubule-associated protein-like 4/ anaplastic lymphoma kinase, or EML4/ALK, and c-ros oncogene 1, receptor tyrosine kinase, or ROS1, gene fusions, as well as mutation analysis for the epidermal growth factor receptor, or EGFR, gene, the K-ras gene and the B-raf gene. Life Technologies Corporation will be collaborating with us in the commercialization of the OncoCEE-LU test.

Other biomarker analyses can be added to these tests as their clinical relevance is demonstrated, for example, ret proto-oncogene gene fusions in NSCLC. In addition, we are developing a series of other proprietary CTC and ctDNA tests for different solid tumor types, including colorectal cancer, prostate cancer, gastric cancer and melanoma, each incorporating treatment-associated biomarker analyses specific to that cancer, planned to be launched over the next two to three years. We also have a research and development program focused on technology enhancements and novel platform development, and a translational research group evaluating clinical applications for our cancer diagnostic tests in different cancer types and clinical settings. We plan to launch new tests for these solid tumor types at the rate of at least 1-2 per year for the next 3 years.

We collaborate with physicians and researchers at The University of Texas MD Anderson Cancer Center and the Dana-Farber Cancer Institute and plan to expand our current collaborative relationships to include other key thought leaders for the types of cancer we are targeting with our current and planned CTC and ctDNA tests. Such relationships help us

 

 

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develop and validate the effectiveness and utility of our current test and our planned tests in specific clinical settings and provide us access to patient samples and data.

Market Overview

Despite many advances in the treatment of cancer, cancer remains one of the greatest areas of unmet medical need. In 2008, the World Health Organization attributed 7.6 million deaths worldwide to cancer-related causes. The World Health Organization projects that by 2030 this number will rise to 13.1 million deaths per year. They also project that worldwide, cancer has surpassed cardiovascular disease as the leading cause of death. The incidence of, and deaths caused by, the major cancers are staggering.

Cancer constitutes a heterogeneous class of diseases, characterized by uncontrollable cell growth, that result from a combination of both environmental and hereditary risk factors. Many different tissue types can become malignant, such as breast, lung, liver, and skin, and even within a particular tumor there is heterogeneity, with certain cancer cells in a patient bearing specific cellular or genetic biomarkers, while other cells in the tumor may not have these markers. It has only been in recent years that technology has progressed far enough to enable researchers to understand many cancers at a molecular level and attribute specific cancers to associated genetic changes.

Limitations of Traditional Cancer Diagnostic and Profiling Approaches

Cancer is difficult to diagnose and manage due to its heterogeneity at visual, genetic and clinical levels. Traditional methods of diagnosis for solid tumors, routinely used as the initial step in cancer detection, involve a tissue biopsy, followed by a pathologist examining a thin slice of potentially cancerous tissue under a microscope. The tissue sample must be used in combination with chemical staining techniques to enable analysis of the biopsy. Through visual inspection, the pathologist determines whether the biopsy contains normal or cancerous cells, with those cells that are deemed cancerous being graded on a level of aggressiveness. In recent years, molecular (or genetic) testing has become the standard of care and will also be performed in order to provide information about which drugs a patient is likely or unlikely to respond to. After the diagnosis, a clinical workup is performed according to established guidelines for the specific cancer type. From there, the physician determines the stage of progression of the cancer based on a series of clinical measures, such as size, grade, metastasis rates, symptoms and patient history, and decides on a treatment plan that may include surgery, watchful waiting, radiation, chemotherapy, or stem cell transplant.

Molecular analysis is dependent on the availability of a relevant tissue biopsy for the pathologist to analyze. Such a biopsy is often not available. A tumor may not be readily accessible for biopsy, a patient’s condition may be such that a biopsy is not advised, and for routine periodic patient monitoring to evaluate potential progression or recurrence, a biopsy is a fairly invasive procedure and not typically performed. As the length of time between when the original biopsy, diagnosis or surgery is conducted to the current evaluation of the patient increases, the likelihood that an original biopsy specimen is truly representative of the current disease condition declines, as does the usefulness of the original biopsy for making treatment decisions. This risk intensifies in situations where a drug therapy is being administered, because the drug can put selective pressure on the tumor cells to adapt and change. Similarly, the heterogeneity referred to above means that different parts or areas of the same tumor can have different molecular features or properties. In evaluating a biopsy specimen, the pathologist will take a few thin slices of the tumor for microscopic review rather than exhaustively analyzing the whole tumor mass. The pathologist can only report on the tumor sections analyzed, and if other parts of the tumor have different features, such as biomarkers corresponding to specific treatments, they can be missed. A more representative analysis of the entire tumor, as well as any metastases if they are present, is very helpful.

CTCs, ctDNA and Cancer

Circulating tumor cells, or CTCs, are cancer cells that have detached from the tumor and invaded the patient’s blood or other bodily fluids. These cells are representative of the tumor and its metastases, and can function as their surrogates. Testing CTCs can complement pathologic information drawn from a biopsy or resected tissue sample, helping to insure that the analysis is comprehensive and not biased by tumor heterogeneity and sampling issues. Testing CTCs can also provide critical data when a biopsy is not possible. Clinical studies have demonstrated that the presence and number of CTCs provides information on the likely course of the cancer for the patient, or in other words they are considered “prognostic.” Since CTCs are understood to be representative of the tumor, they can also be used for biomarker analysis, for

 

 

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example, to help guide therapy selection. In this way they are “predictive” in that they offer insight into the likely responsiveness or resistance to particular therapies. After surgery and during any subsequent therapy or monitoring period, blood samples can periodically be drawn and analyzed to evaluate a therapy’s continuing effectiveness, as well as to detect other biomarkers, such as new genetic mutations that may arise as a result of selection pressure by a particular therapy or by chance. Physicians can use this information to determine which therapy is most likely to benefit their patients at particular times through the course of their disease. Treatment decisions based on patient-specific information are the foundation of personalized medicine, and tests, or assays, that guide a physician in the selection of individualized therapy for a patient are termed “predictive assays.”

Nucleic acid that is released into blood by dying tumor cells is called ctDNA. Cell death occurs in all tissues, especially those that are rapidly dividing, and in cancer, where cell growth is not only rapid but also uncontrolled, parts of tumors often outgrow their blood supply, resulting in cell death. As a consequence, ctDNA is common in cancer patients, and like CTCs, scientists believe that it may be more representative of a patient’s tumor than a few thin sections from a tissue biopsy, thus reducing the heterogeneity problem. ctDNA is found in the plasma component of blood, and is readily accessible in a standard blood sample. Analyzing ctDNA for mutations that are used as biomarkers for therapy selection shows great promise. One of its strengths, in addition to not requiring a tissue biopsy, is that it is not dependent on capturing rare tumor cells from blood to provide a sample for testing. The negative side of this approach is that the cellular context is lost, as the ctDNA is mixed with a much larger amount of circulating DNA from normal cells that are continuously dying and being replaced in the body, thus making analysis challenging. This requires a mutation detection methodology with enhanced sensitivity and specificity, to distinguish mutations in particular gene regions in cancer cells from the normal gene sequence which co-exist in blood as normal cells die and are replaced in the body. Our CEE-Selector technology provides the necessary sensitivity and specificity, creating an opportunity for ctDNA testing to complement CTC analysis or potentially to serve as stand-alone tests.

Use of CTC- and ctDNA-Derived Biomarker Data in Cancer Treatment

CTCs and ctDNA are derived from, and are understood to be representative of, a solid tumor and its metastases and can be analyzed as adjuncts to, or in place of, the tumor, especially when a recent tumor biopsy is not available. Almost any analysis that can be performed on tumor tissue can also be performed on CTCs, while the number of currently available assays that can be performed on ctDNA is more limited. We have focused our analysis of CTCs and ctDNA on known biomarkers associated with specific therapies to support treatment decisions and therapy selection made by oncologists. We analyze proteins and genetic aberrations and mutations which are detected in CTCs or ctDNA by molecular diagnostic tests, such as PCR and gene sequencing. Specific examples include (i) the detection of the estrogen receptor protein in breast cancer, indicative of the likely responsiveness to hormonal therapies like tamoxifen, often sold under the trade name Nolvadex®, (ii) the presence of an amplified HER2 gene in breast cancer, indicative of the likely responsiveness to HER2-targeted agents like Herceptin®, and (iii) the presence of an EGFR activating mutation in Non-Small Cell Lung Cancer (NSCLC) , indicative of the likely responsiveness to EGFR-targeted agents like Tarceva®. All of these biomarkers are currently tested on tumor tissue and can be tested on CTCs, while ctDNA only provides information on mutations. The resulting information is then used to guide patient care, specifically treatment selection.

To date, these types of molecular and genetic detection methods have been successfully utilized to provide predictive information for several cancers, including breast, colon, NSCLC, melanoma and others in the form of companion diagnostics, typically performed on tumor tissue. CTC and ctDNA tests analyze the same biomarkers in a more convenient, standard blood test format that permits periodic testing.

Our Business Strategy

We plan to provide oncologists with a straightforward means to profile and characterize their patients’ tumors on a real-time basis by analyzing CTCs and ctDNA found in standard blood test draws. Biomarkers are currently detected and analyzed primarily in tissue biopsy specimens. We believe that our technology, which not only provides information on CTC enumeration (quantitation of CTCs) but also the assessment of treatment-associated biomarkers identified within the

 

 

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CTCs or in ctDNA, provide information to oncologists that improve patient treatment and management and will become a key component in the standard of care for personalized cancer treatment.

Our approach is to develop and commercialize proprietary CTC and ctDNA tests and services to enable us to offer to oncologists standard blood sample based, real-time, testing solutions for a range of solid tumor types, starting with breast cancer and progressing to future launches of tests for NSCLC, gastric cancer, colorectal cancer, prostate cancer, melanoma and others, to improve patient treatment with better prognostic and predictive tools. To achieve this, we intend to:

 

   

Develop and commercialize a portfolio of proprietary CTC and ctDNA tests and services.

 

   

Establish our internal sales and marketing capabilities in a scalable manner.

 

   

Develop and expand our collaborations with leading university hospitals and research centers.

 

   

Enhance our efforts in reaching and educating community oncologists about CTC and ctDNA tests and services.

 

   

Increase our efforts to provide biopharmaceutical companies and clinical research organizations with our current and planned proprietary CTC and ctDNA tests and services.

 

   

Support our current test and our planned tests with clinical utility studies to drive adoption and facilitate reimbursement.

 

   

Continue to enhance our current and planned proprietary CTC and ctDNA tests and reduce the costs associated with providing them through internal research and development and partnering with leading technology developers and reagent suppliers.

Our Competitive Advantages

We believe that our competitive advantages are as follows:

Our current and planned proprietary CTC and ctDNA tests enable detailed analysis of a patient’s cancer utilizing a standard blood sample, facilitating testing at any time, including when a biopsy is not available or inconclusive, offering real-time monitoring of the cancer and the response of the cancer to therapy, and allowing oncologists to select timely modifications to treatment regimens. CTCs and ctDNA, because they are derived from the primary tumor or its metastases, function as surrogates for the tumor, with the advantage of being readily accessible in a standard blood sample, which is especially important in situations where a biopsy is not available or advised. The simplicity of obtaining a standard blood sample permits repeat testing in a monitoring mode to detect recurrence or progression, and to offer information on treatment modifications based on a current assessment of the cancer’s properties.

Our current test and our planned tests provide more information than competitors’ existing tests, including predictive information on biomarkers linked to specific therapies. Such additional biomarker information enables a physician to develop a personalized treatment plan. By including biomarker information in our analysis in addition to CTC enumeration, our current test and our planned tests are designed to provide a more complete profile of a patient’s disease than existing CTC tests can. The biomarker information assists physicians in selecting appropriate therapies for individual patients. Our ctDNA tests are expected to offer enhanced sensitivity and specificity based on the CEE-Selector technology, enabling earlier detection of therapy-associated mutation targets or resistance markers, again supporting treatment decisions.

Our current and planned CTC tests are designed to capture and detect a broader range of CTCs than existing tests and are applicable to, or can be quickly modified for, a wide range of cancer types. Our CEE-CapTM antibody capture cocktail is comprised of antibodies targeting not only EpCAM, the traditional epithelial CTC capture antigen utilized in Janssen Diagnostics, LLC’s CellSearch® system and in other platforms, but also other epithelial antigens and mesenchymal and cancer stem cell antigens, indicative of cells having undergone the epithelial-to-mesenchymal transition, or EMT. These cells may be more relevant for metastasis. Our detection modalities include cytokeratin staining, with a broader range of cytokeratin isotypes than existing CTC tests. We plan to introduce our CEE-EnhancedTM staining, which would enable detection of cells specifically captured with our antibody cocktail, including EMT cells lacking cytokeratin. Through CEE-Enhanced staining, more CTCs and different types of CTCs can be identified, potentially at earlier stages of disease, resulting in fewer non-informative cases and more information for physicians.

 

 

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Our current and planned CTC and ctDNA tests are flexible, and can readily be configured to accommodate new biomarkers with clinical relevance as they are identified. Our CEE platform permits almost any analysis that is currently performed on tumor tissue to be performed on CTCs. As new therapies are approved, we will be able to include them in our tests with minimal changes. This is attractive to pharmaceutical and biotechnology companies that are developing such therapies, or seeking ways to make their clinical trials more efficient, as it enables them to focus on patients more likely to respond to a particular therapy and demonstrate a benefit from that therapy.

Collaborative relationships with physicians at MD Anderson Cancer Center. We work closely with a number of physicians at MD Anderson Cancer Center in Houston, Texas, with various collaborative projects in different cancer types, including breast, NSCLC, prostate, colorectal, ovarian, bladder, renal and endometrial cancers. These projects provide us access to leading researchers, leading clinicians and key thought leaders, access to valuable patient samples and insight into clinical applications for tests. Some of these projects have resulted in publications in leading journals, such as Cancer Discovery and Cancer Medicine, which enhances our standing in the oncology community and supports our marketing efforts.

Our planned CEE-Selector mutation tests are not platform dependent. These tests can be performed on almost any molecular instrument, which provides flexibility to us in our laboratory operations. To the extent we elect to develop these tests as in vitro diagnostic kits, or IVDs, including pursuing CE marks for them to be marketed outside the United States, the ability to rapidly deploy them on different approved instrument platforms already in many laboratories greatly simplifies their distribution and commercialization.

Focus on targeting oncologists at private and group practices and at community hospitals, where approximately 85% of all cancer patients in the United States are initially diagnosed. Our sales and marketing efforts will be directed primarily at oncologists at community hospitals to better service their oncology patients. Our current test and our planned proprietary tests and testing services can help oncologists and community hospitals deliver a higher value of service to their cancer patients.

Our Proprietary Tests and Services

We are in the process of commercializing our first proprietary test, OncoCEE-BR for breast cancer, and plan to continue to launch a series of tests for CTCs in different tumor types, including NSCLC, gastric, colorectal and prostate cancers and melanoma, incorporating analyses for different biomarkers, at the rate of at least 1-2 per year for the next 3 years. OncoCEE-BR and the planned future tests are based on the CEE technology platform. The CEE system isolates CTCs from blood samples of cancer patients for enumeration (or count) and genetic analysis. A sample is shipped to us in our proprietary blood collection tube called the CEE-SureTM tube for recovery and analysis of CTCs. When performing the CTC assay, the sample is processed in our laboratory. The specimen of blood is separated into its parts (red blood cells, buffy coat and plasma). The buffy coat is incubated with the antibody solution and passed through a proprietary microfluidic channel containing 9,000 microscopic posts coated with reagents to capture antibody-labeled tumor cells. The captured cells are suitable for further testing of whole cells directly in the microfluidic channel or by releasing the cells from the microfluidic channel and performing CEE-Selector or similar techniques.

Clinicians acknowledge limitations of currently available CTC test systems such as the CellSearch® that rely on capture solely by anti-EpCAM antibodies and detection by anti-cytokeratin antibodies. Capture and detection based only on these two antigens is unlikely to identify all CTCs, and clinically this may result in no CTCs being detected in cases in which they are present. For example, some tumor cells that have been released into the circulatory system have undergone an EMT. These mesenchymal cells are less differentiated than epithelial cells and more similar to stem cells.

 

 

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We have developed several assays that have enabled the capture of significantly more CTCs than is accomplished through the use of traditional anti-EpCAM immuno-capture alone.

In addition to enhanced capture, we are also improving identification of CTCs. We have developed alternative methods of fluorescent cell staining that are uniquely possible within the CEE system to enhance detection of CTCs. This technology is called CEE-Enhanced. We believe that the combination of our assay with more sensitive fluorescent detection of CTCs through CEE-Enhanced staining will lead to major advances in the capture, enumeration and analysis of CTCs. CEE-Enhanced staining is expected to be included in our commercially available and planned tests by the end of 2013.

Analysis of CTCs performed by us incorporates both standard and novel methods. Immunocytochemistry which looks at proteins, analogous to the immunohistochemistry, or IHC, performed on tissues, can be readily applied and performed in the microfluidic channel, dependent only on suitable biomarkers. Similarly, FISH, used to evaluate genetic abnormalities in cells, may be performed in our microfluidic channel using validated assays available from a number of vendors. For genetic mutation analysis, standard technologies can be applied. We have also developed proprietary CEE-Selector technology for mutation analysis in CTCs and ctDNA, with enhanced sensitivity and specificity.

As indicated, CEE-Selector was developed specifically for analysis of CTCs, which are generally very rare and outnumbered many-fold by white blood cells. This complexity has been a challenge for standard technologies. CEE-Selector offers enhanced specificity and sensitivity (greater than 1 in 10,000 of mutated sequence to normal sequence in a complex genetic background) compared to other approaches, and potentially has broader application than just CTC analysis, including analysis of ctDNA in plasma, both in a CLIA lab setting and as an IVD.

We are developing and offering Laboratory Developed Tests for CTCs and ctDNA. FDA clearance or approval is not currently required to offer these types of tests in our laboratory once they have been clinically and analytically validated. We seek licenses and approvals for our laboratory facility and for our LDTs from the appropriate regulatory authorities, such as the Centers for Medicare & Medicaid Services, or CMS, which oversees CLIA, and various state regulatory bodies. Certain states, such as New York and Florida, require us to obtain approval of our proprietary tests in order for us to be paid for testing patient specimens from that state. We are currently in the process of addressing the requirements for licensure in New York, and we have all required licenses and approvals from all other states.

Clinical Trial Services

Industry research has shown many promising drugs have produced disappointing results in clinical trials. For example, a study by Princess Margaret Hospital in Toronto estimated that 85% of the phase III trials testing new therapies for solid tumors studied over a five-year period failed to meet their primary endpoint. Given such a high failure rate of oncology drugs in clinical development, combined with constrained budgets for biopharmaceutical companies, there is a significant need for drug developers to utilize molecular diagnostics to decrease these failure rates. For specific molecular-targeted therapeutics, the identification of appropriate biomarkers potentially may help to optimize clinical trial patient selection and success rates by helping clinicians identify patients that are most likely to benefit from a therapy based on their individual genetic profile.

Although historically the bulk of our commercial revenues have come from performing our breast cancer test, we also offer clinical trial testing services to help increase the efficiency and economic viability of clinical trials for biopharmaceutical companies and clinical research organizations. Our clinical trial services could include developing customizable tests and techniques utilizing our proprietary CTC and ctDNA technologies to provide sensitive, real-time characterization of individual patient’s tumors using a standard blood sample. These tests may also be useful as, and ultimately developed into, companion diagnostics associated with a specific therapeutic. Additionally, through our services we hope to gain further insights into disease progression and the latest drug development that we can incorporate into our proprietary tests and services.

 

 

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Risks That We Face

An investment in our common stock involves a high degree of risk. You should carefully consider the risks summarized below. The risks are discussed more fully in the “Risk Factors” section of this prospectus immediately following this prospectus summary. These risks include, but are not limited to, the following:

 

   

we are an early-stage company with an accumulated deficit of approximately $117 million (at June 30, 2013). Before 2008, we were pursuing a business plan relating to fetal genetic disorders and other fields, all of which were unrelated to cancer diagnostics. The portion of our accumulated deficit that relates to the period from inception through December 31, 2007 is approximately $66.5 million.

 

   

we may never achieve sustained profitability;

 

   

our business depends upon our ability to introduce additional tests and increase sales of our cancer diagnostic test;

 

   

our current cash resources are insufficient to fund our operations without this offering;

 

   

our business depends on executing on our sales and marketing strategy for our cancer diagnostic tests and gaining acceptance of our current test and future tests in the market;

 

   

our business depends on our ability to continually develop new cancer diagnostic tests and enhance our current test and future tests;

 

   

our business depends on being able to obtain adequate reimbursement from governmental and other third-party payors for tests and services;

 

   

our business depends on satisfying any applicable United States (including FDA) and international regulatory requirements with respect to tests and services; and many of these requirements are new and still evolving;

 

   

our business depends on our ability to effectively compete with other diagnostic tests, methods and services that now exist or may hereafter be developed;

 

   

we depend on our senior management and in August 2013 we hired a new chief executive officer;

 

   

we depend on our ability to attract and retain scientists, clinicians and sales personnel with extensive experience in oncology, who are in short supply; and

 

   

we need to obtain or maintain patents or other appropriate protection for the intellectual property utilized in our current and planned proprietary tests and services.

Company Information

We maintain our principal executive offices at 5810 Nancy Ridge Drive, San Diego, California 92121. Our telephone number is (858) 320-8200 and our website address is www.biocept.com. The information contained in, or that can be accessed through, our website is not incorporated into and is not part of this prospectus. We were incorporated in California on May 12, 1997 and reincorporated as a Delaware corporation on July 30, 2013.

Implications of Being an Emerging Growth Company

As a company with less than $1.0 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 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;

 

   

not being required to comply with the auditor attestation requirements of Section 404 of 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.

 

 

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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 2018. However, if certain events occur before the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenues exceed $1.0 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 before the end of such five-year period.

We have elected to take advantage of certain of the reduced disclosure obligations 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 the information you might receive from other public reporting companies in which you hold equity interests.

The Offering

 

Common stock offered by us

[            ] shares of our common stock.

 

Over-allotment option

We have granted the underwriters a 45-day option to purchase up to [            ] additional shares of our common stock from us at the public offering price less underwriting discounts and commissions.

 

Common stock outstanding after this offering

[            ] shares.

 

Use of proceeds

We estimate that the net proceeds from our sale of shares of our common stock in this offering will be approximately $[    .    ] million, or approximately $[    .    ] million if the underwriters exercise their over-allotment option in full, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We currently expect to use the net proceeds from this offering as follows:

 

   

approximately $5 million to hire sales and marketing personnel and support increased sales and marketing activities;

 

   

approximately $5 million to fund further research and development, clinical utility studies and future enhancements of our current proprietary test and our planned proprietary tests and services;

 

   

approximately $3 million to acquire equipment, implement automation and scale our capabilities to prepare for significant test volume;

 

   

approximately $1 million to satisfy deferred salary obligations; and

 

   

the balance for general corporate purposes and to fund ongoing operations and expansion of our business.

 

  For additional information please refer to the section entitled “Use of Proceeds” on page 42 of this prospectus.

 

Risk Factors

See the section entitled “Risk Factors” beginning on page 12 of this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

 

NASDAQ Capital Market symbol

BIOC.

 

 

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The number of shares of our common stock to be outstanding after this offering is based on 255,376 shares of our common stock outstanding as of June 30, 2013 and excludes as of such date:

 

   

73,899 shares of our common stock issuable upon the exercise of stock options as of June 30, 2013, with a weighted average exercise price of $3.54 per share;

 

   

45,873 shares of our common stock issuable upon the exercise of outstanding restricted stock units as of June 30, 2013;

 

   

other shares of our common stock reserved for future issuance under our 2013 and 2007 Equity Incentive Plans;

 

   

an estimated 424,178 shares of our common stock issuable upon the exercise of outstanding common stock warrants as of June 30, 2013, at an estimated weighted average exercise price of $4.31 per share;

 

   

269,184 common stock equivalents issuable upon the exercise of our outstanding warrants to purchase preferred stock (the warrants overlying all but 2,222 of which will terminate upon the closing of our initial public offering in accordance with their terms);

 

   

any shares of our common stock issuable upon exercise of the underwriters’ over-allotment option; and

 

   

any shares of common stock that will underlie the representative’s warrant.

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

 

   

the filing of our amended certificate of incorporation and the adoption of our amended and restated bylaws, which will occur immediately before the closing of this offering;

 

   

a 1-for-10 reverse stock split of our common stock to be effected before the completion of this offering;

 

   

the automatic conversion of all outstanding shares of our Series A preferred stock into 2,314,001 (post-reverse-split) shares of our common stock immediately before the closing of the offering;

 

   

the automatic issuance of an estimated 46,422 (post-reverse-split) shares of common stock immediately before or immediately after the closing of the offering, pursuant to the terms of certain outstanding restricted stock units currently expressed in shares of Series A preferred stock; but otherwise no settlement of the outstanding restricted stock units described above;

 

   

the automatic conversion of all outstanding convertible notes, at a conversion price equal to the public offering price per share of this offering, into shares of common stock upon the closing of this offering;

 

   

no exercise of the outstanding options or warrants described above;

 

   

no exercise by the underwriters of their option to purchase additional shares of our common stock to cover over-allotments, if any;

 

   

the issuance of the warrants to be issued to the representative of the underwriters in connection with this offering as described in the “Underwriting—Representative’s Warrants” section of this prospectus; and

 

   

no exercise by the representative of the underwriters of such representative’s warrants.

 

 

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SUMMARY FINANCIAL DATA

The following tables set forth a summary of our historical financial data as of, and for the period ended on, the dates indicated. We have derived the statement of operations data for the years ended December 31, 2011 and 2012 and the balance sheet data as of December 31, 2012 from our audited financial statements appearing elsewhere in this prospectus. We have derived the statements of operations data for the six months ended June 30, 2012 and 2013 and balance sheet data as of June 30, 2013 from our unaudited financial statements appearing elsewhere in this prospectus. All “Weighted average shares outstanding” data and all “Net loss per common share” data, whether derived from our audited financial statements or from our unaudited financial statements, have been adjusted to reflect a 1-for-10 reverse stock split which we intend to effect before the effective date of this prospectus. The unaudited financial statements have been prepared on a basis consistent with our audited financial statements included in this prospectus and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state our financial position as of June 30, 2013 and results of operations for the six months ended June 30, 2012 and 2013. You should read this data together with our financial statements and related notes appearing elsewhere in this prospectus and the sections in this prospectus entitled “Capitalization,” “Selected Historical Financial Data,” and “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.

 

     Year ended December 31,     For the six months ended June 30,  
     2011     2012     2012     2013  
                 (unaudited)     (unaudited)  
     (in thousands, except share and per share data)  

Statement of Operations Data:

        

Revenues

   $ 1      $ 109      $ 64      $ 84   

Cost of revenues

     17        1,201        465        1,141   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     (16     (1,092     (401     (1,057

Research and development expenses

     8,853        6,562        3,797        1,401   

General and administrative expenses

     2,729        2,063        1,165        929   

Sales and marketing expenses

     673        786        402        124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (12,271     (10,503     (5,765     (3,511

Total other income/(expense)

     (1,357     (1,756     (677     (389
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss Before Income Taxes

   $ (13,628   $ (12,259   $ (6,442   $ (3,900

Income tax expense

     1        1        1        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss & comprehensive loss

   $ (13,629   $ (12,260   $ (6,443   $ (3,901
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding used in computing net loss per common share:

        

Basic

     159,377        224,672        224,672        252,751   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     159,377        224,672        224,672        252,751   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share

        

Basic

   $ (85.52   $ (54.57   $ (28.68   $ (15.43
  

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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     Year ended December 31,     For the six months ended June 30,  
     2011     2012     2012     2013  
                 (unaudited)     (unaudited)  
     (in thousands, except share and per share data)  

Diluted

   $ (85.52   $ (54.57   $ (28.68   $ (15.43
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     As of December 31, 2012     As of June 30, 2013  
     Actual     Actual     Pro  Forma(1)  
           (Unaudited)     (Unaudited)  

Balance Sheet Data:

      

Cash and cash equivalents

   $ 185      $ 4      $     

Total assets

   $ 1,470      $ 992      $     

Notes payable, net of debt discount

   $ 22,376      $ 3,816      $     

Total liabilities

   $ 28,855      $ 9,207      $     

Convertible preferred stock

   $ 3      $ 7      $     

Total shareholders’ deficit

   $ (27,385   $ (8,215   $     

 

(1) Gives effect to (i) the automatic conversion of all outstanding shares of our Series A preferred stock (including shares issued in July 2013 which, as of June 30, 2013, were classified as to-be-issued for conversion of debt and accrued interest) into 2,314,001 shares of common stock, (ii) the conversion of convertible promissory notes and accrued interest in the amount of $[            ] million into an aggregate of [            ] shares of our common stock in connection with the closing of our initial public offering, (iii) the issuance of an estimated 46,422 shares of common stock upon such initial public offering pursuant to the settlement of certain restricted stock units (which are currently expressed in shares of preferred stock) in accordance with their terms, (iv) the termination of certain warrants upon the closing of our initial public offering in accordance with their terms and (v) the reclassification to shareholders’ deficit of the fair value of certain warrants the exercise price and/or exercisability period length of which will be fixed upon the closing of our initial public offering in accordance with their terms, assuming for all such items an initial public offering price of $[            ] per share, the midpoint of the price range listed on the cover page of this prospectus. The pro forma information 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.

The unaudited pro forma balance sheet information as of June 30, 2013 assumes that the completion of our initial public offering had occurred as of June 30, 2013 and excludes              shares of common stock issued in the initial public offering and any related net proceeds.

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should consider carefully the specific risk factors described below in addition to the other information contained in this prospectus, including our financial statements and related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in the prospectus, before making your investment decision. The occurrence of any of the events or developments described below could harm our business, financial condition, results of operations and growth prospects. In such an event, the market price of our common stock could decline, and you may lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations.

Risks Relating to Our Financial Condition and Capital Requirements

We are an early stage company with a history of net losses; we expect to incur net losses in the future, and we may never achieve sustained profitability.

We have historically incurred substantial net losses, including net losses of $13.6 million in 2011, $12.3 million in 2012 and $3.9 million in the first six months of 2013, and we have never been profitable. At June 30, 2013, our accumulated deficit was approximately $117 million. Before 2008, we were pursuing a business plan relating to fetal genetic disorders and other fields, all of which were unrelated to cancer diagnostics. The portion of our accumulated deficit that relates to the period from inception through December 31, 2007 is approximately $66.5 million.

We expect our losses to continue as a result of costs relating to our lab operations as well as increased sales and marketing costs and ongoing research and development expenses. These losses have had, and will continue to have, an adverse effect on our working capital, total assets and stockholders’ equity. Because of the numerous risks and uncertainties associated with our commercialization efforts, we are unable to predict when we will become profitable, and we may never become profitable. Even if we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our inability to achieve and then maintain profitability would negatively affect our business, financial condition, results of operations and cash flows. Our chief executive officer Michael W. Nall, who joined us in August 2013, has not previously been the chief executive officer of a public or private company.

Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern.

As described in Note 2 of our accompanying audited financial statements, our auditors have included a “going concern” provision in their opinion on our financial statements, expressing substantial doubt that we can continue as an ongoing business for the next twelve months. Our financial statements do not include any adjustments that may result from the outcome of this uncertainty. If we cannot secure the financing needed to continue as a viable business, our stockholders may lose some or all of their investment in us.

We will need to raise additional capital.

We believe our current cash resources and committed borrowing capacity are sufficient to satisfy our liquidity requirements at our current level of operations only into November of 2013. We need to raise additional financing by the fourth quarter of 2013, through this offering or otherwise, to fund our current level of operations. Such financing may not be available to us on favorable terms, if at all. Without proceeds from this offering or other sources of financing, we would need to scale back our general and administrative activities and certain of our research and development activities. Our forecast pertaining to the adequacy of our current financial resources supporting our current level of operations until the fourth quarter of 2013 is a forward-looking statements and involves risks and uncertainties.

We will also need to raise additional capital to expand our business to meet our long-term business objectives. Additional financing, which is not in place at this time, may be from the sale of equity or convertible or other debt securities in a public or private offering, from an additional credit facility or strategic partnership coupled with an investment in us or a combination of both. We may be unable to raise sufficient additional financing on terms that are acceptable to us, if at all. Failure to raise additional capital in sufficient amounts would significantly impact our ability to expand our business. For further discussion of our liquidity requirements as they relate to our long-term plans, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

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Risks Relating to Our Business and Strategy

If we are unable to increase sales of our OncoCEE-BR breast cancer diagnostic tests or successfully develop and commercialize other proprietary tests, our revenues will be insufficient for us to achieve profitability.

We currently derive substantially all of our revenues from sales of cancer diagnostic tests. We recently began offering our OncoCEE-BR breast cancer test through our CLIA-accredited and state licensed laboratory. We are in varying stages of research and development for other cancer diagnostic tests that we may offer. If we are unable to increase sales of our OncoCEE-BR breast cancer diagnostic test or successfully develop and commercialize other cancer diagnostic tests, we will not produce sufficient revenues to become profitable.

 

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If we are unable to execute our sales and marketing strategy for cancer diagnostic tests and are unable to gain acceptance in the market, we may be unable to generate sufficient revenue to sustain our business.

We are an early-stage company and have engaged in only limited sales and marketing activities for the OncoCEE-BR breast cancer diagnostic tests we offer through our CLIA laboratory. To date, we have received very limited revenue.

Although we believe that our current test and our planned diagnostic tests represent a promising commercial opportunity, our tests may never gain significant acceptance in the marketplace and therefore may never generate substantial revenue or profits for us. We will need to establish a market for our cancer diagnostic tests and build that market through physician education, awareness programs and the publication of clinical trial results. Gaining acceptance in medical communities requires publication in leading peer-reviewed journals of results from studies using our current test and/or our planned cancer tests. The process of publication in leading medical journals is subject to a peer review process and peer reviewers may not consider the results of our studies sufficiently novel or worthy of publication. Failure to have our studies published in peer-reviewed journals would limit the adoption of our current test and our planned tests.

Our ability to successfully market the cancer diagnostic tests that we may develop will depend on numerous factors, including:

 

   

conducting clinical utility studies of such tests in collaboration with key thought leaders to demonstrate their use and value in important medical decisions such as treatment selection;

 

   

whether healthcare providers believe such diagnostic tests provide clinical utility;

 

   

whether the medical community accepts that such diagnostic tests are sufficiently sensitive and specific to be meaningful in patient care and treatment decisions; and

 

   

whether health insurers, government health programs and other third-party payors will cover and pay for such cancer diagnostic tests and, if so, whether they will adequately reimburse us.

Failure to achieve widespread market acceptance of our current test and our planned cancer diagnostic tests would materially harm our business, financial condition and results of operations.

If we cannot develop tests to keep pace with rapid advances in technology, medicine and science, our operating results and competitive position could be harmed.

In recent years, there have been numerous advances in technologies relating to the diagnosis and treatment of cancer. Several new cancer drugs have been approved, and a number of new drugs in clinical development may increase patient survival time. There have also been advances in methods used to identify patients likely to benefit from these drugs based on analysis of biomarkers. We must continuously develop new cancer diagnostic tests and enhance any existing tests to keep pace with evolving standards of care. Our current test and our planned tests could become obsolete unless we continually innovate and expand them to demonstrate benefit in the diagnosis, monitoring or prognosis of patients with cancer. New cancer therapies typically have only a few years of clinical data associated with them, which limits our ability to develop cancer diagnostic tests based on, for example, biomarker analysis related to the appearance or development of resistance to those therapies. If we cannot adequately demonstrate the applicability of our current test and our planned tests to new treatments, by incorporating important biomarker analysis, sales of our tests could decline, which would have a material adverse effect on our business, financial condition and results of operations.

If our current test and our planned tests do not continue to perform as expected, our operating results, reputation and business will suffer.

Our success depends on the market’s confidence that we can continue to provide reliable, high-quality diagnostic results. We believe that our customers are likely to be particularly sensitive to test defects and errors. As a result, the failure of our current or planned tests to perform as expected would significantly impair our reputation and the public image of our cancer tests, and we may be subject to legal claims arising from any defects or errors.

 

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If our sole laboratory facility becomes damaged or inoperable, or we are required to vacate the facility, our ability to sell and provide cancer diagnostic tests and pursue our research and development efforts may be jeopardized.

We currently derive our revenues from our OncoCEE-BR breast cancer diagnostic tests conducted in our CLIA laboratory. We do not have any clinical reference laboratory facilities outside of our facility in San Diego, California. Our facilities and equipment could be harmed or rendered inoperable by natural or man-made disasters, including fire, earthquake, flooding and power outages, which may render it difficult or impossible for us to perform our diagnostic tests for some period of time. The inability to perform our current test and our planned tests or the backlog of tests 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 or relationships with scientific or clinical collaborators, and we may be unable to regain those customers or repair our reputation in the future. Furthermore, our facilities and the equipment we use to perform our research and development work could be costly and time-consuming to repair or replace.

The San Diego area has recently experienced serious fires and power outages, and is considered to lie in an area with earthquake risk.

Additionally, a key component of our research and development process involves using biological samples as the basis for our diagnostic test development. In some cases, these samples are difficult to obtain. If the parts of our laboratory facility where we store these biological samples were damaged or compromised, our ability to pursue our research and development projects, as well as our reputation, could be jeopardized. We carry insurance for damage to our property and the disruption of our business, but this insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, if at all.

Further, if our CLIA laboratory became inoperable we may not be able to license or transfer our proprietary technology to another facility with the necessary state licensure and CLIA accreditation under the scope of which our current test and our planned cancer diagnostic tests could be performed. Even if we find a facility with such qualifications to perform Biocept tests, it may not be available to us on commercially reasonable terms.

If we cannot compete successfully with our competitors, we may be unable to increase or sustain our revenues or achieve and sustain profitability.

Our principal competition comes from mainstream diagnostic methods, used by pathologists and oncologists for many years, which focus on tumor tissue analysis. It may be difficult to change the methods or behavior of oncologists to incorporate our CTC and ctDNA testing, including molecular diagnostic testing, in their practices in conjunction with or instead of tissue biopsies and analysis. In addition, companies offering capital equipment and kits or reagents to local pathology laboratories represent another source of potential competition. These kits are used directly by the pathologist, which can facilitate adoption. We plan to focus our marketing and sales efforts on medical oncologists rather than pathologists.

We also face competition from companies that offer products or are conducting research to develop products for CTC or ctDNA testing in various cancers. In particular, Janssen Diagnostics, LLC markets its CellSearch® test and Atossa Genetics markets its ArgusCYTE® test, which are competitive to our OncoCEE-BR test for CTC enumeration, and HER2 analysis, respectively. CTC and ctDNA testing is a new area of science and we cannot predict what tests others will develop that may compete with or provide results similar or superior to the results we are able to achieve with the tests we develop. In addition to Janssen Diagnostics and Atossa Genetics, our competitors also include public companies such as Alere (Adnagen) and Illumina as well as many private companies, including Apocell, EPIC Sciences, Clearbridge Biomedics, Cynvenio Biosystems, Fluxion Biosciences, RareCells, ScreenCell and Silicon Biosystems. Many of these groups, in addition to operating research and development laboratories, are establishing CLIA-certified testing laboratories while others are focused on selling equipment and reagents.

We expect that pharmaceutical and biopharmaceutical companies will increasingly focus attention and resources on the personalized cancer diagnostic sector as the potential and prevalence of molecularly targeted oncology therapies approved by the FDA along with companion diagnostics increases. For example, the FDA has recently approved two such agents—Xalkori® from Pfizer Inc. along with its companion anaplastic lymphoma kinase FISH test from Abbott Laboratories, Inc., Zelboraf® from Daiichi-Sankyo/Genentech/Roche along with its companion B-raf kinase V600 mutation

 

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test from Roche Molecular Systems, Inc. and Tafinlar® from GlaxoSmithKline along with its companion B-raf kinase V600 mutation test from bioMerieux. These recent FDA approvals are only the second, third and fourth instances of simultaneous approvals of a drug and companion diagnostic, the first being the 1998 approval of Genentech’s Herceptin® for HER2 positive breast cancer along with the HercepTest from partner Dako A/S. Our competitors may invent and commercialize technology platforms or tests that compete with ours.

There are a number of companies which are focused on the oncology diagnostic market, such as Biodesix, Caris, Clarient, Foundation Medicine, Neogenomics, Response Genetics, Agendia, Genomic Health, and Genoptix, who while not currently offering CTC or ctDNA tests are selling to the medical oncologists and pathologists. Large laboratory services companies, such as Sonic USA, Quest and LabCorp, provide more generalized cancer diagnostic testing.

Additionally, projects related to cancer diagnostics and particularly genomics have received increased government funding, both in the United States and internationally. As more information regarding cancer genomics becomes available to the public, we anticipate that more products aimed at identifying targeted treatment options will be developed and that these products may compete with ours. In addition, competitors may develop their own versions of our current or planned tests in countries where we did not apply for patents or where our patents have not issued and compete with us in those countries, including encouraging the use of their test by physicians or patients in other countries.

Some of our present and potential competitors have widespread brand recognition and substantially greater financial and technical resources and development, production and marketing capabilities than we do. Others may develop lower-priced, less complex tests that payors, pathologists and oncologists could view as functionally equivalent to our current or planned tests, which could force us to lower the list price of our tests and impact our operating margins and our ability to achieve and maintain profitability. In addition, technological innovations that result in the creation of enhanced diagnostic tools that are more sensitive or specific than ours may enable other clinical laboratories, hospitals, physicians or medical providers to provide specialized diagnostic tests similar to ours in a more patient-friendly, efficient or cost-effective manner than is currently possible. If we cannot compete successfully against current or future competitors, we may be unable to increase or create market acceptance and sales of our current or planned tests, which could prevent us from increasing or sustaining our revenues or achieving or sustaining profitability.

We expect to continue to incur significant expenses to develop and market cancer diagnostic tests, which could make it difficult for us to achieve and sustain profitability.

In recent years, we have incurred significant costs in connection with the development of cancer diagnostic tests. For the year ended December 31, 2011, our research and development expenses were $8.9 million and our sales and marketing expenses were $0.7 million. For the year ended December 31, 2012, our research and development expenses were $6.6 million and our sales and marketing expenses were $0.8 million. We expect our expenses to continue to increase for the foreseeable future as we conduct studies of our current test and our planned cancer diagnostic tests, establish a sales and marketing organization, drive adoption of and reimbursement for our diagnostic tests and develop new tests. As a result, we need to generate significant revenues in order to achieve sustained profitability.

If oncologists decide not to order OncoCEE-BR breast cancer diagnostic tests or our future cancer diagnostic tests, we may be unable to generate sufficient revenue to sustain our business.

To generate demand for our current test and our planned cancer diagnostic tests, we will need to educate oncologists, pathologists, and other health care professionals on the clinical utility, benefits and value of the tests we provide through published papers, presentations at scientific conferences, educational programs and one-on-one education sessions by members of our sales force. In addition, we need to assure oncologists of our ability to obtain and maintain adequate reimbursement coverage from third-party payors. We need to hire additional commercial, scientific, technical and other personnel to support this process. If we cannot convince medical practitioners to order our current test and our planned tests, we will likely be unable to create demand in sufficient volume for us to achieve sustained profitability.

 

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Clinical utility studies are important in demonstrating to both customers and payors a test’s clinical relevance and value. If we are unable to identify collaborators willing to work with us to conduct clinical utility studies, or the results of those studies do not demonstrate that a test provides clinically meaningful information and value, commercial adoption of such test may be slow, which would negatively impact our business.

Clinical utility studies show when and how to use a clinical test, and describe the particular clinical situations or settings in which it can be applied and the expected results. Clinical utility studies also show the impact of the test results on patient care and management. Clinical utility studies are typically performed with collaborating oncologists at medical centers and hospitals, analogous to a clinical trial, and generally result in peer-reviewed publications. Sales and marketing representatives use these publications to demonstrate to customers how to use a clinical test, as well as why they should use it. These publications are also used with payors to obtain coverage for a test, helping to assure there is appropriate reimbursement.

We are currently conducting a clinical utility study for our OncoCEE-BR test with investigators at the Dana-Farber Cancer Institute and The Ohio State University. We will need to conduct additional studies for this test, as well as other CTC and ctDNA tests we plan to introduce, to drive test adoption in the marketplace and reimbursement. Should we not be able to perform these studies, or should their results not provide clinically meaningful data and value for oncologists, adoption of our tests could be impaired and we may not be able to obtain reimbursement for them.

We are undergoing a management transition.

Until August 26, 2013, David F. Hale, our Executive Chairman, served as our principal executive officer. On that date, Michael W. Nall began his employment with us as our Chief Executive Officer and President, with David F. Hale remaining employed as our Executive Chairman. We intend to recruit and hire other senior executives. Such a management transition subjects us to a number of risks, including risks pertaining to coordination of responsibilities and tasks, creation of new management systems and processes, differences in management style, effects on corporate culture, and the need for transfer of historical knowledge. In addition, Mr. Nall has not previously been the chief executive officer of a public or private company.

The loss of key members of our executive management team could adversely affect our business.

Our success in implementing our business strategy depends largely on the skills, experience and performance of key members of our executive management team and others in key management positions, including Michael W. Nall, our Chief Executive Officer and President, David F. Hale, our Executive Chairman, Lyle J. Arnold, Ph.D., our Senior Vice-President of Research & Development/Chief Scientific Officer, and Farideh Z. Bischoff, Ph.D., our Vice-President of Translational Research and Clinical Development. The collective efforts of each of these persons and others working with them as a team are critical to us as we continue to develop our technologies, tests and research and development and sales programs. As a result of the difficulty in locating qualified new management, the loss or incapacity of existing members of our executive management team could adversely affect our operations. If we were to lose one or more of these key employees, we could experience difficulties in finding qualified successors, competing effectively, developing our technologies and implementing our business strategy. Our Chief Executive Officer and President, Executive Chairman, Chief Financial Officer and Chief Scientific Officer have employment agreements, however, the existence of an employment agreement does not guarantee retention of members of our executive management team and we may not be able to retain those individuals for the duration of or beyond the end of their respective terms. We do not maintain “key person” life insurance on any of our employees.

In addition, we rely on collaborators, consultants and advisors, including scientific and clinical advisors, to assist us in formulating our research and development and commercialization strategy. Our collaborators, consultants and advisors are generally employed by employers other than us and may have commitments under agreements with other entities that may limit their availability to us.

 

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The loss of a key employee, the failure of a key employee to perform in his or her current position or our inability to attract and retain skilled employees could result in our inability to continue to grow our business or to implement our business strategy.

There is a scarcity of experienced professionals in our industry. If we are not able to retain and recruit personnel with the requisite technical skills, we may be unable to successfully execute our business strategy.

The specialized nature of our industry results in an inherent scarcity of experienced personnel in the field. Our future success depends upon our ability to attract and retain highly skilled personnel, including scientific, technical, commercial, business, regulatory and administrative personnel, necessary to support our anticipated growth, develop our business and perform certain contractual obligations. Given the scarcity of professionals with the scientific knowledge that we require and the competition for qualified personnel among life science businesses, we may not succeed in attracting or retaining the personnel we require to continue and grow our operations.

Our inability to attract, hire and retain a sufficient number of qualified sales professionals would hamper our ability to increase demand for our cancer diagnostic test, to expand geographically and to successfully commercialize any other tests or products we may develop.

To succeed in selling our breast cancer diagnostic test and any other tests or products that we are able to develop, we must expand our sales force in the United States and/or internationally by recruiting additional sales representatives with extensive experience in oncology and close relationships with medical oncologists, surgeons, oncology nurses, pathologists and other hospital personnel. To achieve our marketing and sales goals, we will need to substantially build our sales and commercial infrastructure, with which to date we have had little experience. Sales professionals with the necessary technical and business qualifications are in high demand, and there is a risk that we may be unable to attract, hire and retain the number of sales professionals with the right qualifications, scientific backgrounds and relationships with decision-makers at potential customers needed to achieve our sales goals. We expect to face competition from other companies in our industry, some of whom are much larger than us and who can pay greater compensation and benefits than we can, in seeking to attract and retain qualified sales and marketing employees. If we are unable to hire and retain qualified sales and marketing personnel, our business will suffer.

Our dependence on commercialization partners for sales of tests could limit our success in realizing revenue growth.

We intend to grow our business through the use of commercialization partners for the sales, marketing and commercialization of our current test and our planned future tests, and to do so we must enter into agreements with these partners to sell, market or commercialize our tests. These agreements may contain exclusivity provisions and generally cannot be terminated without cause during the term of the agreement. We may need to attract additional partners to expand the markets in which we sell tests. These partners may not commit the necessary resources to market and sell our cancer diagnostics tests to the level of our expectations, and we may be unable to locate suitable alternatives should we terminate our agreement with such partners or if such partners terminate their agreement with us. If current or future commercialization partners do not perform adequately, or we are unable to locate commercialization partners, we may not realize revenue growth.

We depend on third parties for the supply of blood samples and other biological materials that we use in our research and development efforts. If the costs of such samples and materials increase after we complete our initial public offering or our third party suppliers terminate their relationship with us, our business may be materially harmed.

We have relationships with suppliers and institutions that provide us with blood samples and other biological materials that we use in developing and validating our current test and our planned future tests. If one or more suppliers terminate their relationship with us or are unable to meet our requirements for samples, we will need to identify other third parties to provide us with blood samples and biological materials, which could result in a delay in our research and development activities and negatively affect our business. In addition, as we grow, our research and academic institution collaborators may seek additional financial contributions from us, which may negatively affect our results of operations.

 

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We currently rely on third-party suppliers for critical materials needed to perform our current test and our planned future tests and any problems experienced by them could result in a delay or interruption of their supply to us.

We currently purchase raw materials for our microfluidic channels and testing reagents under purchase orders and do not have long-term contracts with most of the suppliers of these materials. If suppliers were to delay or stop producing our materials or reagents, or if the prices they charge us were to increase significantly, or if they elected not to sell to us, we would need to identify other suppliers. We could experience delays in manufacturing the microfluidic channels or performing tests while finding another acceptable supplier, which could impact our results of operations. The changes could also result in increased costs associated with qualifying the new materials or reagents and in increased operating costs. Further, any prolonged disruption in a supplier’s operations could have a significant negative impact on our ability to perform cancer diagnostic tests in a timely manner.

Some of the components used in our current or planned products are currently sole-source, and substitutes for these components might not be able to be obtained easily or may require substantial design or manufacturing modifications. Any significant problem experienced by one of our sole source suppliers may result in a delay or interruption in the supply of components to us until that supplier cures the problem or an alternative source of the component is located and qualified. Any delay or interruption would likely lead to a delay or interruption in our manufacturing operations. The inclusion of substitute components must meet our product specifications and could require us to qualify the new supplier with the appropriate government regulatory authorities.

If we were sued for product liability or professional liability, we could face substantial liabilities that exceed our resources.

The marketing, sale and use of our current test and our planned future diagnostic tests could lead to the filing of product liability claims against us if someone alleges that our tests failed to perform as designed. We may also be subject to liability for errors in the test results we provide to physicians or for a misunderstanding of, or inappropriate reliance upon, the information we provide. A product liability or professional liability claim could result in substantial damages and be costly and time-consuming for us to defend.

Although we believe that our existing product and professional liability insurance is adequate, our insurance may not fully protect us from the financial impact of defending against product liability or professional liability claims. Any product liability 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 damage our reputation, result in the recall of tests, or cause current partners to terminate existing agreements and potential partners to seek other partners, any of which could impact our results of operations.

If we use biological and hazardous materials in a manner that causes injury, we could be liable for damages.

Our activities currently require the controlled use of potentially harmful biological materials and chemicals. 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, and any liability could exceed our resources or any applicable insurance coverage we may have. Additionally, we are subject to, on an ongoing basis, federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. The cost of compliance with these laws and regulations may become significant and could have a material adverse effect on our financial condition, results of operations and cash flows. In the event of an accident or if we otherwise fail to comply with applicable regulations, we could lose our permits or approvals or be held liable for damages or penalized with fines.

We may acquire other businesses or 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 businesses and assets. We also may pursue strategic alliances and joint ventures that leverage our core technology and industry experience to expand our offerings or distribution. We have no experience with acquiring other companies and limited experience with forming strategic alliances

 

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and joint ventures. We may not be able to find suitable partners or acquisition candidates, and we may not be able to complete such transactions on favorable terms, if at all. If we make any acquisitions, we may not be able to integrate these acquisitions successfully into our existing business, and we could assume unknown or contingent liabilities. Any future acquisitions also could result in significant write-offs or the incurrence of debt and contingent liabilities, any of which could have a material adverse effect on our financial condition, results of operations and cash flows. Integration of an acquired company also may disrupt ongoing operations and require management resources that would otherwise focus on developing our existing business. We may experience losses related to investments in other companies, which could have a material negative effect on our results of operations. 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 or joint venture.

To finance any acquisitions or joint ventures, we may choose to issue shares of our common stock as consideration, which would dilute the ownership of our stockholders. If the price of our common stock is low or volatile, we may not be able to acquire other companies or fund a joint venture project using our stock as consideration. Alternatively, it may be necessary for us to raise additional funds for acquisitions through public or private financings. Additional funds may not be available on terms that are favorable to us, or at all.

If we cannot support demand for our current test and our planned future diagnostic tests, including successfully managing the evolution of our technology and manufacturing platforms, our business could suffer.

As our test volume grows, we will need to increase our testing capacity, implement automation, increase our scale and related processing, customer service, billing, collection and systems process improvements and expand our internal quality assurance program and technology to support testing on a larger scale. We will also need additional cytogenetic technicians, certified laboratory scientists and other scientific and technical personnel to process these additional tests. Any increases in scale, related improvements and quality assurance may not be successfully implemented and appropriate personnel may not be available. As additional tests are commercialized, we may need to bring new equipment on line, implement new systems, technology, controls and procedures and hire personnel with different qualifications. Failure to implement necessary procedures or to hire the necessary personnel could result in a higher cost of processing or an inability to meet market demand. We cannot assure you that we will be able to perform tests on a timely basis at a level consistent with demand, that our efforts to scale our commercial operations will not negatively affect the quality of our test results or that we will respond successfully to the growing complexity of our testing operations. If we encounter difficulty meeting market demand or quality standards for our current test and our planned future tests, our reputation could be harmed and our future prospects and business could suffer, which may have a material adverse effect on our financial condition, results of operations and cash flows.

We may encounter manufacturing problems or delays that could result in lost revenue.

We currently manufacture our proprietary microfluidic channels at our San Diego facility and intend to continue to do so. We believe we currently have adequate manufacturing capacity for our microfluidic channels. If demand for our current test and our planned future tests increases significantly, we will need to either expand our manufacturing capabilities or outsource to other manufacturers. If we or third party manufacturers engaged by us fail to manufacture and deliver our microfluidic channels or certain reagents in a timely manner, our relationships with our customers could be seriously harmed. We cannot assure you that manufacturing or quality control problems will not arise as we attempt to increase the production of our microfluidic channels or reagents or that we can increase our manufacturing capabilities and maintain quality control in a timely manner or at commercially reasonable costs. If we cannot manufacture our microfluidic channels consistently on a timely basis because of these or other factors, it could have a significant negative impact on our ability to perform tests and generate revenues.

International expansion of our business would expose us to business, regulatory, political, operational, financial and economic risks associated with doing business outside of the United States.

Our business strategy contemplates possible international expansion, including partnering with academic and commercial testing laboratories, and introducing OncoCEE technology outside the United States as part of CE-marked IVD

 

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test kits and/or testing systems utilizing our CEE and/or CEE-Selector technologies. Doing business internationally involves a number of risks, including:

 

   

multiple, conflicting and changing laws and regulations such as tax laws, export and import restrictions, employment laws, regulatory requirements and other governmental approvals, permits and licenses;

 

   

failure by us or our distributors to obtain regulatory approvals for the sale or use of our current test and our planned future tests in various countries;

 

   

difficulties in managing foreign operations;

 

   

complexities associated with managing government payor systems, multiple payor-reimbursement regimes or self-pay systems;

 

   

logistics and regulations associated with shipping blood samples, including infrastructure conditions and transportation delays;

 

   

limits on our ability to penetrate international markets if our current test and our planned future diagnostic tests cannot be processed by an appropriately qualified local laboratory;

 

   

financial risks, such as longer payment cycles, difficulty enforcing contracts and collecting accounts receivable and exposure to foreign currency exchange rate fluctuations;

 

   

reduced protection for intellectual property rights, or lack of them in certain jurisdictions, forcing more reliance on our trade secrets, if available;

 

   

natural disasters, political and economic instability, including wars, terrorism and political unrest, outbreak of disease, boycotts, curtailment of trade and other business restrictions; and

 

   

failure to comply with the Foreign Corrupt Practices Act, including its books and records provisions and its anti-bribery provisions, by maintaining accurate information and control over sales activities and distributors’ activities.

Any of these risks, if encountered, could significantly harm our future international expansion and operations and, consequently, have a material adverse effect on our financial condition, results of operations and cash flows.

Declining general economic or business conditions may have a negative impact on our business.

Continuing concerns over United States health care reform legislation and energy costs, geopolitical issues, the availability and cost of credit and government stimulus programs in the United States and other countries have contributed to increased volatility and diminished expectations for the global economy. These factors, combined with low business and consumer confidence and high unemployment, precipitated an economic slowdown and recession. If the economic climate does not improve, or it deteriorates, our business, including our access to patient samples and the addressable market for diagnostic tests that we may successfully develop, as well as the financial condition of our suppliers and our third-party payors, could be adversely affected, resulting in a negative impact on our business, financial condition and results of operations.

Intrusions into our computer systems could result in compromise of confidential information.

Despite the implementation of security measures, our technology or systems that we interface with, including the Internet and related systems, may be vulnerable to physical break-ins, hackers, improper employee or contractor access, computer viruses, programming errors, or similar problems. Any of these might result in confidential medical, business or other information of other persons or of ourselves being revealed to unauthorized persons.

There are a number of state, federal and international laws protecting the privacy and security of health information and personal data. As part of the American Recovery and Investment Act 2009, or ARRA, Congress amended the privacy and security provisions of the Health Insurance Portability and Accountability Act, or HIPAA. HIPAA imposes limitations on the use and disclosure of an individual’s healthcare information by healthcare providers, healthcare clearinghouses, and health insurance plans, collectively referred to as covered entities. The HIPAA amendments also impose compliance obligations and corresponding penalties for non-compliance on individuals and entities that provide services to healthcare providers and other covered entities, collectively referred to as business associates. ARRA also made significant increases in

 

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the penalties for improper use or disclosure of an individual’s health information under HIPAA and extended enforcement authority to state attorneys general. The amendments also create notification requirements for individuals whose health information has been inappropriately accessed or disclosed: notification requirements to federal regulators and in some cases, notification to local and national media. Notification is not required under HIPAA if the health information that is improperly used or disclosed is deemed secured in accordance with encryption or other standards developed by the U.S. Department of Health and Human Services, or HHS. Most states have laws requiring notification of affected individuals and state regulators in the event of a breach of personal information, which is a broader class of information than the health information protected by HIPAA. Many state laws impose significant data security requirements, such as encryption or mandatory contractual terms to ensure ongoing protection of personal information. Activities outside of the United States implicate local and national data protection standards, impose additional compliance requirements and generate additional risks of enforcement for non-compliance. We may be required to expend significant capital and other resources to ensure ongoing compliance with applicable privacy and data security laws, to protect against security breaches and hackers or to alleviate problems caused by such breaches.

We depend on our information technology and telecommunications systems, and any failure of these systems could harm our business.

We depend on information technology and telecommunications systems for significant aspects of our operations. In addition, our third-party billing and collections provider depends upon telecommunications and data systems provided by outside vendors and information we provide on a regular basis. These information technology and telecommunications systems support a variety of functions, including test processing, sample tracking, quality control, customer service and support, billing and reimbursement, research and development activities and our general and administrative activities. Information technology and telecommunications systems are vulnerable to damage from a variety of sources, including telecommunications or network failures, malicious human acts and natural disasters. Moreover, despite network security and back-up measures, some of our servers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems. Despite the precautionary measures we have taken to prevent unanticipated problems that could affect our information technology and telecommunications systems, failures or significant downtime of our information technology or telecommunications systems or those used by our third-party service providers could prevent us from processing tests, providing test results to oncologists, pathologists, billing payors, processing reimbursement appeals, handling patient or physician inquiries, conducting research and development activities and managing the administrative aspects of our business. Any disruption or loss of information technology or telecommunications systems on which critical aspects of our operations depend could have an adverse effect on our business.

 

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Regulatory Risks Relating to Our Business

Healthcare policy changes, including recently enacted legislation reforming the U.S. health care system, may have a material adverse effect on our financial condition, results of operations and cash flows.

The 2010 Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or collectively the ACA, makes a number of substantial changes in the way health care is financed by both governmental and private insurers. Among other things, the ACA:

 

   

Mandates a reduction in payments for clinical laboratory services paid under the Medicare Clinical Laboratory Fee Schedule annual Consumer Price Index update of 1.75% for the years 2011 through 2015. In addition, a permanent productivity adjustment is made to the fee schedule payment amount, which could range from 1.1% to 1.4% each year over the next 10 years. These changes in payments may apply to some or all of the tests we furnish to Medicare beneficiaries.

 

   

Establishes an Independent Payment Advisory Board to reduce the per capita rate of growth in Medicare spending if spending exceeds a target growth rate. The Independent Payment Advisory Board has broad discretion to propose policies, which may have a negative impact on payment rates for services, including clinical laboratory services, beginning in 2016, and for hospital services beginning in 2020.

 

   

Requires each medical device manufacturer to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its medical devices, beginning in 2013. We do not believe, at this time, that this tax applies to our current cancer diagnostic test or will apply to our products that are in development.

Although some of these provisions may negatively impact payment rates for clinical laboratory tests, the ACA also extends coverage to over 30 million previously uninsured people, which may result in an increase in the demand for our current test and our planned future cancer diagnostic tests. The mandatory purchase of insurance has been strenuously opposed by a number of state governors, resulting in lawsuits challenging the constitutionality of certain provisions of the ACA. In 2012, the Supreme Court upheld the constitutionality of the health care reform law, with the exception of certain provisions dealing with the expansion of Medicaid coverage under the law. Therefore, most of the law’s provisions will go into effect in 2013 and 2014. Congress has also proposed a number of legislative initiatives, including possible repeal of the ACA. At this time, it remains unclear whether there will be any changes made to the ACA, whether to certain provisions or its entirety.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. The Budget Control Act of 2011, among other things, created the Joint Select Committee on Deficit Reduction to recommend proposals in spending reductions to Congress. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers and suppliers of up to 2% per fiscal year, starting in 2013. The full impact on our business of the ACA and the sequester law is uncertain. In addition, the Middle Class Tax Relief and Job Creation Act of 2012, or MCTRJCA, mandated an additional change in Medicare reimbursement for clinical laboratory tests. This legislation requires a rebasing of the Medicare clinical laboratory fee schedule to effect a 2% reduction in payment rates otherwise determined for 2013. This will serve as a base for 2014 and subsequent years. In January 2013, as a result of the changes mandated by the ACA and MCTRJCA, the Centers for Medicare & Medicaid Services reduced its reimbursement for laboratory tests for 2013 by approximately 3%.

Some of our laboratory test business is subject to the Medicare Physician Fee Schedule and, under the current statutory formula, the rates for these services are updated annually. For the past several years, the application of the statutory formula would have resulted in substantial payment reductions if Congress failed to intervene. In the past, Congress passed interim legislation to prevent the decreases. On November 1, 2012, the CMS issued its 2013 Physician Fee Schedule Final Rule, or the 2013 Final Rule. In the 2013 Final Rule, CMS called for a reduction of approximately 26.5% in the 2013 conversion factor that is used to calculate physician reimbursement. However, the American Taxpayer Relief Act of 2012 prevented this proposed cut and keeps the current reimbursement rate in effect until

 

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December 31, 2013. If Congress fails to act in future years to offset similar proposed reductions, the resulting decrease in payment could adversely impact our revenues and results of operations.

In addition, many of the Current Procedure Terminology, or CPT, procedure codes that we use to bill for cancer diagnostic tests were revised by the American Medical Association, effective January 1, 2013. In the 2013 Final Rule, CMS announced that it has decided to keep the new molecular codes on the Clinical Laboratory Fee Schedule rather than move them to the Physician Fee Schedule as some stakeholders had urged. CMS has also announced that for 2013 it will price the new codes using a “gapfilling” process by which it will refer the codes to the Medicare contractors to allow them to determine an appropriate price. Our reimbursement could be adversely affected by CMS’ actions. If it reduces reimbursement for the new test codes or does not pay for our codes, then our revenues would be adversely affected. There can be no guarantees that Medicare and other payors will establish positive or adequate coverage policies or reimbursement rates.

On July 9, 2013, CMS issued a proposed Physician Fee Schedule revision that would, in the aggregate, impose a 25% reduction for payments for pathology codes when services are provided by independent laboratories. We cannot predict the outcome of this initiative.

We cannot predict whether future health care initiatives will be implemented at the federal or state level, or how any future legislation or regulation may affect us. The taxes imposed by the new federal legislation and the expansion of government’s role in the U.S. health care industry as well as changes to the reimbursement amounts paid by payors for our current test and our planned future cancer diagnostic tests may reduce our profits and have a materially adverse effect on our business, financial condition, results of operations and cash flows. Moreover, Congress has proposed on several occasions to impose a 20% coinsurance payment requirement on patients for clinical laboratory tests reimbursed under the Medicare Clinical Laboratory Fee Schedule, which would require us to bill patients for these amounts. In the event that Congress were to ever enact such legislation, the cost of billing and collecting for our tests could often exceed the amount actually received from the patient.

Our commercial success could be compromised if third-party payors, including managed care organizations and Medicare, do not provide coverage and reimbursement, breach, rescind or modify their contracts or reimbursement policies or delay payments for our current test and our planned future tests.

Oncologists may not order our current breast cancer test and our planned future cancer diagnostic tests unless third-party payors, such as managed care organizations and government payors such as Medicare and Medicaid, pay a substantial portion of the test price. Coverage and reimbursement by a third-party payor may depend on a number of factors, including a payor’s determination that tests using our technologies are:

 

   

not experimental or investigational;

 

   

medically necessary;

 

   

appropriate for the specific patient;

 

   

cost-effective;

 

   

supported by peer-reviewed publications; and

 

   

included in clinical practice guidelines.

Uncertainty surrounds third-party payor reimbursement of any test incorporating new technology, including tests developed using our technologies. Technology assessments of new medical tests conducted by research centers and other entities may be disseminated to interested parties for informational purposes. Third-party payors and health care providers may use such technology assessments as grounds to deny coverage for a test or procedure. Technology assessments can include evaluation of clinical utility studies, which define how a test is used in a particular clinical setting or situation.

Because each payor generally determines for its own enrollees or insured patients whether to cover or otherwise establish a policy to reimburse our cancer diagnostic tests, seeking payor approvals is a time-consuming and costly process. We cannot be certain that coverage for our current test and our planned future tests will be provided in the future by additional third-party payors or that existing agreements or policy decisions or reimbursement levels will remain in place or be fulfilled under existing terms and provisions. If we cannot obtain coverage and reimbursement from private and

 

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governmental payors such as Medicare and Medicaid for our current test, or new tests or test enhancements that we may develop in the future, our ability to generate revenues could be limited, which may have a material adverse effect on our financial condition, results of operations and cash flow. Further, we have experienced in the past, and will likely experience in the future, delays and interruptions in the receipt of payments from third-party payors due to missing documentation and/or other issues, which could cause delay in collecting our revenue.

We will depend on Medicare and a limited number of private payors for a significant portion of our revenues and if these or other payors stop providing reimbursement or decrease the amount of reimbursement for our current test and our planned future tests, our revenues could decline.

We expect that as much as approximately 50% of the patients for whom we perform cancer diagnostic tests will have Medicare coverage. Medicare and other third-party payors may change their coverage policies or cancel future contracts with us at any time, review and adjust the rate of reimbursement or stop paying for our tests altogether, which would reduce our total revenues.

Payors have increased their efforts to control the cost, utilization and delivery of health care services. In the past, measures have been undertaken to reduce payment rates for and decrease utilization of the clinical laboratory testing generally. Because of the cost-trimming trends, third-party payors that currently cover and provide reimbursement for our current breast cancer test and our planned future cancer diagnostic tests may suspend, revoke or discontinue coverage at any time, or may reduce the reimbursement rates payable to us. Any such action could have a negative impact on our revenues, which may have a material adverse effect on our financial condition, results of operations and cash flows.

In addition, we are currently considered a “non-contracted provider” by private third-party payors because we have not entered into a specific contract to provide cancer diagnostic tests to their insured patients at specified rates of reimbursement. If we were to become a contracted provider with one more payors in the future, the amount of overall reimbursement we receive would likely decrease because we would be reimbursed less money per test performed at a contracted rate than at a non-contracted rate, which could have a negative impact on our revenues. Further, we typically are unable to collect payments from patients beyond that which is paid by their insurance and will continue to experience lost revenue as a result.

Because of certain Medicare billing policies, we may not receive complete reimbursement for tests provided to Medicare patients. Medicare reimbursement revenues are an important piece of our business model, and private payors sometimes look to Medicare determinations when making their own payment determinations; therefore, incomplete or inadequate reimbursement from Medicare would negatively affect our business.

We believe that as much as approximately 50% of our future market for our current test and our planned tests may be derived from patients covered by Medicare. The Medicare Administrative Contractors, MACs, who process claims for Medicare also can impose their own rules related to coverage and payment for laboratory services provided in their jurisdiction. Because our laboratory is in California, the MAC for California is the relevant MAC for all our testing. Palmetto GBA, LLC, until September 2013 the MAC for California, has issued a negative coverage determination for the capture/enumeration component of CTC tests such as our current CTC test and our planned CTC tests, which means we would receive no reimbursement from Medicare with regard to that component of tests provided to Medicare patients. Our understanding is that the new MAC for California, Noridian Health Solutions, will follow Palmetto GBA’s determinations in this regard. We have received positive Medicare coverage determinations and/or have the benefit of specific CPT codes for the analysis components of our CTC tests, and we have presented a new dossier to Palmetto GBA for the capture/enumeration component. The processing of Medicare claims is subject to change at the discretion of CMS at any time. Cost containment initiatives may be a threat to Medicare reimbursement levels for the foreseeable future.

 

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Long payment cycles of Medicare, Medicaid and/or other third-party payors, or other payment delays, could hurt our cash flows and increase our need for working capital.

Medicare and Medicaid have complex billing and documentation requirements that we must satisfy in order to receive payment, and the programs can be expected to carefully audit and monitor our compliance with these requirements. We must also comply with numerous other laws applicable to billing and payment for healthcare services, including privacy laws. Failure to comply with these requirements may result in non-payment, refunds, exclusion from government healthcare programs, and civil or criminal liabilities, any of which may have a material adverse effect on our revenues and earnings. In addition, failure by third-party payors to properly process our payment claims in a timely manner could delay our receipt of payment for our products and services, which may have a material adverse effect on our cash flows.

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 regulating clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. Our clinical laboratory must be certified under CLIA in order for us to perform testing on human specimens. CLIA is intended to ensure the quality and reliability of clinical laboratories in the United States by mandating 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 high complexity testing, and our laboratory is accredited by the College of American Pathologists, or CAP, one of six CLIA-approved accreditation organizations. To renew this certificate, we are subject to survey and inspection every two years. Moreover, CLIA inspectors may make periodic inspections of our clinical laboratory outside of the renewal process.

In addition, our laboratory is located in California and is required by state law to have a California state license; as we expand our geographic focus, we may need to obtain laboratory licenses from additional states. California laws establish standards for operation of our clinical laboratory, including the training and skills required of personnel and quality control. In addition, Florida, Maryland, New York and Rhode Island require that we hold licenses to test specimens from patients in those states; Pennsylvania licensure or registration may be required as well, depending on the circumstances. We currently do not have the necessary New York license, but we are in the process of addressing the requirements for licensure in New York. Other states may have similar requirements or may adopt similar requirements in the future. Finally, we may be subject to regulation in foreign jurisdictions if we seek to expand international distribution of our tests outside the United States.

If we were to lose our CLIA accreditation or California laboratory license, whether as a result of a revocation, suspension or limitation, we would no longer be able to offer our tests, which would limit our revenues and harm our business. If we were to lose our license in any other state where we are required to hold a license, we would not be able to test specimens from those states.

If the FDA were to begin requiring approval or clearance of our current test and our planned future tests, we could incur substantial costs and time delays associated with meeting requirements for pre-market clearance or approval or we could experience decreased demand for, or reimbursement of, our tests.

Although the FDA maintains that it has authority to regulate the development and use of laboratory developed tests, or LDTs, such as ours, as medical devices, it has not exercised its authority with respect to most LDTs as a matter of enforcement discretion. The FDA could, at any time, change its policy with regard to this matter.

We believe that our cancer diagnostic tests, as utilized in our clinical laboratory, are and would be LDTs. As a result, we believe that pursuant to the FDA’s current policies and guidance, the FDA does not require that we obtain regulatory clearances or approvals for our LDTs. The container we provide for collection and transport of blood samples from a health care provider to our clinical laboratory may be a medical device subject to the FDA regulation but is currently exempt from pre-market review by the FDA. While we believe that we are currently in material compliance with applicable laws and regulations, we cannot assure you that the FDA or other regulatory agencies would agree with our determination, and a

 

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determination that we have violated these laws, or a public announcement that we are being investigated for possible violations of these laws, could adversely affect our business, prospects, results of operations or financial condition.

Moreover, FDA policy pertaining to diagnostic testing is continuing to evolve and is subject to ongoing review and revision. A significant change in any of the laws, regulations or policies may require us to achieve regulatory compliance. At various times since 2006, the FDA has issued guidance documents or announced draft guidance regarding initiatives that may require varying levels of FDA oversight of our current test and our planned future tests. For example, in June 2010, the FDA announced a public meeting to discuss the agency’s oversight of LDTs prompted by the increased complexity of LDTs and their increasingly important role in clinical decision-making and disease management, particularly in the context of personalized medicine. The FDA indicated that it was considering a risk-based application of oversight to LDTs and that, following public input and discussion, it might issue separate draft guidance on the regulation of LDTs, which ultimately could require that we seek and obtain either pre-market clearance or approval of LDTs, depending upon the risk-based approach the FDA adopts. The public meeting was held in July 2010 and further public comments were submitted to the FDA through September 2010. The FDA has stated it is continuing to develop draft guidance in this area. Section 1143 of the Food and Drug Administration Safety and Innovation Act of 2012 requires the FDA to notify U.S. Congress at least 60 days before issuing a draft or final guidance regulating LDTs and to provide details of the anticipated action.

We cannot provide any assurance that FDA regulation, including pre-market review, will not be required in the future for our current test and our planned future tests, whether through additional guidance issued by the FDA, new enforcement policies adopted by the FDA or new legislation enacted by Congress. We believe it is possible that legislation will be enacted into law or guidance could be issued by the FDA which may result in increased regulatory burdens for us to continue to offer our breast cancer test or to develop and introduce new tests. Given the attention Congress continues to give to these issues, legislation affecting this area may be enacted into law and may result in increased regulatory burdens on us as we continue to offer our test and to develop and introduce new tests.

In addition, HHS requested that its Advisory Committee on Genetics, Health and Society make recommendations about the oversight of genetic testing. A final report was published in April 2008. If the report’s recommendations for increased oversight of genetic testing were to result in further regulatory burdens, they could negatively affect our business and delay the commercialization of tests in development.

The requirement of pre-market review could negatively affect our business until such review is completed and clearance to market or approval is obtained. The FDA could require that we stop selling our cancer diagnostic tests pending pre-market clearance or approval. If the FDA allows our tests to remain on the market but there is uncertainty about our tests, if they are labeled investigational by the FDA or if labeling claims the FDA allows us to make are very limited, orders from oncologists or reimbursement may decline. The regulatory approval process may involve, among other things, successfully completing additional clinical trials and making a 510(k) submission, or filing a pre-market approval application with the FDA. If the FDA requires pre-market review, our tests may not be cleared or approved on a timely basis, if at all. We may also decide voluntarily to pursue FDA pre-market review of our tests if we determine that doing so would be appropriate.

Additionally, should future regulatory actions affect any of the reagents we obtain from suppliers and use in conducting our tests, our business could be adversely affected in the form of increased costs of testing or delays, limits or prohibitions on the purchase of reagents necessary to perform our testing.

If we were required to conduct additional clinical studies or trials before continuing to offer tests that we have developed or may develop as LDTs, those studies or trials could lead to delays or failure to obtain necessary regulatory approval, which could cause significant delays in commercializing any future products and harm our ability to achieve sustained profitability.

If the FDA decides to require that we obtain clearance or approvals to commercialize our current breast cancer test or our planned future proprietary cancer diagnostic tests, we may be required to conduct additional pre-market clinical testing before submitting a regulatory notification or application for commercial sales. In addition, as part of our long-term strategy we may plan to seek FDA clearance or approval so we can sell our proprietary tests outside our CLIA laboratory; however,

 

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we would need to conduct additional clinical validation activities on our proprietary tests before we can submit an application for FDA approval or clearance. Clinical trials must be conducted in compliance with FDA regulations or the FDA may take enforcement action or reject the data. The data collected from these clinical trials may ultimately be used to support market clearance or approval for our tests. We believe it would likely take two years or more to conduct the clinical studies and trials necessary to obtain approval from the FDA to commercially launch our current test and our planned future tests outside of our clinical laboratory. Even if our clinical trials are completed as planned, we cannot be certain that their results will support our test claims or that the FDA or foreign authorities will agree with our conclusions regarding our test results. Success in early clinical trials does not ensure that later clinical trials will be successful, and we cannot be sure that the later trials will replicate the results of prior clinical trials and studies. If we are required to conduct pre-market clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase our test development costs and delay commercialization. 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. Moreover, the clinical trial process may fail to demonstrate that our current test and our planned future tests are effective for the proposed indicated uses, which could cause us to abandon a test candidate and may delay development of other tests.

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 properly. 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 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 current test and our planned future tests. 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 tests or to achieve sustained profitability.

We are subject to federal and state healthcare fraud and abuse laws and regulations and could face substantial penalties if we are unable to fully comply with such laws.

We are subject to health care fraud and abuse regulation and enforcement by both the federal government and the states in which we conduct our business. These health care laws and regulations include, for example:

 

   

the federal Anti-Kickback Statute, which prohibits, among other things, persons or entities from soliciting, receiving, offering or providing remuneration, directly or indirectly, in return for or to induce either the referral of an individual for, or the purchase order or recommendation of, any item or services for which payment may be made under a federal health care program such as the Medicare and Medicaid programs;

 

   

the federal physician self-referral prohibition, commonly known as the Stark Law, which prohibits physicians from referring Medicare or Medicaid patients to providers of “designated health services” with whom the physician or a member of the physician’s immediate family has an ownership interest or compensation arrangement, unless a statutory or regulatory exception applies;

 

   

the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which established federal crimes for knowingly and willfully executing a scheme to defraud any health care benefit program or making false statements in connection with the delivery of or payment for health care benefits, items or services;

 

   

federal false claims laws, which, prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us to the extent that our interactions with customers may affect their billing or coding practices; and

 

   

state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, which may apply to items or services reimbursed by any third-party payor, including commercial insurers.

 

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We have adopted policies and procedures designed to comply with these laws. Our compliance is also subject to governmental review. The risk of our being found in violation of these laws and regulations is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Further, the ACA, among other things, amends the intent requirement of the federal anti-kickback and criminal health care fraud statutes. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. 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 statutes. Any action brought against us for violation of these laws or regulations, 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. If our operations are found to be in violation of any of these laws and regulations, we may be subject to any applicable penalty associated with the violation, including civil and criminal penalties, damages and fines, and/or exclusion from participation in Medicare, the California Medical Assistance Program (Medi-Cal – the California Medicaid program) or other state or federal health care programs, we could be required to refund payments received by us, and we could be required to curtail or cease our operations. Any of the foregoing consequences could seriously harm our business and our financial results.

We may be required to comply with laws governing the transmission, security and privacy of health information that require significant compliance costs, and any failure to comply with these laws could result in material criminal and civil penalties.

Under the administrative simplification provisions of HIPAA, HHS has issued regulations which establish uniform standards governing the conduct of certain electronic health care transactions and protecting the privacy and security of Protected Health Information used or disclosed by health care providers and other covered entities.

The privacy regulations regulate the use and disclosure of Protected Health Information by health care providers engaging in certain electronic transactions or “standard transactions.” They also set forth certain rights that an individual has with respect to his or her Protected Health Information maintained by a covered health care provider, including the right to access or amend certain records containing Protected Health Information or to request restrictions on the use or disclosure of Protected Health Information. The HIPAA security regulations establish administrative, physical and technical standards for maintaining the integrity and availability of Protected Health Information in electronic form. These standards apply to covered health care providers and also to “business associates” or third parties providing services involving the use or disclosure of Protected Health Information. The HIPAA privacy and security regulations establish a uniform federal “floor” and do not supersede state laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their records containing Protected Health Information. As a result, we may be required to comply with both HIPAA privacy regulations and varying state privacy and security laws.

Moreover, the Health Information Technology for Economic and Clinical Health Act, or HITECH, among other things, established certain health information security breach notification requirements. In the event of a breach of unsecured Protected Health Information, a covered entity must notify each individual whose Protected Health Information is breached, federal regulators and in some cases, must publicize the breach in local or national media. Breaches affecting 500 individuals or more are publicized by federal regulators who publicly identify the breaching entity, the circumstances of the breach and the number of individuals affected.

These laws contain significant fines and other penalties for wrongful use or disclosure of Protected Health Information. Given the complexity of HIPAA and HITECH and their overlap with state privacy and security laws, and the fact that these laws are rapidly evolving and are subject to changing and potentially conflicting interpretation, our ability to comply with the HIPAA, HITECH and state privacy requirements is uncertain and the costs of compliance are significant. Adding to the complexity is that our operations are evolving and the requirements of these laws will apply differently depending on such things as whether or not we bill electronically for our services, or provide services involving the use or disclosure of Protected Health Information and incur compliance obligations as a business associate. The costs of complying with any changes to the HIPAA, HITECH and state privacy restrictions may have a negative impact on our operations. Noncompliance could subject us to criminal penalties, civil sanctions and significant monetary penalties as well as reputational damage.

 

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Clinical research is heavily regulated and failure to comply with human subject protection regulations may disrupt our research program leading to significant expense, regulatory enforcement, private lawsuits and reputational damage.

Clinical research is subject to federal, state and, for studies conducted outside of the United States, international regulation. At the federal level, the FDA and NIH impose regulations for the protection of human subjects and requirements such as initial and ongoing institutional review board review; informed consent requirements, adverse event reporting and other protections to minimize the risk and maximize the benefit to research participants. Many states impose human subject protection laws that mirror or in some cases exceed federal requirements. HIPAA also regulates the use and disclosure of Protected Health Information in connection with research activities. Research conducted overseas is subject to a variety of national protections such as mandatory ethics committee review, as well as laws regulating the use, disclosure and cross-border transfer of personal data. The costs of compliance with these laws may be significant and compliance with regulatory requirements may result in delay. Noncompliance may disrupt our research and result in data that is unacceptable to regulatory authorities, data lock or other sanctions that may significantly disrupt our operations.

Intellectual Property Risks Related to Our Business

Our collaborators may assert ownership or commercial rights to inventions we develop from our use of the biological materials which they provide to us, or otherwise arising from the collaboration.

We rely on certain third parties to provide us with blood samples and biological materials that we use to develop tests, and we collaborate with several institutions, physicians and researchers in other manners as well. We do not have written agreements with certain collaborators, or the written agreements we have do not cover intellectual property rights. If we cannot successfully negotiate sufficient ownership and commercial rights to any inventions that result from our use of a third party collaborator’s materials, or if disputes arise with respect to the intellectual property developed with the use of a collaborator’s samples, or data developed in a collaborator’s study, we may be limited in our ability to capitalize on the market potential of these inventions or developments.

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

Our ability to protect our proprietary discoveries and technologies affects our ability to compete and to achieve sustained profitability. Currently, we rely on a combination of U.S. and foreign patents and patent applications, copyrights, trademarks and trademark applications, confidentiality or non-disclosure agreements, material transfer agreements, licenses, consulting agreements, work-for-hire agreements and invention assignment agreements to protect our intellectual property rights. We also maintain certain company know-how, trade secrets and technological innovations designed to provide us with a competitive advantage in the market place as trade secrets. Currently, we have only two issued U.S. patents and 33 pending U.S. and foreign patent applications relevant to our cancer diagnostics business. 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 patents are issued, third parties may independently develop similar or competing technology that avoids our patents. Further, we cannot be certain that the steps we have taken will prevent the misappropriation of our trade secrets and other confidential information as well as the misuse of our patents and other intellectual property, particularly in foreign countries where we have not filed for patent protection.

From time to time the U.S. Supreme Court, other federal courts, the U.S. Congress or the U.S. Patent and Trademark Office, or USPTO, may change the standards of patentability and any such changes could have a negative impact on our business. For instance, in 2008, the Court of Appeals for the Federal Circuit issued a decision that methods or processes cannot be patented unless they are tied to a machine or involve a physical transformation. The U.S. Supreme Court later reversed that decision in Bilski v. Kappos, finding that the “machine-or-transformation” test is not the only test for determining patent eligibility. The Court, however, declined to specify how and when processes are patentable. In 2012, in

 

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the case Mayo Collaborative Services v. Prometheus Laboratories, Inc., the U.S. Supreme Court reversed the Federal Circuit’s application of Bilski and invalidated a patent focused on a diagnostic process because the patent claim embodied a law of nature. It is unclear at this time whether the USPTO will amend its patent prosecution guidelines for determining patentability of diagnostic or other processes, and how lower courts will implement the decision. Some aspects of our technology involve processes that may be subject to this evolving standard and we cannot guarantee that any of our pending process claims will be patentable as a result of such evolving standards.

In 2013, in Association for Molecular Pathology v. Myriad Genetics, the Supreme Court unanimously ruled that, “A naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated,” invalidating Myriad Genetics’ patents on the BRCA1 and BRCA2 genes. However, the Supreme Court also held that manipulation of a gene to create something not found in nature, such as a strand of synthetically-produced complementary DNA, could still be eligible for patent protection. The Supreme Court noted that method patents, which concern technical procedures for carrying out a certain process, are not affected by the ruling.

It should also be noted that in 2010, the Secretary’s Advisory Committee on Genetics, Health and Society voted to approve a report entitled “Gene Patents and Licensing Practices and Their Impact on Patient Access to Genetic Tests.” That report defines “patent claims on genes” broadly to include claims to isolated nucleic acid molecules as well as methods of detecting particular sequences or mutations. The report also contains six recommendations, including the creation of an exemption from liability for infringement of patent claims on genes for anyone making, using, ordering, offering for sale or selling a test developed under the patent for patient care purposes, or for anyone using the patent-protected genes in the pursuit of research. The report also recommended that HHS should explore, identify and implement mechanisms that will encourage more voluntary adherence to current guidelines that promote nonexclusive in-licensing of diagnostic genetic and genomic technologies. It is unclear whether HHS will act upon these recommendations, or if the recommendations would result in a change in law or process that could negatively impact our patent portfolio or future research and development efforts.

We may face intellectual property infringement claims that could be time-consuming and costly to defend, and could result in our loss of significant rights and the assessment of treble damages.

From time to time we may face intellectual property infringement or misappropriation claims from third parties. Some of these claims may lead to litigation. The outcome of any such litigation can never be guaranteed, and an adverse outcome could affect us negatively. For example, were a third-party to succeed on an infringement claim against us, we may be required to pay substantial damages, including treble damages if such infringement were found to be willful. In addition, we could face an injunction, barring us from conducting the allegedly infringing activity. The outcome of the litigation could require us to enter into a license agreement which may not be pursuant to acceptable or commercially reasonable or practical terms or which may not be available at all.

It is also possible that an adverse finding of infringement against us may require us to dedicate substantial resources and time in developing non-infringing alternatives, which may or may not be possible. In the case of diagnostic tests, we would also need to include non-infringing technologies which would require us to re-validate the test. Any such re-validation, in addition to being costly and time consuming, may be unsuccessful.

Finally, we may initiate claims to assert or defend our own intellectual property against third parties. Any intellectual property litigation, irrespective of whether we are the plaintiff or the defendant, and regardless of the outcome, is expensive and time-consuming, and could divert our management’s attention from our business and negatively affect our operating results or financial condition.

Risks Relating to Our Common Stock and This Offering

The price of our common stock may be volatile, and the market price of our common stock after this offering may drop below the price you pay.

The initial public offering price per share may vary from the market price of our common stock after the offering. If an active market for our stock develops and continues, our stock price nevertheless may be volatile. Market prices for securities of early-stage life sciences companies have historically been particularly volatile. As a result of this volatility, you may not

 

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be able to sell your common stock at or above the initial public offering price per share. The factors that may cause the market price of our common stock to fluctuate include, but are not limited to:

 

   

progress, or lack of progress, in developing and commercializing our current breast cancer test and our planned future cancer diagnostic tests;

 

   

favorable or unfavorable decisions about our tests from government regulators, insurance companies or other third-party payors;

 

   

our ability to recruit and retain qualified research and development personnel;

 

   

changes in investors’ and securities analysts’ perception of the business risks and conditions of our business;

 

   

changes in our relationship with key collaborators;

 

   

changes in the market valuation or earnings of our competitors or companies viewed as similar to us;

 

   

changes in key personnel;

 

   

depth of the trading market in our common stock;

 

   

termination of the lock-up agreements or other restrictions on the ability of our existing stockholders to sell shares after this offering;

 

   

changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;

 

   

the granting or exercise of employee stock options or other equity awards;

 

   

realization of any of the risks described under this section entitled “Risk Factors”; and

 

   

general market and economic conditions.

In addition, the equity markets have experienced significant price and volume fluctuations that have affected the market prices for the securities of newly public companies for a number of reasons, including reasons that may be unrelated to our business or operating performance. These broad market fluctuations may result in a material decline in the market price of our common stock and you may not be able to sell your shares at prices you deem acceptable. In the past, following periods of volatility in the equity markets, securities class action lawsuits have been instituted against public companies. Such litigation, if instituted against us, could result in substantial cost and the diversion of management attention.

The NASDAQ Capital Market may not list our securities, which could limit investors’ ability to make transactions in our securities and subject us to additional trading restrictions.

We anticipate that our securities will be listed on The NASDAQ Capital Market, a national securities exchange, upon consummation of this offering. Although, after giving effect to this offering, we expect to meet, on a pro forma basis, The NASDAQ Capital Market’s minimum initial listing standards, which generally mandate that we meet certain requirements relating to stockholders’ equity, market capitalization, aggregate market value of publicly held shares and distribution requirements, we cannot assure you that we will be able to meet those initial listing requirements. If The NASDAQ Capital Market does not list our securities for trading on its exchange, we could face significant material adverse consequences, including:

 

   

a limited availability of market quotations for our securities;

 

   

reduced liquidity with respect to our securities;

 

   

a determination that our shares of common stock are “penny stock” which will require brokers trading in our shares of common stock to adhere to more stringent rules, possibly resulting in a reduced level of trading activity in the secondary trading market for our shares of common stock;

 

   

a limited amount of news and analyst coverage for our company; and

 

   

a decreased ability to issue additional securities or obtain additional financing in the future.

The National Securities Markets Improvement Act of 1996, which is a federal statute, prevents or preempts the states from regulating the sale of certain securities, which are referred to as “covered securities.” Assuming our common stock will be listed on The NASDAQ Capital Market, our common stock will be covered securities. Although the states are preempted from regulating the sale of our securities, the federal statute does allow the states to investigate companies if there is a

 

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suspicion of fraud, and, if there is a finding of fraudulent activity, then the states can regulate or bar the sale of covered securities in a particular case. Further, if we were no longer listed on The NASDAQ Capital Market, our common stock would not be covered securities and we would be subject to regulation in each state in which we offer our securities.

Our failure to meet the continued listing requirements of The NASDAQ Capital Market could result in a de-listing of our common stock.

If after listing we fail to satisfy the continued listing requirements of The NASDAQ Capital Market, such as the corporate governance requirements or the minimum closing bid price requirement, NASDAQ may take steps to de-list our common stock. Such a de-listing 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 de-listing, we would take actions to restore our compliance with NASDAQ’s listing requirements, but we can provide no assurance that any such action taken by us 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.

If our shares become subject to the penny stock rules, it would become more difficult to trade our shares.

The SEC has adopted rules that regulate broker-dealer practices in connection with transactions in penny stocks. Penny stocks are generally equity securities with a price of less than $5.00, other than securities registered on certain national securities exchanges or authorized for quotation on certain automated quotation systems, provided that current price and volume information with respect to transactions in such securities is provided by the exchange or system. If we do not obtain or retain a listing on The NASDAQ Capital Market and if the price of our common stock is less than $5.00, our common stock will be deemed a penny stock. The penny stock rules require a broker-dealer, before a transaction in a penny stock not otherwise exempt from those rules, to deliver a standardized risk disclosure document containing specified information. In addition, the penny stock rules require that before effecting any transaction in a penny stock not otherwise exempt from those rules, a broker-dealer must make a special written determination that the penny stock is a suitable investment for the purchaser and receive (i) the purchaser’s written acknowledgment of the receipt of a risk disclosure statement; (ii) a written agreement to transactions involving penny stocks; and (iii) a signed and dated copy of a written suitability statement. These disclosure requirements may have the effect of reducing the trading activity in the secondary market for our common stock, and therefore stockholders may have difficulty selling their shares.

Our quarterly operating results may fluctuate significantly.

We expect our operating results to be subject to quarterly fluctuations. Our net loss and other operating results will be affected by numerous factors, including:

 

   

the rate of adoption and/or continued use of our current breast cancer test and our planned future tests by healthcare practitioners;

 

   

variations in the level of expenses related to our development programs;

 

   

addition or reduction of resources for sales and marketing;

 

   

addition or termination of clinical utility studies;

 

   

any intellectual property infringement lawsuit in which we may become involved;

 

   

third party payor determinations affecting our tests; and

 

   

regulatory developments affecting our tests.

If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially.

The shares you purchase in this offering will experience immediate and substantial dilution and may also be diluted by exercises of outstanding options and warrants.

 

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The initial public offering price per share of our common stock will be substantially higher than the net tangible book value per share of our common stock immediately after the offering. At the assumed initial public offering price of $[        ] per share, purchasers of our common stock will effectively incur dilution of $[    .    ] per share in the net tangible book value of their purchased shares. Conversely, the shares of our common stock that our existing stockholders currently own will receive a material increase in net tangible book value per share. As of June 30, 2013, we had outstanding options to purchase an aggregate of 73,899 shares of our common stock at a weighted average exercise price of $3.54 per share and warrants to purchase an estimated aggregate of 424,178 shares of our common stock at an estimated weighted average exercise price of $4.31 per share. The exercise of such outstanding options and warrants will result in further dilution of your investment. In addition, you may experience additional dilution if we issue common stock in the future. As a result of this dilution, you may receive significantly less than the full purchase price you paid for the shares in the event of liquidation.

 

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Future sales of our common stock, or the perception that future sales may occur, may cause the market price of our common stock to decline, even if our business is doing well.

Sales of substantial amounts of our common stock after this offering, or the perception that these sales may occur, could materially and adversely affect the price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. The shares of common stock sold in this offering will be freely tradable, without restriction, in the public market, except for any shares sold to our affiliates.

In connection with this offering, we have agreed, subject to limited exceptions, not to issue, sell or transfer any shares of common stock for 180 days after the date of this prospectus without the consent of Aegis Capital Corp. Our officers, directors and certain stockholders have agreed before the commencement of this offering, subject to limited exceptions, not to sell or transfer any shares of common stock for 180 days after the date of this prospectus without the consent of Aegis Capital Corp. However, Aegis Capital Corp. may release these shares from any restrictions at any time. We cannot predict what effect, if any, market sales of shares held by any stockholder or the availability of shares for future sale will have on the market price of our common stock.

Approximately 2,569,300 shares of common stock may be sold in the public market by existing stockholders on or about 181 days after the date of this prospectus, subject to volume and other limitations imposed under the federal securities laws. Sales of substantial amounts of our common stock in the public market after the completion of this offering, or the perception that such sales could occur, could adversely affect the market price of our common stock and could materially impair our ability to raise capital through offerings of our common stock. See the section entitled “Shares Eligible for Future Sale” for a more detailed description of the restrictions on selling shares of our common stock after this offering.

In addition, as of June 30, 2013, we had outstanding options to purchase 73,899 shares of our common stock and outstanding warrants to purchase shares of our common and Series A preferred stock overlying an estimated aggregate of 693,362 common stock equivalents. We plan to register for offer and sale the shares of common stock that are reserved for issuance pursuant to outstanding options. Shares covered by such registration statements upon the exercise of stock options generally will be eligible for sale in the public market, except that affiliates will continue to be subject to volume limitations and other requirements of Rule 144 under the Securities Act. The issuance or sale of such shares could depress the market price of our common stock.

In addition, we are registering the [            ] shares of our common stock underlying the warrants to be issued to the representative of the underwriters in connection with this offering as described in the “Underwriting – Representative’s Warrants” section of this prospectus.

We also intend to register all shares of common stock that we may issue under our equity compensation plans. Once we register these shares, they can be freely sold in the public market upon issuance, subject to volume limitations applicable to affiliates and the lock-up agreements described in the “Underwriting” section of this prospectus.

An active trading market may not develop for our common stock, and you may not be able to sell your stock at or above the initial public offering price per share.

There is no established trading market for our common stock, the market for our common stock will likely be highly volatile, and the market price of our common stock may decline regardless of our operating performance. Before this offering, you could not buy or sell our securities publicly. Although we anticipate that our common stock will be approved for listing on The NASDAQ Capital Market, an active public market for our common stock may not develop or be sustained after this offering. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market in our common stock or how liquid that market might become. If a market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at the time you wish to sell them, at a price that is attractive to you, or at all.

The initial public offering price per share has been determined through negotiation between us and representatives of the underwriters, and may not be indicative of the market price for our common stock after this offering. You may not be able to sell your shares at or above the initial public offering price per share.

 

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If securities or industry analysts do not publish research or reports or publish unfavorable research or reports about our business, 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 securities or industry analysts publish about us, our business, our market or our competitors. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of our company, the trading price for our stock would be negatively impacted. In the event we obtain securities or industry analyst coverage, if one or more of the analysts who covers us downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to regularly publish reports on us, interest in our stock could decrease, which could cause our stock price or trading volume to decline.

Our largest stockholder will continue to have substantial influence over us after this offering and could delay or prevent a change in corporate control.

Claire K. T. Reiss beneficially owns approximately 78% of our common stock and, upon the closing of this offering, assuming we sell              shares of common stock in this offering and there is no exercise of the underwriters’ option to purchase additional shares, will beneficially own approximately     % of our common stock. Mrs. Reiss has significant influence over the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. Accordingly, this concentration of ownership might harm the market price of our common stock by:

 

   

delaying, deferring or preventing a change in control;

 

   

impeding a merger, consolidation, takeover or other business combination involving us; or

 

   

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.

If we are unable to favorably assess the effectiveness of our internal control over financial reporting, investors may lose confidence in our financial reporting and our stock price could be materially adversely affected.

As a private company, we were not subject to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. After completion of this offering, we will be required to document and test our internal control over financial reporting. If we fail to remediate any significant deficiencies or material weaknesses in internal controls that may be identified in the future, we may be unable to conclude that our internal control over financial reporting is effective. Under the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, issuers that qualify as “emerging growth companies” under the JOBS Act will not be required to provide an auditor’s attestation report on internal controls for so long as the issuer qualifies as an emerging growth company. We currently qualify as an emerging growth company under the JOBS Act and we may choose not to provide an auditor’s attestation report on internal controls. However, if we cannot favorably assess the effectiveness of our internal control over financial reporting, or if we require an attestation report from our independent registered public accounting firm in the future and that firm is unable to provide an unqualified attestation report on the effectiveness of our internal controls over financial reporting, investor confidence and, in turn, our stock price could be materially adversely affected.

We are an “emerging growth company,” and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.

We are an emerging growth company, as defined in the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, reduced disclosure obligations regarding executive compensation in this prospectus and our periodic reports and proxy statements and exemptions from the requirements of holding nonbinding advisory votes on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years, although circumstances could cause us to lose that status earlier, including if the market value of our common stock held by non-affiliates exceeds $700 million as of any June 30 before that time or if we have total annual gross revenue of $1.0 billion

 

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or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of the following December 31 or, if we issue more than $1.0 billion in non-convertible debt during any three year period before that time, we would cease to be an emerging growth company immediately. Even after we no longer qualify as an emerging growth company, we may still qualify as a “smaller reporting company” which would allow us to take advantage of many of the same exemptions from disclosure requirements including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in this prospectus and our periodic reports and proxy statements. We cannot predict if investors will find our common stock less attractive because we may 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 more volatile.

Under the JOBS Act, emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies. As a result, changes in rules of U.S. generally accepted accounting principles or their interpretation, the adoption of new guidance or the application of existing guidance to changes in our business could significantly affect our financial position and results of operations.

 

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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 Securities Exchange Act of 1934, as amended, or the Exchange Act, which will require, among other things, that we file with the Securities and Exchange Commission, or the SEC, annual, quarterly and current reports with respect to our business and financial condition. In addition, the Sarbanes-Oxley Act, as well as rules subsequently adopted by the SEC and The NASDAQ Stock Market to implement provisions of the Sarbanes-Oxley Act, imposes significant requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Further, there are significant corporate governance and executive compensation related provisions in the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, that require the SEC to adopt additional rules and regulations in these areas such as “say on pay” and proxy access. Recent legislation permits smaller “emerging growth companies” to implement many of these requirements over a longer period and up to five years from the pricing of this offering. We intend to take advantage of this new legislation but cannot guarantee that we will not be required to implement these requirements sooner than budgeted or planned and thereby incur unexpected expenses. 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 consolidated net loss, and may require us to reduce costs in other areas of our business or increase the prices of our 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.

Our management will have broad discretion over the use of the proceeds we receive in this offering, and may not apply the proceeds in ways that increase the value of your investment.

We estimate that net proceeds of 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 this offering in full. We currently intend to use the net proceeds of the offering to hire sales and marketing personnel and support increased sales and marketing activities, to fund further research and development, clinical utility studies and future enhancements of our proprietary tests, to acquire equipment, implement automation and scale our capabilities to prepare for significant test volume, to satisfy deferred salary obligations, and for general corporate purposes and to fund ongoing operations and expansion of our business. We will have broad discretion in the application of the net proceeds in the category of “for general corporate purposes and to fund ongoing operations and expansion of our business,” and investors will be relying on our judgment regarding the application of the proceeds of this offering. The actual amounts and timing of our actual expenditures depend on numerous factors, including the success of our efforts to market OncoCEE-BR, the timing and progress of our discovery, research and development activities for the tests in our pipeline, our ability to reduce operating costs through the implementation of automation and economies of scale, changes in regulatory requirements for LDTs, and other unforeseen regulatory or compliance costs. The costs and timing of development activities, particularly conducting clinical utility studies and validation studies are highly uncertain, subject to substantial risks and can often change. Depending on the outcome of these activities and other unforeseen events, our plans and priorities may change and we may apply the net proceeds of this offering in different proportions than we currently anticipate. Moreover, you will not have the opportunity to influence our decision on how to use the proceeds from this offering. We may use the proceeds for corporate purposes that do not immediately enhance our prospects for the future or increase the value of your investment. See the Section entitled “Use of Proceeds.”

 

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Existing stockholders may view our initial public offering process unfavorably.

The process of effecting an initial public offering has taken considerable time and is associated with several personnel and other changes, including a reverse common stock split. Some of our current stockholders have invested in our securities at prices which are at or above the initial public offering price per share. No assurances can be given as to whether any stockholders will seek to take actions against our company or the board with respect to our initial public offering process.

 

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Anti-takeover provisions of our certificate of incorporation, our bylaws and Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove the current members of our board and management.

Certain provisions of our amended and restated certificate of incorporation and bylaws that will be in effect upon the completion of this offering could discourage, delay or prevent a merger, acquisition or other change of control that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove members of our board of directors. (For example, Delaware law provides that if a corporation has a classified board of directors, stockholders cannot remove any director during his or her term without cause.) These provisions also could limit the price that investors might be willing to pay in the future for our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these transactions may not have the opportunity to do so. These provisions, among other things:

 

   

classify our board of directors into three classes of equal (or roughly equal) size, with all directors serving for a three-year term and the directors of only one class being elected at each annual meeting of stockholders, so that the terms of the classes of directors are “staggered”;

 

   

allow the authorized number of directors to be changed only by resolution of our board of directors;

 

   

authorize our board of directors to issue, without stockholder approval, preferred stock, the rights of which will be determined at the discretion of the board of directors and that, if issued, could operate as a “poison pill” to dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that our board of directors does not approve;

 

   

establish advance notice requirements for stockholder nominations to our board of directors or for stockholder proposals that can be acted on at stockholder meetings; and

 

   

limit who may call a stockholders meeting.

In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, or DGCL, which may, unless certain criteria are met, prohibit large stockholders, in particular those owning 15% or more of the voting rights on our common stock, from merging or combining with us for a prescribed period of time.

Because we do not expect to pay cash dividends for the foreseeable future, you must rely on appreciation of our common stock price for any return on your investment. Even if we change that policy, we may be restricted from paying dividends on our common stock.

We do not intend to pay cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon results of operations, financial performance, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, you will have to rely on capital appreciation, if any, to earn a return on your investment in our common stock. Investors seeking cash dividends in the foreseeable future should not purchase our common stock.

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

Our ability to utilize our federal net operating loss, carryforwards and federal tax credit may be limited under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended. The limitations apply if an “ownership change,” as defined by Section 382, occurs. Generally, an ownership change occurs if the percentage of the value of the stock that is owned by one or more direct or indirect “five percent shareholders” increases by more than 50 percentage points over their lowest ownership percentage at any time during the applicable testing period, typically three years. If we have experienced an “ownership change” at any time since our formation, we may already be subject to limitations on our ability to utilize our existing net operating losses and other tax attributes to offset taxable income. In addition, future changes in our stock ownership, which may be outside of our control, may trigger an “ownership change” and, consequently, Section 382 and 383 limitations. As a result, if we earn net taxable income, our ability to use our pre-change net operating loss carryforwards

 

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and other tax attributes to offset United States federal taxable income may be subject to limitations, which could potentially result in increased future tax liability to us. As of December 31, 2012, we had federal and state net operating loss carryforwards of approximately $104.4 million and $95.7 million, respectively, and federal and California research and development credits of $2.9 million and $3.0 million, respectively, which could be limited if we experience an “ownership change.”

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 early-stage life sciences 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.

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, prospective products, product approvals, timing and likelihood of success, plans and objectives of management for future operations, and future results of current and anticipated products 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 do not plan 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.

This prospectus also contains estimates and other statistical data made by independent parties and by us relating to market size and growth and other data about our industry. This data involves a number of assumptions and limitations, and you are cautioned not to give undue weight to such estimates. In addition, projections, assumptions and estimates of our future performance and the future performance of the markets in which we operate are necessarily subject to a high degree of uncertainty and risk.

 

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USE OF PROCEEDS

We estimate that we will receive net proceeds from this offering of approximately $[            ] million, or approximately $[            ] million if the underwriters exercise their over-allotment option in full, assuming an initial public offering price of $[            ] per share, the midpoint of the price range listed 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, or approximately $[            ] million if the underwriters exercise their over-allotment option in full, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us.

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

 

   

approximately $5 million to hire sales and marketing personnel and support increased sales and marketing activities;

 

   

approximately $5 million to fund further research and development, clinical utility studies and future enhancements of our current proprietary test and our planned proprietary tests and services;

 

   

approximately $3 million to acquire equipment, implement automation and scale our capabilities to prepare for significant test volume;

 

   

approximately $1 million to satisfy deferred salary obligations; and

 

   

the balance for general corporate purposes and to fund ongoing operations and expansion of our business.

The expected use of net proceeds of this offering represents our current intentions based upon our present plan and business conditions. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering. We will have broad discretion in the application of the net proceeds in the category of “for general corporate purposes and to fund ongoing operations and expansion of our business,” and investors will be relying on our judgment regarding the application of the proceeds of this offering. For example, if we identify opportunities that we believe are in the best interests of our stockholders, we may use a portion of the net proceeds from this offering to acquire, invest in or license complementary products, technologies or businesses although we have no current commitments, understandings or agreements to do so. The actual amounts and timing of our actual expenditures depend on numerous factors, including the success of our efforts to market OncoCEE-BR, the timing and progress of our discovery, research and development activities for the tests in our pipeline, the success of our efforts to increase sales of our laboratory services, the success of our efforts to expand our international sales, changes in regulatory requirements for LDTs, and other unforeseen regulatory or compliance costs. The costs and timing of test discovery and development activities, particularly conducting clinical validation studies and obtaining regulatory clearance or approval, if required, are highly uncertain, subject to substantial risks and can often change. Depending on the outcome of these activities and other unforeseen events, our plans and priorities may change and we may apply the net proceeds of this offering in different proportions than we currently anticipate.

DIVIDEND POLICY

We have never declared dividends on our equity securities, and currently do not plan to declare dividends on shares of our common stock in the foreseeable future. We expect to retain our future earnings, if any, for use in the operation and expansion of our business. Subject to the foregoing, the payment of cash dividends in the future, if any, will be at the discretion of our board of directors and will depend upon such factors as earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our board of directors.

 

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CAPITALIZATION

The following table sets forth our capitalization as of June 30, 2013:

 

   

on an actual basis; and

 

   

on a pro forma basis as of June 30, 2013, to reflect the sale of [            ] shares of common stock in this offering less offering costs of $[            ] million and underwriting discounts, expenses, and commissions of $[            ] million, of which $[            ] million was previously paid, a 1-for-10 reverse stock split of our common stock to be effected before the effective date of this offering, the automatic conversion of all outstanding shares of our Series A preferred stock (including shares issued in July 2013 which, as of June 30, 2013, were classified as to-be-issued for conversion of debt and accrued interest) into 2,314,001 shares of common stock, the conversion of convertible promissory notes and accrued interest in the amount of $[            ] million into an aggregate of [            ] shares of our common stock in connection with the closing of our initial public offering, and the issuance of an estimated 46,422 shares of common stock upon such initial public offering pursuant to the settlement of certain restricted stock units (which are currently expressed in shares of preferred stock) in accordance with their terms, the termination of certain warrants upon the closing of our initial public offering in accordance with their terms and the reclassification to shareholders’ deficit of the fair value of certain warrants the exercise price and/or exercisability period length of which will be fixed upon the closing of our initial public offering in accordance with their terms, assuming for all such items an initial public offering price of $[            ] per share, the midpoint of the price range listed on the cover page of this prospectus.

You should read this table together with the sections entitled “Use of Proceeds” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” as well as our financial statements and the related notes, which appear elsewhere in this prospectus.

 

     As of June 30, 2013  
(dollars in thousands)    (unaudited)
Actual
    (unaudited)
Pro Forma
 

Cash and cash equivalents

   $ 4      $     
  

 

 

   

 

 

 

Long term debt (inclusive of current portion)

     3,816     

Series A convertible preferred stock, par value $0.0001 per share, 36,460,000 shares authorized, 27,175,213 shares issued and outstanding, actual; 5,000,000 shares of preferred stock authorized, no shares issued and outstanding, pro forma

     3     

Series A convertible preferred stock, par value $0.0001 per share, 42,245,834 shares to be issued for conversion of debt and accrued interest

     4     

Common stock, par value $0.0001 per share, 14,600,000 shares authorized, 255,304 shares issued and outstanding, actual; 40,000,000 shares authorized,              shares issued and outstanding, pro forma

     —       

Accumulated deficit

     (117,089  

Total stockholders’ equity/(deficit)

     (8,215  

Total capitalization

     (4,399  

The number of shares of common stock to be outstanding after the offering is based on the pro forma number of shares outstanding as of June 30, 2013 after giving effect to (i) the sale of [            ] shares of common stock in this offering, (ii) the automatic conversion of all outstanding shares of our Series A preferred stock (including shares issued in July 2013 which, as of June 30, 2013, were classified as to-be-issued for conversion of debt and accrued interest) into 2,314,001 shares of common stock, (iii) the conversion of convertible promissory notes and accrued interest in the amount of $[            ] million into an aggregate of [            ] shares of our common stock in connection with the closing of our initial public offering, (iv) the issuance of an estimated 46,422 shares of common stock upon such initial public offering pursuant to the

 

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settlement of certain restricted stock units (which are currently expressed in shares of preferred stock) in accordance with their terms, (v) the termination of certain warrants upon the closing of our initial public offering in accordance with their terms and (vi) the reclassification to shareholders’ deficit of the fair value of certain warrants the exercise price and/or exercisability period length of which will be fixed upon the closing of our initial public offering in accordance with their terms, assuming for all such items an initial public offering price of $[            ] per share, the midpoint of the price range listed on the cover page of this prospectus. This number excludes:

 

   

73,899 shares of our common stock issuable upon the exercise of stock options as of June 30, 2013, with a weighted average exercise price of $3.54 per share;

 

   

45,873 shares of our common stock issuable upon the exercise of outstanding restricted stock units as of June 30, 2013;

 

   

other shares of our common stock reserved for future issuance under our 2013 and 2007 Equity Incentive Plans;

 

   

an estimated 424,178 shares of our common stock issuable upon the exercise of outstanding common stock warrants as of June 30, 2013, at an estimated weighted average exercise price of $4.31 per share;

 

   

269,184 common stock equivalents issuable upon the exercise of our outstanding warrants to purchase preferred stock (the warrants overlying all but 2,222 of which will terminate upon the closing of our initial public offering in accordance with their terms);

 

   

any shares of our common stock issuable upon exercise of the underwriters’ over-allotment option; and

 

   

any shares of common stock that will underlie the representative’s warrants.

DILUTION

If you invest in our common stock in this offering, your ownership interest will be diluted to the extent of the difference between the public offering price per share of our common stock in this offering and our pro forma net tangible book value per share immediately after this offering. We calculate net tangible book value per share by dividing our net tangible book value, which is tangible assets less total liabilities less debt discounts and financing fees related to debt to be paid as a result of this offering, by the number of outstanding shares of our common stock. Before considering the effects of the proceeds of this offering, but giving effect to the completion of our initial public offering of              shares of our common stock at $             per share, a 1-for-10 reverse stock split of our common stock to be effected before the effective date of this offering, the automatic conversion of our outstanding shares of Series A preferred stock into 2,314,001 shares of our common stock upon completion of our initial public offering, and the conversion of convertible promissory notes and accrued interest in the amount of $             million at a conversion price of $             per share, into an aggregate of              shares of our common stock, our pro forma net tangible book value (deficit) as of June 30, 2013 was approximately $ (            ) million, or approximately $(            ) per share. Upon completion of this offering, our pro forma net tangible book value as of June 30, 2013 will be approximately $             million or approximately $             per share. This represents an immediate increase in pro forma net tangible book value of $             per share to our existing stockholders and an immediate dilution of $             per share to new investors purchasing our common stock in this offering. The following table illustrates the per share dilution (unaudited):

 

Assumed public offering price per share

     $                

Pro forma net tangible book value per share as of June 30, 2013

   $ (              

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

    
  

 

 

   

Pro forma net tangible book value per share after this offering

    
    

 

 

 

Dilution in pro forma net tangible book value per share to new investors

     $     
    

 

 

 

The information above assumes that the underwriters do not exercise their over-allotment option. If the underwriters exercise their over-allotment option in full, the pro forma net tangible book value will increase to $             per share, representing an immediate increase to existing stockholders of $             per share and an immediate dilution of $             per share

 

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to new investors. If any shares are issued upon exercise of outstanding options or warrants, new investors will experience further dilution.

The following table summarizes, on a pro forma basis as of June 30, 2013, the differences between the number of shares of common stock purchased from us, the total consideration and the average price per share paid by existing stockholders and by investors participating in this offering, after deducting estimated underwriting discounts and commissions and estimated offering expenses, at an assumed public offering price of $             per share (unaudited).

 

     Shares Purchased      Total Consideration      Average Price
Per  Share
 
     Number    %      Amount    %     

Existing stockholders

            $         $            

New investors

            $        
  

 

  

 

 

    

 

  

 

 

    

Total

        100          $ 100       $     
  

 

  

 

 

    

 

  

 

 

    

 

 

 

The number of shares purchased from us by existing stockholders is based on              shares of our common stock outstanding as of June 30, 2013 after giving effect to the automatic conversion of all outstanding shares of our Series A preferred stock (including shares issued in July 2013 which, as of June 30, 2013, were classified as to-be-issued for conversion of debt and accrued interest) into 2,314,001 shares of common stock, the conversion of convertible promissory notes and accrued interest in the amount of $[            ] million into an aggregate of [            ] shares of our common stock in connection with the closing of our initial public offering, and the issuance of an estimated 46,422 shares of common stock upon such initial public offering pursuant to the settlement of certain restricted stock units (which are currently expressed in shares of preferred stock) in accordance with their terms, assuming for all such items an initial public offering price of $[            ] per share, the midpoint of the price range listed on the cover page of this prospectus. This number excludes:

 

   

73,899 shares of our common stock issuable upon the exercise of stock options as of June 30, 2013, with a weighted average exercise price of $3.54 per share;

 

   

45,873 shares of our common stock issuable upon the exercise of outstanding restricted stock units as of June 30, 2013;

 

   

other shares of our common stock reserved for future issuance under our 2013 and 2007 Equity Incentive Plans;

 

   

an estimated 424,178 shares of our common stock issuable upon the exercise of outstanding common stock warrants as of June 30, 2013, at an estimated weighted average exercise price of $4.31 per share;

 

   

269,184 common stock equivalents issuable upon the exercise of our outstanding warrants to purchase preferred stock (the warrants overlying all but 2,222 of which will terminate upon the closing of our initial public offering in accordance with their terms);

 

   

any shares of our common stock issuable upon exercise of the underwriters’ over-allotment option; and

 

   

any shares of common stock that will underlie the representative’s warrants.

To the extent that the underwriters’ over-allotment option is exercised or any warrants or options are exercised, there will be further dilution to investors.

SELECTED HISTORICAL FINANCIAL DATA

The following table summarizes our selected financial data for the periods and as of the dates indicated. Our selected statements of operations data for each of the years in the periods ended December 31, 2011 and 2012, and our selected balance sheet data as of December 31, 2011 and 2012, have been derived from our audited financial statements and their related notes, which are included elsewhere in this prospectus. The unaudited selected statements of operations data for the six months ended June 30, 2012 and 2013, and the unaudited balance sheet data as of June 30, 2013, are derived from our unaudited financial statements, which are included elsewhere in this prospectus. All “Weighted average shares

 

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outstanding” data and all “Net loss per common share” data, whether derived from our audited financial statements or from our unaudited financial statements, have been adjusted to reflect a 1-for-10 reverse stock split which we intend to effectuate before the effective date of this offering. Our unaudited financial statements have been prepared on the same basis as the audited financial statements and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments necessary for a fair presentation of our financial condition as of such dates and our results of operations for such periods. Our historical results are not necessarily indicative of the results to be expected for any future periods and our interim results are not necessarily indicative of the results to be expected for the full fiscal year. Our selected financial data should be read together with the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our financial statements and their related notes, which are included elsewhere in this prospectus.

 

    

 

Year ended December 31,

    For the six months ended June 30,  
     2011     2012     2012     2013  
                 (unaudited)     (unaudited)  
     (in thousands, except share and per share data)  

Revenues

   $ 1      $ 109      $ 64      $ 84   

Cost of revenues

     17        1,201        465        1,141   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     (16     (1,092     (401     (1,057

Research and development expenses

     8,853        6,562        3,797        1,401   

General and administrative expenses

     2,729        2,063        1,165        929   

Sales and marketing expenses

     673        786        402        124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (12,271     (10,503     (5,765     (3,511

Total other income/(expense)

     (1,357     (1,756     (677     (389
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss Before Income Taxes

   $ (13,628   $ (12,259   $ (6,442   $ (3,900

Income tax expense

     1        1        1        1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss & comprehensive loss

   $ (13,629   $ (12,260   $ (6,443   $ (3,901
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

        

Basic

     159,377        224,672        224,672        252,751   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     159,377        224,672        224,672        252,751   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per common share

        

Basic

   $ (85.52   $ (54.57   $ (28.68   $ (15.43
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (85.52   $ (54.57   $ (28.68   $ (15.43
  

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per common share

        

Basic

   $        $        $        $     
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Year ended December 31,

     For the six months ended June 30,  
     2011      2012      2012      2013  
                   (unaudited)      (unaudited)  
     (in thousands, except share and per share data)  

Diluted

   $         $         $         $     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     As of December 31,
2012
    As of June 30, 2013
     Actual     Actual     Pro Forma(1)
           (unaudited)     (unaudited)

Balance Sheet Data:

      

Cash and cash equivalents

   $ 185      $ 4     

Total assets

     1,470        992     

Notes payable, net of debt discount

     22,376        3,816     

Warrant liability

     982        1,384     

Total liabilities

     28,855        9,207     

Convertible preferred stock

     3        7     

Total shareholders’ deficit

     (27,385     (8,215  

 

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(1) Gives effect to (i) the automatic conversion of all outstanding shares of our Series A preferred stock (including shares issued in July 2013 which, as of June 30, 2013, were classified as to-be-issued for conversion of debt and accrued interest) into 2,314,001 shares of common stock, (ii) the conversion of convertible promissory notes and accrued interest in the amount of $[            ] million into an aggregate of [            ] shares of our common stock in connection with the closing of our initial public offering, (iii) the issuance of an estimated 46,422 shares of common stock upon such initial public offering pursuant to the settlement of certain restricted stock units (which are currently expressed in shares of preferred stock) in accordance with their terms, (iv) the termination of certain warrants upon the closing of our initial public offering in accordance with their terms and (v) the reclassification to shareholders’ deficit of the fair value of certain warrants the exercise price and/or exercisability period length of which will be fixed upon the closing of our initial public offering in accordance with their terms, assuming for all such items an initial public offering price of $[            ] per share, the midpoint of the price range listed on the cover page of this prospectus. The pro forma information 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.

The unaudited pro forma balance sheet information as of June 30, 2013 assumes that the completion of our initial public offering had occurred as of June 30, 2013 and excludes                     shares of common stock issued in the initial public offering and any related net proceeds.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with our financial statements and related notes included elsewhere in the prospectus. This discussion contains forward-looking statements based upon our current plans, estimates, beliefs and expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the sections entitled “Risk Factors,” “Special Note Regarding Forward-Looking Statements” and elsewhere in this prospectus. The share numbers in the following discussion reflect a 1-for-3 reverse common stock split that we effected on November 3, 2011 and a further 1-for-10 reverse common stock split that we will effect before the completion of this offering.

Overview

We are an early-stage cancer diagnostics company that develops and commercializes proprietary circulating tumor cell, or CTC, and circulating tumor DNA, or ctDNA, tests utilizing a standard blood sample. Our current CTC breast cancer test provides, and our planned future tests would provide, information to oncologists that enable them to select appropriate personalized treatment for their patients based on better, timelier and more-detailed data on the characteristics of tumors.

Our current breast cancer test and our planned future tests utilize our Cell Enrichment and Extraction (CEE) technology for the detection and analysis of CTCs, and our CEE-Selector technology for the detection and analysis of ctDNA, each performed on a standard blood sample. The CEE technology is an internally invented and developed, microfluidics-based CTC capture and analysis platform, with enabling features that change how CTC testing can be used by clinicians by providing real-time biomarker monitoring with only a standard blood sample. The CEE-Selector technology enables mutation detection with enhanced sensitivity and specificity and is applicable to nucleic acid from CTCs or other samples types, such as blood plasma for ctDNA. We believe the CEE-Selector technology is an important part of certain of our pipeline CTC tests and will be a stand-alone test for molecular analysis of biomarkers.

At our corporate headquarters facility located in San Diego, California, we operate a clinical laboratory that is certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and accredited by the College of American Pathologists, or CAP. We manufacture our CEE microfluidic channels, related equipment and certain reagents to perform our current breast cancer test and our planned future tests at this facility. CLIA certification and CAP accreditation are required before any clinical laboratory, including ours, may perform testing on human specimens for the purpose of obtaining information for the diagnosis, prevention, or treatment of disease or the assessment of health. The tests we offer and intend to offer are classified as laboratory developed tests, or LDTs, under CLIA regulations.

We are in the process of commercializing our first proprietary test, OncoCEE-BR, for breast cancer, and anticipate launching an OncoCEE-LU test for non-small cell lung cancer, or NSCLC, in the first half of 2014. These tests utilize our CEE technology platform and provide CTC enumeration as well as biomarker analysis from a standard blood sample. In the case of the OncoCEE-BR test, biomarker analysis involves fluorescence in situ hybridization, or FISH, for the detection and quantitation of the human epidermal growth factor receptor 2, or HER2, gene copy number. We plan to include immunocytochemical analysis of estrogen receptor and progesterone receptor proteins in the OncoCEE-BR test within the next year. The OncoCEE-LU test’s biomarker analysis would include FISH for EML4/ALK and ROS1 gene fusions, as well as mutation analysis for the epidermal growth factor receptor, or EGFR, gene, the K-ras gene and the B-raf gene.

The L858R mutation of the EGFR gene and D747-751 deletions as activators of EGFR kinase activity are linked to the drugs Tarceva® and Iressa® (AstraZeneca). The T790M mutation of the EGFR gene as a resistance marker for EGFR tyrosine kinase inhibitors is linked to drugs in clinical development that address this resistance such as Gilotrif® (Boehringer-Ingelheim) and dacomitinib (Pfizer). The codon 12 and 13 mutations of the K-ras gene are linked to non-responsiveness to the EGFR kinase inhibitors, and the codon 600 mutations of the B-raf gene are linked to Zelboraf® and Tafinlar®, which are both approved for melanoma and are in clinical trials for lung cancer. Our OncoCEE-LU test would be performed on a standard blood sample.

 

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We plan to add other biomarker analyses to our current breast cancer test and our planned future OncoCEE tests as their relevance is demonstrated in clinical trials, for example, ret proto-oncogene gene fusions in NSCLC, which may indicate a particular course of therapy, and NRAS for melanoma, which may predict therapy resistance. In addition, we are developing a series of other proprietary CTC and ctDNA tests for different solid tumor types, including colorectal cancer, prostate cancer, gastric cancer and melanoma, each incorporating treatment-associated biomarker analyses specific to that cancer, planned to be launched over the next two to three years.

Key Factors Affecting our Results of Operations and Financial Condition

Our overall long-term growth plan depends on our ability to develop and commercialize proprietary tests through our CLIA laboratory. We have the OncoCEE-BR test available as a commercial product and we plan to enhance revenue for this product through the efforts of a sales and marketing organization we plan to hire after the completion of this offering. We are developing additional OncoCEE tests for non-small cell lung, colorectal, gastric and prostate cancers and melanoma that we expect to make available to physicians over the next several years. To facilitate market adoption of our proprietary tests, we anticipate having to successfully complete additional clinical utility studies with clinical samples to generate clinical utility data and then publish our results in peer-reviewed scientific journals. Our ability to complete such clinical studies is dependent upon our ability to leverage our collaborative relationships with leading institutions to facilitate our research, to conduct the appropriate clinical studies and to obtain favorable clinical data.

We believe that the factors discussed in the following paragraphs have had and are expected to continue to have a material impact on our results of operations and financial condition.

Revenues

Almost all of our revenue in 2012 was generated through limited commercialization of our OncoCEE-BR test. Over 75% of this revenue was generated through our arrangement with Clarient. The clinical laboratory industry is highly competitive, and our relationships and our partners’ relationships with decision-makers at hospitals, cancer centers or physician offices is a critical component of securing their business. Consequently, our ability to establish and manage partnerships with groups that have sales and marketing capabilities in our target markets and attract and maintain productive sales personnel that have and can grow these relationships will largely determine our ability to grow our clinical services revenue.

The majority of our commercial revenue for 2012 was billed through our prior arrangement with Clarient, which until May 2013 had responsibility for billing the payor. As a result, we have limited information about the payor mix, reimbursement history and collectability for the tests performed under such arrangement. Clarient has paid us for all tests that we conducted under our arrangement in 2012. In the May 2013 revision of our arrangements with Clarient, we undertook responsibility for billing the payor and for reporting the results of the tests to the ordering physician, and the exclusivity of Clarient’s marketing rights for OncoCEE-BR ended. The May 2013 revision of our arrangements with Clarient will, in general, have the effect of delaying the timing of revenue recognition (see the “Revenue Recognition” paragraph of Note 3 of the notes to our audited financial statements) and adding uncertainty to the collectability of our accounts receivable.

We expect that in the future the percentage of our revenue which is generated through our arrangement with Clarient will diminish.

Cost of Revenues

Our cost of revenues consists principally of personnel costs, laboratory and manufacturing supplies and overhead. We are pursuing various strategies to reduce and control our cost of revenues, including automating aspects of our processes, developing more efficient technology and methods, attempting to negotiate improved terms with our suppliers and exploring relocating our operations to a lower-cost facility.

Operating Expenses

We classify our operating expenses into three categories: research and development, sales and marketing, and general and administrative. Our operating expenses principally consist of personnel costs, outside services, laboratory consumables and overhead, development costs, and legal and accounting fees.

 

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Research and Development Expenses. We incur research and development expenses principally in connection with our efforts to develop and improve our proprietary tests. Our primary research and development expenses consist of direct personnel costs, laboratory equipment and consumables and overhead expenses. We anticipate that research and development expenses will increase in the near-term, principally as a result of hiring additional personnel to develop and validate tests in our pipeline and to perform work associated with clinical utility studies and development collaborations. In addition, we expect that our costs related to collaborations with research and academic institutions will increase. All research and development expenses are charged to operations in the periods in which they are incurred.

Sales and Marketing Expenses. Our sales and marketing expenses consist principally of personnel and related overhead costs for our sales team and their support personnel, travel and entertainment expenses, and other selling costs including sales collaterals and trade shows. We expect our sales and marketing expenses to increase significantly after we complete our initial public offering as we hire additional sales and marketing personnel and launch new tests.

General and Administrative Expenses. General and administrative expenses consist principally of personnel-related expenses, professional fees, such as legal, accounting and business consultants, occupancy costs, and other general expenses. We expect that our general and administrative expenses will increase as we expand our business operations. When we begin billing a significant number of tests, bad debt is expected to become a greater expense. We further expect that general and administrative expenses will increase significantly due to increased information technology, legal, insurance, accounting and financial reporting expenses associated with being a public company.

Seasonality

We expect our test volume to decrease during vacation and holiday seasons, when patients are less likely to visit their health care providers. We expect this trend in seasonality to continue for the foreseeable future.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates based on historical experience and make various assumptions, which management believes to be reasonable under the circumstances, which form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

The notes to our audited and unaudited financial statements, which are included elsewhere in this prospectus, contain a summary of our significant accounting policies. We consider the following accounting policies critical to the understanding of the results of our operations:

 

   

Revenue recognition;

 

   

Accounts receivable and bad debts;

 

   

Stock-based compensation;

 

   

Common stock valuation; and

 

   

Warrant liability.

Revenue Recognition

We recognize revenue in accordance with ASC 605, Revenue Recognition, and ASC 954-605, Health Care Entities, Revenue Recognition which requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred and title and the risks and rewards of ownership have been transferred to the client or services have been rendered; (3) the price is fixed or determinable; and (4) collectability is reasonably assured. For contract partners, revenue is recorded based upon the contractually agreed upon fee schedule. When assessing collectability, we consider whether we have sufficient payment history to reliably estimate a payor’s individual

 

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payment patterns. For new tests where there is limited evidence of payment history at the time the tests are completed, we recognize revenue equal to the amount of cash received until such time as reimbursement experience can be established.

Our primary source of revenue for the year ended December 31, 2012 was Clarient, our collaboration partner. This revenue was derived from clinical laboratory testing performed in our laboratories under our collaboration agreement. As there was a contractually agreed upon price under our collaboration agreement as in effect until May 2013, and collectability from our collaboration partner is reasonably assured, revenues for these tests under our collaboration agreement as in effect until May 2013 is earned at the time the test is completed and the results are delivered to the third party.

Accounts Receivable and Bad Debts

We carry accounts receivable at original invoice amounts, less an estimate for doubtful receivables, based on a review of all outstanding amounts on a periodic basis. The estimate for doubtful receivables is determined from an analysis of the accounts receivable on a quarterly basis, and is recorded as bad debt expense. Since we only recognize revenue to the extent we expect to collect such amounts, bad debt expense related to receivables from patient service revenue is recorded in general and administrative expense in the statements of operations. Accounts receivable are written off when deemed uncollectible. Recoveries of accounts receivable previously written off are recorded when received.

Stock-Based Compensation Expense

We account for stock-based compensation under the provisions of ASC Topic 718, Compensation—Stock Compensation, which requires the measurement and recognition of compensation expense for all stock-based awards made to employees and directors based on estimated fair values on the grant date. We estimate the fair value of stock-based awards on the date of grant using the Black-Scholes option pricing model, or Black-Scholes valuation model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods using the straight-line method. We estimate forfeitures at the time of grant and revise our estimates in subsequent periods if actual forfeitures differ from those estimates. At June 30, 2013, we had unrecognized compensation cost related to nonvested employee stock options of approximately $53,000, which amount is expected to be recognized over the next 1.05 years.

We account for stock-based compensation awards to non-employees in accordance with ASC Topic 505-50, Equity-Based Payments to Non-Employees. Under ASC 505-50, we determine the fair value of the warrants or stock-based compensation awards granted as either the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measurable. All issuances of equity instruments issued to non-employees as consideration for goods or services received by us are accounted for based on the fair value of the equity instruments issued. These awards are recorded in expense and additional paid-in capital in stockholders’ equity over the applicable service periods based on the fair value of the options at the end of each period.

Calculating the fair value of stock-based awards requires the input of highly subjective assumptions into the Black-Scholes valuation model. Stock-based compensation expense is calculated using our best estimate, which involves inherent uncertainties, and the application of our management’s judgment. Significant estimates include the fair value of our common stock at the date of grant, the expected life of the stock option, stock price volatility, risk-free interest rate and forfeiture rates.

Common Stock Valuation

In the absence of a public trading market, our board of directors determined a reasonable estimate of the then-current fair value of our common stock for purposes of granting stock-based compensation based on input from management and valuation reports prepared by an independent third-party valuation specialist. We determined the fair value of our common stock utilizing methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants Practice Aid, “Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” which we refer to as the AICPA Practice Aid. In addition, we exercised judgment in evaluating and assessing the foregoing based on several factors including:

 

   

the nature and history of our business;

 

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our historical operating and financial results;

 

   

the market value of companies that are engaged in a similar business to ours;

 

   

the lack of marketability of our common stock;

 

   

the price at which shares of our equity instruments have been sold;

 

   

our progress in developing our technology;

 

   

the overall inherent risks associated with our business at the time stock option grants or warrants were approved; and

 

   

the overall equity market conditions and general economic trends.

Warrant Liability

Warrants for shares that are contingently redeemable and for which the exercise price is not fixed are classified as liabilities on the accompanying balance sheets and carried at their estimated fair value, determined through use of a Black-Scholes valuation model. At the end of each reporting period, any changes in fair value are recorded as a component of total other income/(expense). We will continue to adjust the carrying value of the warrants until the earlier of the exercise of the warrants, the warrants no longer meeting the criteria to be classified as liabilities or the completion of a liquidation event, including the completion of an initial public offering under the Securities Act, at which time the exercise price will be fixed for the surviving warrants, and the fair value of those warrants will be reclassified to shareholders’ deficit.

Results of Operations

Six Months Ended June 30, 2012 and 2013

The following table sets forth certain information concerning our results of operations for the periods shown:

 

     Six Months Ended June 30,     Change  
     2012     2013     $     %  
    

(unaudited)

    (unaudited)              
(dollars in thousands)                         

Revenue

   $ 64      $ 84      $ 20        31.3

Cost of revenues

     465        1,141        676        145.4

Research and development expenses

     3,797        1,401        (2,396     (63.1 %) 

General and administrative expenses

     1,165        929        (236     (20.3 %) 

Sales and marketing expenses

     402        124        (278     (69.2 %) 
  

 

 

   

 

 

   

 

 

   

Total Operating Loss

     (5,765     (3,511     (2,254     (39.1 %) 

Interest income/(expense), net

     (1,020     (978     (42     (4.1 %) 

Change in fair value of warrant liability

     356        601        245        68.8

Other income/(expense)

     (13     (12     (1     (7.7 %) 
  

 

 

   

 

 

   

 

 

   

Income/(loss) before income taxes

     (6,442     (3,900     (2,542     (39.5 %) 
  

 

 

   

 

 

   

 

 

   

Income tax expense

     1        1        0        0.0
  

 

 

   

 

 

   

 

 

   

 

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     Six Months Ended June 30,     Change  
     2012     2013     $     %  
    

(unaudited)

    (unaudited)              

Net income/(loss)

   $ (6,443   $ (3,901   $ (2,542     (39.5 %) 
  

 

 

   

 

 

   

 

 

   

Revenue

Revenues were $84,000 for the six months ended June 30, 2013, compared with $64,000 for the six months ended June 30, 2012, an increase of $20,000, or 31.3%. The increase was primarily related to tests ordered through our development collaboration program with the Dana-Farber Cancer Institute, partially offset by a decrease in revenues from Clarient. The average price per test decreased from $739 for the six months ended June 30, 2012 to an average of $440 for the six months ended June 30, 2013. The decrease in price is due to the 2013 period including testing under the Dana-Farber program, which by agreement carries significantly lower pricing than commercial tests.

Cost of Revenues

Cost of revenues were $1.1 million for the six months ended June 30, 2013, compared with $465,000 for the six months ended June 30, 2012, an increase of $675,000, or 145.4%. The increase was related to the volume of tests performed, which increased from 66 for the six months ended June 30, 2012 to 185 for the six months ended June 30, 2013, an increase of 180%. The volume increase was due to tests performed under our development collaboration program with the Dana-Farber Cancer Institute.

Operating Expenses

Research and Development Expenses.

Research and development expenses were $1.4 million for the six months ended June 30, 2013, compared with $3.8 million for the six months ended June 30, 2012, a decrease of $2.4 million, or 63.1%. The decrease was primarily due to a $1.2 million decrease in personnel expenses relating to a reduction in research and development headcount from an average of 19 for the six months ended June 30, 2012 to an average of 8 for the same period in 2013. Additionally, research and development expenses decreased by $675,000 due to the allocation of lab expenses to cost of revenues based on the number of samples processed.

General and Administrative Expenses.

General and administrative expenses were $929,000 for the six months ended June 30, 2013, compared with $1.2 million for the six months ended June 30, 2012, a decrease of $236,000, or 20.3%. The decrease was primarily due to a $374,000 decrease in personnel expenses relating to a reduction in general and administrative headcount from an average of 10 for the six months ended June 30, 2012 to an average of 6 for the same period in 2013. This was partially offset by a $100,000 increase in legal fees, particularly fees pertaining to our patent portfolio.

Sales and Marketing Expenses.

Sales and marketing expenses were $124,000 for the six months ended June 30, 2013, compared with $402,000 for the six months ended June 30, 2012, a decrease of $278,000, or 69.2%. The decrease was primarily due to a $240,000 decrease in personnel expenses relating to a reduction in sales and marketing headcount from an average of 3 for the six months ended June 30, 2012 to an average of 1 for the same period in 2013.

 

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Interest Income and Expense

Net interest expense was $978,000 for the six months ended June 30, 2013, compared with $1.0 million for the six months ended June 30, 2012, a decrease of $42,000, or 4.1%. The decrease was due to lower amortization of debt discount due to the completion of the amortization in prior periods.

Change in Fair Value of Warrant Liability

The change in the fair value of warrant liability was $601,000 for the six months ended June 30, 2013 compared with $356,000 for the six months ended June 30, 2012, an increase of $245,000, or 68.8%. The increase in the change in fair value is primarily due to (i) a change in the underlying share price of ($1.20) as of June 30, 2013, versus a change in the underlying share price of ($0.90) as of June 30, 2012, resulting in an approximately $132,000 higher change in fair value in the 2013 period; (ii) a higher number of warrants outstanding resulting in a higher change in fair value of approximately $74,000 related to the change in fair value of warrants issued between June 30, 2012 and December 31, 2013; and (iii) a lower discount rate used in the valuation of the warrants at June 30, 2013 of between 0.58% and 1.20%, versus discount rates at June 30, 2012 of between 0.55% and 0.71%, resulting in an approximately $39,000 higher change in fair value for the period.

Years Ended December 31, 2012 and 2011

The following table sets forth certain information concerning our results of operations for the periods shown:

 

     Year Ended December 31,     Change  
     2011     2012     $     %  
(dollars in thousands)                   

Revenue

   $ 1      $ 109      $ 108        10800.0

Cost of revenues

     17        1,201        1,184        6964.7

Research and development expenses

     8,853        6,562        (2,291     (25.9 %) 

General and administrative expenses

     2,729        2,063        (666     (24.4 %) 

Sales and marketing expenses

     673        786        113        16.8
  

 

 

   

 

 

   

 

 

   

Total Operating Loss

     (12,271     (10,503     (1,768     (14.4 %) 

Interest income/(expense), net

     (1,700     (2,187     487        28.6

Change in fair value of warrant liability

     361        454        93        25.8

Other income/(expense)

     (18     (23     5        27.8
  

 

 

   

 

 

   

 

 

   

Income/(loss) before income taxes

     (13,628     (12,259     (1,369     (10.0 %) 

Income tax expense

     1        1        —          0.0
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (13,629   $ (12,260   $ (1,369     (10.0 %) 
  

 

 

   

 

 

   

 

 

   

 

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Revenue

Revenues were $109,000 for the year ended December 31, 2012, compared with $1,000 for the year ended December 31, 2011, an increase of $108,000. The increase was primarily due to commercial tests ordered through our marketing partner, Clarient. The average price per test decreased from $866 for the year ended December 31, 2011 to an average of $694 for the year ended December 31, 2012.

Cost of Revenues

Cost of revenues was $1.2 million for the year ended December 31, 2012, compared with $17,000 for the year ended December 31, 2011, an increase of $1.2 million. The increase was related to the volume of commercial tests performed, which was only 1 in the year ended December 31, 2011 and which increased to 130 for the year ended December 31, 2012. The volume increase was primarily due to tests ordered through our marketing partner, Clarient.

Operating Expenses

Research and Development Expenses. Research and development expenses were $6.6 million for the year ended December 31, 2012, compared with $8.9 million for the year ended December 31, 2011, a decrease of $2.3 million, or 25.9%. Research and development expenses decreased by $1.2 million due to the allocation of lab expenses to cost of revenues based on the number of samples processed. $639,000 of the decrease was attributable to reduced expenditures on clinical samples and $342,000 of the reduction related to lower expenses for lab supplies as we approached commercialization.

General and Administrative Expenses. General and administrative expenses were $2.1 million for the year ended December 31, 2012, compared with $2.7 million for the year ended December 31, 2011, a decrease of $0.7 million, or 24.4%. $534,000 of this decrease was attributable to a reduced level of legal fees, particularly fees pertaining to our patent portfolio. $72,000 of the decrease related to the use of employees for functions that previously had been performed by consultants.

Sales and Marketing Expenses. Sales and marketing expenses were $786,000 for the year ended December 31, 2012, compared with $673,000 for the year ended December 31, 2011, an increase of $113,000, or 16.8%. This increase was primarily attributable to personnel costs relating to the two sales personnel we employed in 2012.

Interest Income and Expense

Interest expense was $2.2 million for the year ended December 31, 2012, compared with $1.7 million for the year ended December 31, 2011, with the $500,000 increase primarily related to higher debt balances.

Income Taxes

Over the past several years we have generated operating losses in all jurisdictions in which we may be subject to income taxes. As a result, we have accumulated significant net operating losses and other deferred tax assets. Because of our history of losses and the uncertainty as to the realization of those deferred tax assets, a full valuation allowance has been recognized. We do not expect to report a provision for income taxes until we have a history of earnings, if ever, that would support the realization of our deferred tax assets.

We have not completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since our formation, due to the complexity and cost associated with such a study, and the fact that there may be additional ownership changes in the future. We estimate that if such a change did occur, the federal and state net operating loss carryforwards and research and development credits that can be utilized in the future will be significantly limited.

Liquidity and Capital Resources

We are actively working to improve our financial position and enable the growth of our business, by raising new capital and resolving our outstanding debt.

 

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Pursuant to a note and warrant purchase agreement executed as of June 28, 2013 to reflect certain prior and possible future borrowings under a series of notes, totaling up to $7.0 million, we have borrowed from several of our directors and their affiliates an aggregate of $3.8 million through July 31, 2013 (including $0.7 million borrowed under this arrangement during fiscal year 2012.) The maturity date of each note is May 31, 2014 and may be extended for two successive six month periods. Each note bears interest at 8.0% per annum, payable at maturity. The principal amount of and accrued interest on each note will automatically convert into shares of our common stock upon the closing of an underwritten initial public offering resulting in at least $8.0 million of gross proceeds to us, at a conversion price equal to the price per share of our common stock sold in the initial public offering. The number of shares underlying the associated common stock warrants will be determined by dividing the warrant coverage amount, which is 50% of the note principal, by the exercise price, which will be set at the price per share of common stock sold in the initial public offering.

In June 2013, we arranged the conversion of all outstanding indebtedness under our January 2009 amended and restated loan agreement, our February 2011 note and warrant purchase agreement and our January 2012 note and warrant purchase agreement. In this series of transactions, promissory notes with outstanding principal totaling $20,231,000 and accrued interest of approximately $2,581,000 were converted into 42,245,834 shares of Series A preferred stock. The conversion included the issuance of 41,694,122 shares of Series A preferred stock to directors and their affiliates and other related parties. All of the converted notes and interest were in default and classified as current as of December 31, 2012.

In connection with the conversion of the 2009 amended and restated loan agreement’s promissory note, we issued 33,333 common stock warrants to Goodman Co. Ltd., a 5% shareholder.

In July 2013, we amended a secured promissory note with a principal balance of $1.4 million, held by a trust affiliated with Claire K. T. Reiss, a 5% shareholder and at the time a director, to provide that all principal of and accrued interest on the note would automatically convert into common stock upon the closing of an initial public offering, at the price per share at which common stock is sold in such initial public offering. This amendment was not related to Mrs. Reiss’ later decision to resign from the board of directors.

In July 2013, we entered into a revolving line of credit with UBS Bank USA in the initial amount of $1.5 million. Interest accrues daily on the outstanding balance and is paid monthly at a variable rate which is currently 2.75% over the 30 day LIBOR rate or a current effective annual interest rate of 2.942%. UBS Bank USA has the right to terminate the revolving line of credit at any time, and if it does, all amounts drawn under the revolving line of credit would be immediately payable. An affiliate of our director David F. Hale, and an affiliate of Claire K. T. Reiss, a 5% shareholder and at the time a director, and our director Edward Neff guaranteed the loan and pledged financial assets to UBS Bank USA to secure their guaranties. In return, we issued common stock warrants to the guarantors. The number of shares subject to the common stock warrants will be determined by dividing the warrant coverage amount, which is 50% of the fair market value of the collateral provided by the respective guarantors to secure their respective guaranty obligations to UBS Bank USA, by the exercise price, which will be set at the price per share of our common stock sold in our initial public offering. We have entered into an agreement with the guarantors that provides for us to reimburse them for any amounts paid by them on such guaranties. This reimbursement obligation is secured by a security interest in our assets.

In September 2013, we entered into an amendment of the lease for our headquarters/laboratory building in San Diego, California, extending the term through July 31, 2020 and providing for five months of free base rent (August 2013 – December 2013). In return, we agreed, among other things, to forfeit our security deposit and to issue common stock warrants to the landlord. The number of shares subject to the common stock warrants will be determined by dividing the warrant coverage amount of $502,605, which is 100% of the five months of base rent forgone, by the exercise price, which will be set at the price per share of our common stock sold in our initial public offering.

 

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Cash Flows

Our net cash flow from operating, investing and financing activities for the periods below were as follows:

 

     Year Ended     Six Months Ended  
     December 31,     June 30,  
     2011     2012     2012     2013  
                 (unaudited)     (unaudited)  
(dollars in thousands)                         

Cash provided by (used in):

        

Operating activities

   $ (10,985   $ (8,607   $ (4,947   $ (3,046

Investing activities

     (295     (8     (8     (1

Financing activities

     10,205        8,365        4,881        2,866   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ (1,075   $ (250   $ (74   $ (181
    

 

 

   

 

 

   

 

 

 

Cash Used in Operating Activities. Net cash used in operating activities was $8.6 million for the year ended December 31, 2012, compared to net cash used in operating activities of $11.0 million for the year ended December 31, 2011. Net cash used in operating activities was $3.0 million for the six months ended June 30, 2013, compared to net cash used in operating activities of $4.9 million for the six months ended June 30, 2012. In all periods the primary use of cash was to fund our net loss.

Cash Used in Investing Activities. Cash used in investing activities was $8,000 for the year ended December 31, 2012, compared to $295,000 for the year ended December 31, 2011. The cash used in investing activities in 2011 was primarily used to acquire laboratory equipment and software.

Cash Provided by Financing Activities. Net cash provided by financing activities was $8.4 million for the year ended December 31, 2012, compared to net cash provided by financing activities of $10.2 million for the year ended December 31, 2011. Net cash provided by financing activities was $2.9 million for the six months ended June 30, 2013, compared to net cash provided by financing activities of $4.9 million for the six months ended June 30, 2012. Our primary source of financing in all periods consisted of loans received from our major shareholder and members of our board of directors and their affiliates, in exchange for convertible promissory notes and warrants. Our ability to continue as a going concern relies on the continued availability of financing from these and other sources.

Capital Resources and Expenditure Requirements

We expect to continue to incur substantial operating losses in the future. It may take several years to achieve positive operational cash flow or we may not ever achieve positive operational cash flow. We expect that we will use a portion of the net proceeds from this offering and our revenues from operations to hire sales and marketing personnel, support increased sales and marketing activities, fund further research and development, clinical utility studies and future enhancements of our proprietary tests, acquire equipment, implement automation and scale our capabilities to prepare for significant test volume, for general corporate purposes and to fund ongoing operations and the expansion of our business, including the increased costs associated with being a public company. We may also use a portion of the net proceeds of this offering to acquire or invest in businesses, technologies, services or products, although we do not have any current plans to do so.

Without the net proceeds from this offering, we believe our current cash resources are insufficient to satisfy our liquidity requirements at our current level of operations. If we do not consummate this offering by October 2013, we expect that we will need to raise additional financing early in the fourth quarter of 2013, which might not be available on favorable terms, if at all. We can provide no assurances that any sources of a sufficient amount of financing will be available to us on favorable terms, if at all. If we are unable to raise a sufficient amount of financing in a timely manner, we would likely need to scale back our general and administrative activities and certain of our research and development activities. Our forecast

 

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pertaining to our current financial resources and the costs to support our general and administrative and research and development activities are forward-looking statements and involve risks and uncertainties. Actual results could vary materially and negatively as a result of a number of factors, including:

 

   

our ability to secure financing and the amount thereof;

 

   

the costs of operating and enhancing our laboratory facilities;

 

   

the costs of developing our anticipated internal sales and marketing capabilities;

 

   

the scope, progress and results of our research and development programs, including clinical utility studies;

 

   

the scope, progress, results, costs, timing and outcomes of the clinical utility studies for our cancer diagnostic tests;

 

   

our ability to manage the costs for manufacturing our microfluidic channels;

 

   

the costs of maintaining, expanding and protecting our intellectual property portfolio, including potential litigation costs and liabilities;

 

   

our ability to obtain adequate reimbursement from governmental and other third-party payors for our tests and services;

 

   

the costs of additional general and administrative personnel, including accounting and finance, legal and human resources, as a result of becoming a public company;

 

   

our ability to collect revenues; and

 

   

other risks discussed in the section entitled “Risk Factors”.

As of June 30, 2013, we had approximately $5 million of outstanding indebtedness, all of which will convert to equity upon completion of this offering. Following completion of this offering, we believe we will have approximately $2 million in outstanding indebtedness, which will consist of borrowings under our revolving line of credit from UBS Bank USA which was initiated in July 2013.

Our auditor’s report on our financial statements includes an explanatory paragraph expressing substantial doubt that we can continue as a going concern for the next twelve months. With the net proceeds of this offering, we believe that we will have sufficient funds to continue our current level of operations for the next eighteen months. During 2012 and this year to date, we are experiencing net cash outflows at our current level of operations of approximately $2 million per quarter. Assuming that we continue at our current level of operations after consummation of our initial public offering and add our planned sales and marketing resources, we would expect our net cash outflow to increase by at least $1 million per quarter.

Furthermore, we may need to raise additional capital to expand our business to meet our long-term business objectives. We expect that our operating expenses and capital expenditures will increase in the future as we expand our business. We plan to increase our sales and marketing headcount to promote our current breast cancer test and our planned future cancer diagnostic tests and our research and development headcount to validate the tests currently in our pipeline. These headcount increases are aimed to expand our pipeline and to perform work associated with our research collaborations. Until we can generate a sufficient amount of revenues to finance our cash requirements, which we may never do, we may need to continue to raise additional capital to fund our operations.

We may raise additional capital to fund our current operations and to fund expansion of our business to meet our long-term business objectives through public or private equity offerings, debt financings, borrowings or strategic partnerships coupled with an investment in our company or a combination thereof. If we raise additional funds through the issuance of convertible debt securities, or other debt securities, these securities could be secured and could have rights senior to those of our common stock. In addition, any new debt incurred by us could impose covenants that restrict our operations. The issuance of any new equity securities will also dilute the interest of our current stockholders. Given the risks associated with our business, including our unprofitable operating history and our ability or inability to develop additional proprietary tests, additional capital may not be available when needed on acceptable terms, or at all. If adequate funds are not available, we will need to curb our expansion plans or limit our research and development activities, which would have a material adverse impact on our business prospects and results of operations.

 

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Off-Balance Sheet Arrangements

We have not engaged in any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

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DESCRIPTION OF THE BUSINESS

Company Overview

We are a cancer diagnostics company that develops and commercializes proprietary circulating tumor cell, or CTC, and circulating tumor DNA, or ctDNA, tests utilizing a standard blood sample. These tests provide information to oncologists that enable them to select the most appropriate treatment for their patients based on better, timelier and more-detailed data on the characteristics of tumors. Our current test and our planned tests utilize our Cell Enrichment and Extraction (CEE) technology for the detection and analysis of CTCs, and our CEE-Selector technology for the detection and analysis of ctDNA, each performed on a standard blood sample. The CEE technology is an internally invented and developed, microfluidics-based CTC capture and analysis platform, with enabling features that change how CTC testing can be used by clinicians by providing real-time biomarker monitoring with a standard blood sample. The CEE-Selector technology enables mutation detection with enhanced sensitivity and specificity and is applicable to nucleic acid from CTCs or other sample types, such as blood plasma for ctDNA. We believe CEE-Selector technology is an important part of certain of our pipeline CTC tests, and believe it could also be a stand-alone test for molecular analysis of biomarkers.

 

LOGO

At our corporate headquarters facility located in San Diego, California, we operate a clinical laboratory that is certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and accredited by the College of American Pathologists, or CAP, and manufacture our CEE microfluidic channels, related equipment and certain reagents to perform our current breast cancer test and our planned future tests at this facility. CLIA certification and CAP accreditation are required before any clinical laboratory, including ours, may perform testing on human specimens for the purpose of obtaining information for the diagnosis, prevention, or treatment of disease, or the assessment of health. The tests we offer and plan to offer are classified as laboratory developed tests, or LDTs, under CLIA regulations.

We are in the process of commercializing our first proprietary test, OncoCEE-BR. OncoCEE-BR is a breast cancer CTC test that is performed on a standard blood sample. It detects CTCs, which are typically very rare compared to normal blood cells, and determines the patient’s human epidermal growth factor receptor 2, or HER2, status by fluorescence in situ hybridization, or FISH. Pursuant to an agreement that we entered into with Clarient Diagnostic Services, Inc., a GE Healthcare Company, as revised in May 2013, Clarient is making OncoCEE-BR available to physicians through its sales force. (Clarient does not have the exclusive marketing rights for the test.)

We believe that the OncoCEE-BR test offers advantages over other available CTC tests, with improved sensitivity and enumeration results as well as diagnostic biomarker analyses. Competitive CTC tests rely on the expression of the epithelial cell adhesion molecule, or EpCAM, and cytokeratins for CTC capture, detection and enumeration. This approach may exclude CTCs that have undergone intrinsic modifications of their phenotype, such as the epithelial-to-mesenchymal transition, or EMT, thought to be critical for metastasis. EMT may represent a possible explanation for many patients who, despite an aggressive disease, are found to be negative for the presence of CTCs by current technologies. OncoCEE™ captures and detects EpCAM and cytokeratin negative CTCs, which are more mesenchymal-like. Additionally, the OncoCEE platform enables evaluation of treatment-associated biomarkers, like HER2 status, which qualifies patients as candidates for HER2-targeted therapeutics such as Herceptin®, Perjeta®, Kadcyla® (all Genentech/Roche) and Tykerb® (GlaxoSmithKline). We plan to include immunocytochemical analysis of estrogen receptor and progesterone receptor proteins, as well as mutation analysis as appropriate, into the OncoCEE-BR test within the next year.

 

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We anticipate launching OncoCEE-LU, a proprietary test performed on a standard blood sample for non-small cell lung cancer, or NSCLC, in the first half of 2014. The biomarkers to be analyzed in the OncoCEE-LU test would include EML4/ALK and ROS1 gene fusions by FISH, and the epidermal growth factor receptor, or EGFR, gene, the K-ras gene and the B-raf gene by mutation analysis, in addition to CTC enumeration. Our OncoCEE-LU test would be run against a standard blood sample. We have entered into an agreement with Life Technologies Corporation, or Life Technologies, under which we are cooperating with Life Technologies to develop, promote and commercialize our OncoCEE-LU test. Under this agreement, we would perform OncoCEE-LU tests in our laboratory and transmit the results to Life Technologies for their interpretation and reporting to healthcare professionals.

We plan to add other biomarker analyses to our OncoCEE tests as their relevance is demonstrated in clinical trials, for example, ret proto-oncogene gene fusions in NSCLC, which may indicate a particular course of therapy. In addition, we are developing a series of other proprietary CTC and ctDNA tests for different solid tumor types, including colorectal cancer, prostate cancer, gastric cancer and melanoma, each incorporating treatment-associated biomarker analyses specific to that cancer, planned to be launched over the next two to three years.

 

LOGO

Biomarkers are molecular or cellular features of a cancer cell that indicate an abnormality. This abnormality, typically a genetic mutation or aberration, detected at either the gene, protein or metabolite level, may in fact be responsible for the transformation of the cell from a normal cell to a cancer cell. We have focused our efforts on biomarkers associated with specific targeted cancer therapeutics, or resistance to those therapeutics. Examples include an amplified HER2 gene, which is associated with HER2-targeted therapeutics like Herceptin®, Perjeta®, Kadcyla® and Tykerb® for the treatment of breast cancer, or a mutated B-ras gene, which is associated with the drugs Zelboraf® (Daiichi-Sankyo/Genentech/Roche) and Tafinlar® (GlaxoSmithKline) for the treatment of melanoma. This is important because the presence or level of these biomarkers indicates to a physician that the associated therapy is appropriate for the patient, or instead that the patient has, or has developed, resistance to that therapy.

Biomarkers have traditionally been detected in tumor tissue after biopsy or re-section, with the analysis performed by a pathologist. We are able to perform these same analyses on CTCs or ctDNA on a standard blood sample using our CEE and CEE-Selector technology in our CLIA laboratory, meaning that the biomarkers detected in a patient’s tumor can now be monitored on a real-time basis without the need for a tissue biopsy. Because of the difficulty or inability to obtain periodic tissue biopsies, especially at the time of recurrence, this offers the physician a new source and level of information than was previously available.

 

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We also have a research and development program focused on technology enhancements and novel platform development and a translational research group evaluating clinical applications for cancer diagnostic tests in different cancer types and clinical settings. We have the capability to offer our current and planned unique cancer diagnostic tests through our CLIA laboratory to physicians for patient care applications as well as to pharmaceutical and biopharmaceutical companies and academic centers using CTC or ctDNA testing, with biomarker analysis including genetic analysis, in their clinical trials and research efforts. CTC tests, particularly those that offer analysis of CTCs for treatment-associated biomarkers, are becoming powerful tools in the practice of personalized medicine. They enable physicians to utilize a standard blood sample as a “liquid biopsy” to assess the status of their patient’s cancer at a cellular and molecular level on an ongoing basis, and to select therapies that have the highest likelihood of benefiting their patients.

Historically, our average price received per OncoCEE-BR test performed for commercial customers has been approximately $695. This was heavily influenced by the fact that historically a high percentage of our sales were through our marketing partner, Clarient. We amended our arrangement with Clarient as of May 2013, and we do not expect a significant percentage of our future sales to come through Clarient. Our future average price could well differ from our historical figure, based on increased demand generated by our future sales and marketing efforts and increasing recognition of the medical value of our products, possible improvement of the product, introduction of additional tests, and similar commercial factors. In addition, governmental and private third-party payors frequently make determinations about how much (if anything) they are willing to pay for tests such as ours, or for components of such tests; these determinations are important to our business.

In addition, our reimbursement rates can vary based on whether we are considered by private third-party payors to be an “in-network” provider, a participating provider, a covered provider or an “out-of-network” provider. These definitions can vary from insurance company to insurance company, but we are generally considered an “out-of-network” or non-participating provider by the vast majority of private third-party payors. It is not unusual for a company that offers highly specialized or unique testing to be an “out-of-network” provider. An “in-network” provider usually has a contracted arrangement with the insurance company or benefits provider. This contract governs, among other things, service-level agreements and reimbursement rates. In certain instances an insurance company may negotiate an “in-network” rate for our testing rather than pay the typical “out-of-network” rate. An “in-network” provider usually has rates that are lower per test than those that are “out-of-network”, and that rate can vary from a single digit percentage deduction discount to upwards of 25% to 30% lower than an “out-of-network” provider. The discount rate varies based on the insurance company, the testing type and often times the specifics of the patient’s insurance plan.

To date, we have engaged in only limited sales and marketing activities. Such activities have primarily related to our OncoCEE-BR test and have been conducted pursuant to an agreement with Clarient. This agreement was revised in May 2013 and Clarient no longer has exclusive marketing rights to this test. We also have established an agreement with Life Technologies for the commercialization of OncoCEE-LU tests when the development and validation of the OncoCEE-LU test are completed.

Using a portion of the proceeds from this offering, we plan to build an internal sales and marketing team to market and sell OncoCEE-BR and our planned future cancer diagnostic tests directly to oncologists. This team will also provide technical expertise and support for the sales representatives of our sales and marketing partners. Our plans call for starting with an initial group of 7 sales representatives, and, based on success and test volume, growing this number to 15-20 within two years.

We collaborate with physicians and researchers at MD Anderson Cancer Center and plan to expand our collaborative relationships to include other key thought leaders at other institutions for the cancer types we target with OncoCEE-BR and our planned future CTC and ctDNA tests. Such relationships help us develop and validate the effectiveness and utility of OncoCEE-BR and our planned future tests in specific clinical settings and provide us access to patient samples and data. We completed a study, recently published in Cancer Medicine, utilizing our OncoCEE-BR test, and a version of this test adapted for use with bone marrow samples, with a group at MD Anderson Cancer Center comprised of breast cancer surgeons, pathologists and basic researchers. In this study, we demonstrated the ability to identify HER2 positive CTCs and disseminated tumor cells, or DTCs, seen in bone marrow in patients that had been previously classified as HER2 negative by analysis of their tumor tissue. A HER2 positive result in a patient with breast cancer provides an indication to the oncologist

 

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that there is likely to be a survival benefit from treatment with Herceptin®, which has been demonstrated in a number of large clinical studies.

We are currently involved in a new clinical study following up on this finding in CTCs, employing OncoCEE-BR tests for patient selection and monitoring. This study, led by investigators at the Dana-Farber Cancer Institute and The Ohio State University, is currently enrolling patients, and is likely to produce initial results within a year. We believe that these results will provide clinical utility data to support the wide use of OncoCEE-BR tests as a routine diagnostic test for breast cancer patients. In the screening phase of this study, we are testing in our CLIA laboratory blood samples from HER2 negative patients based on standard tumor tissue analysis, to identify those patients that have HER2 positive CTCs. These patients are then being randomized to chemotherapy plus/minus Herceptin®, and followed for a period of time, with additional CTC tests, including biomarker analysis for HER2 using FISH, performed at subsequent time points.

We plan to grow our business by directly offering oncologists proprietary CTC and ctDNA tests. Based on our product development data, as well as discussions with our collaborators, we believe that our planned proprietary tests should provide important information and clinical value to oncologists. In particular, our planned proprietary CTC and ctDNA tests should deliver important, actionable information not provided by other tests. For example, the market leading clinical CTC test is the United States Food and Drug Administration, or FDA, approved CellSearch® test (Janssen Diagnostics), which provides CTC enumeration, but lacks the ability to perform biomarker analysis. The CellSearch® test provides prognostic information, but not predictive information that an oncologist can use in selecting appropriate therapies for their patients. We believe our ability to rapidly translate research insights about the utility of cytogenetic, immunocytochemical and molecular biomarkers to provide information to oncologists for treatment decisions in the clinical setting will improve patient treatment and management, and that these tests will become a key component in the standard of care for personalized cancer treatment.

According to the National Cancer Institute, there are approximately 230,000 new cases of both breast cancer and lung cancer diagnosed in the United States each year, with over 3 million patients who have had a diagnosis of these cancers and either are living with these diseases and are undergoing treatment or are being monitored. For example, in breast cancer, many women have been deemed cancer-free, but continue to undergo periodic monitoring to assure there has been no disease recurrence. Our OncoCEE-BR test and our planned OncoCEE-LU test only require a readily accessible standard blood sample and thus may be used to help manage these patients, including supporting the selection of appropriate treatment, at multiple time points during the course of their disease. Because our tests require only a standard blood sample, they can be particularly useful when no, old or inadequate amounts of, biopsy or surgical material is available, as is often the case in lung cancer, even at the time of initial evaluation. For example, up to 25% of patients with lung cancer are not surgically treated for various reasons, including patient status (consensus statement from the American College of Chest Physicians and the Society of Thoracic Surgeons; Chest, Dec. 2012). This is also the case with breast and lung cancers once surgical resection of the tumor has taken place and treatment has been initiated. Patients with breast and lung cancer must often undergo surgical resection of their primary tumor as part of their treatment. Therefore, at the time of progression or recurrence there may be no ability to obtain a tissue biopsy. Additionally, many studies have shown that most tumors mutate during treatment and as the disease progresses, so information from the initial tumor tissue may not be relevant. Again, a significant benefit of our technology is that it allows physicians to assess the current status of the tumors on a real-time basis utilizing a standard blood sample.

We currently offer and conduct our proprietary breast cancer diagnostic tests and offer our clinical trial services at our CLIA and CAP accredited, and state law licensed, laboratory. Our current and near-term cancer diagnostic tests and clinical trial services include:

 

   

Proprietary CTC and ctDNA Testing. Our current breast cancer test and our other planned cancer diagnostic tests are based on our proprietary CEE and CEE-Selector technologies and are currently intended to be performed only in our clinical laboratory. After completing testing, we or our partner provide our customers with an easy to understand report that describes the results of the analyses performed, designed to help oncologists make better decisions about the treatment of their patients.

 

   

Clinical Trial Services. We plan to utilize our clinical laboratory and translational research capabilities to provide clinical trial and research services to pharmaceutical and biopharmaceutical companies and clinical research organizations to improve the efficiency and economic viability of their clinical trials. Our clinical trials and translational research services could leverage our knowledge of CTCs and ctDNA and our ability to develop

 

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and implement new cytogenetic, immunocytochemical and molecular diagnostic tests. Our current breast cancer test and our other planned cancer diagnostic tests and biomarker tests can help optimize clinical trial patient selection, and as a result potentially improve the likelihood of success of the clinical trial. With positive results in a clinical trial, our tests would more easily then move into standard clinical practice, helping physicians select the most appropriate therapy for their patients.

We intend to commercialize proprietary cancer diagnostic tests in the United States as LDTs performed in our CLIA laboratory. We plan to evaluate potential opportunities for the commercialization of our products in other countries. We are currently exploring the possibility of introducing OncoCEE-LU technology outside the United States as part of CE-marked IVD test kits and/or testing systems utilizing our CEE and/or CEE-Selector technologies. We also plan to evaluate this format for our other planned tests.

Our sales strategy is focused on leveraging the sales forces of partners already selling to our target markets, as well as building an internal direct sales and marketing team that can also support our partners. In both cases we plan to engage oncologists in the United States at hospitals and cancer centers. With our academic center and key thought leader collaborators, we intend to focus on oncologists in private and group practices and in community hospitals, where nearly 85% of all cancers are initially diagnosed (National Cancer Institute Community Cancer Center Status Update, February 2010) and where a large percentage are treated.

Market Overview

Cancer Market Overview

Despite many advances in the treatment of cancer, it remains one of the greatest areas of unmet medical need. In 2008, the World Health Organization attributed 7.6 million deaths worldwide to cancer-related causes. The World Health Organization projects that by 2030 this number will rise to 13.1 million deaths per year. They also project that worldwide, cancer has surpassed cardiovascular disease as the leading cause of death. The incidence of, and deaths caused by, the major cancers are staggering. The following data published by the National Cancer Institute shows estimated new cases and deaths for 2013, and prevalence in 2010, in the United States for the major solid cancers types:

 

Cancer Type

   Est. Incidence
(New

Cases/Year-2013)
     Est. Mortality
(Deaths/Year-2013)
     Est.  Prevalence
(Diagnosed
and Alive as of
2010)**
 

Bladder

     72,570         15,210         563,640   

Breast*

     232,340         39,620         2,829,041   

Cervical

     12,340         4,030         249,496   

Colorectal*

     142,820         50,830         1,154,481   

Endometrial

     49,560         8,190         600,346   

Gastric*

     21,600         10,990         72,269   

Kidney

     65,150         13,680         341,505   

Lung*

     228,190         159,480         399,431   

Melanoma*

     76,690         9,480         921,780   

Ovarian

     22,240         14,030         186,138   

 

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Cancer Type

   Est. Incidence
(New

Cases/Year-2013)
     Est. Mortality
(Deaths/Year-2013)
     Est.  Prevalence
(Diagnosed
and Alive as of
2010)**
 

Pancreatic

     42,220         38,460         41,609   

Prostate*

     238,590         29,720         2,617,682   

Thyroid

     60,220         1,850         534,973   

 

* Areas where we currently have tests or active development programs.
** Includes active disease and disease-free.

In addition to the human toll, the financial cost of cancer is overwhelming. An independent study published in 2010 and conducted jointly by the American Cancer Society and LIVESTRONG ranked cancer as the most economically devastating cause of death in the world - estimated to be as high as $895 billion globally. According to an article in the Journal of the National Cancer Institute, the direct cost of cancer deaths in the United States in 2000 was over $115 billion, and if lost wages and caregiver costs were added, the total costs increased to over $230 billion.

Cancer is a Heterogeneous Disease

Cancer constitutes a heterogeneous class of diseases, characterized by uncontrolled cell growth that results from a combination of both environmental and hereditary risk factors. Many different tissue types can become malignant, such as breast, lung, liver, and skin, and even within a particular tumor there is heterogeneity, with certain cancer cells in a patient bearing specific cellular or genetic biomarkers which others lack. It has only been in recent years that technology has progressed far enough to enable researchers to understand many cancers at a cellular and molecular level, attribute specific cancers to associated genetic changes and determine the extent to which these changes are seen in a patient’s tumor.

Cancer cells contain genetic alterations compared to normal human cells. Common genetic abnormalities correlated to cancer include gains or losses of genetic material on specific chromosomal regions, or loci, or changes in specific genes, or mutations, which ultimately result in detrimental cellular changes followed by cancerous or pre-cancerous conditions. For example, multiple gains or losses of or on various chromosomes, and the rearrangement of genetic material among chromosomes, or chromosomal translocations, have been observed in different cancer types, such as HER2 in breast cancer and EML4/ALK in NSCLC. In addition, mutations within gene sequences, or single nucleotide variations, can give rise to aberrant proteins that do not perform their functions correctly, leading to uncontrolled cell growth. Such genetic alterations can be a result of multiple factors, including genetic predisposition, environmental or lifestyle factors or viral infections. Importantly, these genetic changes can be used as biomarkers to help guide appropriate treatment. Detecting these biomarkers, particularly those representing drug targets, or those indicative of responsiveness or resistance of a tumor’s cells to specific therapies, helps clinicians to select drugs, design treatment regimens and optimize patient care and management. Tests that provide such predictive information have the potential to dramatically improve treatment outcomes for patients suffering from cancer.

Limitations of Traditional Cancer Diagnostic and Profiling Approaches

Cancer is difficult to diagnose and manage due to its heterogeneity at morphologic, genetic and clinical levels. Traditional methods of diagnosis for solid tumors, routinely used as the initial step in cancer detection, involve a tissue biopsy followed by a pathologist examining a thin slice of potentially cancerous tissue under a microscope. A recently obtained tissue sample is used in combination with chemical staining techniques to enable analysis of the biopsy. After staining, the pathologist determines through visual inspection whether the biopsy contains normal or cancerous cells, with those that are deemed cancerous being graded on a level of aggressiveness. Often an analysis of biomarkers relevant to that

 

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tumor type is also performed on the tissue, ranging from immunohistochemistry to FISH, to mutation analysis by various means such as microarrays and sequencing. After the diagnosis, a clinical workup is performed according to established guidelines for the specific cancer type. From there, the physician determines the stage of progression of the cancer based on a series of clinical measures, such as size, grade, metastasis rates, symptoms and patient history, and decides on a treatment plan that may include surgery, watchful waiting, radiation, chemotherapy, or stem cell transplant.

This type of analysis is dependent on the availability of a recently obtained tissue biopsy for the pathologist to analyze. Such a biopsy is often not available. A tumor may not be readily accessible for biopsy, a patient’s condition may be such that a biopsy is not advised, and for routine periodic patient monitoring to evaluate potential progression or recurrence, a biopsy is a fairly invasive procedure and not typically performed. As the length of time between when the original biopsy, diagnosis or surgery is conducted to the current evaluation of the patient increases, the likelihood that an original biopsy specimen is truly representative of the current disease condition declines, as does the usefulness of the original biopsy for making treatment decisions. This risk intensifies in situations where a drug therapy is being administered, because the drug can put selective pressure on the tumor cells to adapt and change.

Similarly, the heterogeneity referred to above means that different parts or areas of the same tumor can have different molecular features or properties. In evaluating a biopsy specimen, the pathologist will take a few thin slices of the tumor for microscopic review rather than exhaustively analyzing the whole tumor mass. The pathologist can only report on the tumor sections analyzed and if other parts of the tumor have different features, such as biomarkers corresponding to specific treatments, they can be missed. A more representative analysis of the entire tumor, as well as any metastases if they are present, is very helpful.

CTCs, ctDNA and Cancer

Circulating tumor cells, or CTCs, are cancer cells that have detached from the tumor matrix and invaded the patient’s blood or other bodily fluids. These cells are representative of the tumor and its metastases, and can function as their surrogates. Testing CTCs can complement pathologic information drawn from a biopsy or resected tissue sample, helping to insure that the analysis is comprehensive and not biased by tumor heterogeneity and sampling issues. They can also provide critical data when a biopsy is not possible. Clinical studies have demonstrated that the presence and number of CTCs provides information on the likely course of the disease for the cancer patient, or in other words they are considered “prognostic.” Since CTCs are representative of the tumor, they can also be used for biomarker analysis, such as helping to guide therapy selection. Such analyses are “predictive” in that they offer insight into the likely responsiveness or resistance to particular therapies. After surgery and during any subsequent therapy or monitoring period, blood samples can periodically be drawn in a standard manner and analyzed to evaluate a therapy’s continuing effectiveness, as well as to detect other biomarkers such as new genetic mutations that may arise as a result of selection pressure by a particular therapy or by chance. Physicians can use this information to determine which therapy is most likely to benefit their patients at particular times through the course of their disease. Treatment decisions based on patient-specific information are the foundation of personalized medicine, and tests, or assays, that guide a physician in the selection of individualized therapy for a patient are termed “predictive assays.”

ctDNA is nucleic acid that is released into blood by dying tumor cells. Cell death occurs in all tissues, especially those that are rapidly dividing, and in cancer, where cell growth is not only rapid but also uncontrolled. Parts of tumors often outgrow their blood supply, resulting in cell death. Tumor cells dying as a result of therapy also release nucleic acid into blood. As a consequence, ctDNA is common in cancer patients and scientists believe that like CTCs, it may be more representative of a patient’s tumor than a few thin sections from a tissue biopsy, thus reducing the heterogeneity problem. ctDNA is found in the plasma component of blood and is readily accessible in a standard blood sample. Analyzing ctDNA for mutations that are used as biomarkers for therapy selection shows great promise. One of the strengths of this approach, in addition to not requiring a tissue biopsy, is that it is not dependent on capturing rare tumor cells from blood to provide a sample for testing. The difficulty with this approach is that the cellular context is lost since the ctDNA is mixed with a much larger amount of circulating DNA from normal cells that are continuously dying and being replaced in the body, thus making analysis challenging. This requires a mutation detection methodology with enhanced sensitivity and specificity, to distinguish mutations in particular gene regions in cancer cells from the normal gene sequence present in those same genes in normal cells which co-exist in blood as normal cells die and are replaced in the body. Our CEE-Selector technology provides this

 

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necessary sensitivity and specificity and creates an opportunity for ctDNA analysis to complement CTC analysis, or potentially to serve as the platform for stand-alone tests.

Given the incidence of cancer in the United States, with over 800,000 new cases per year for the major solid tumors targeted by our planned test products, the markets for our current and planned cancer diagnostic tests are very large. Furthermore, these market opportunities are even greater due to the benefits of CTC and ctDNA testing, including not only the ability to offer physicians a simple way to augment an initial tumor biopsy analysis but also to provide a means for relatively frequent monitoring of the tumor’s molecular status, utilizing a standard blood sample as a “liquid biopsy.” The latter application enables the oncologist to determine if or how a tumor is changing over time or is responding to therapy and what the next treatment should be. For example, in the United States, the incidence of new cases of breast cancer alone is over 230,000 per year, and the prevalence of this disease is over 2.8 million, with an estimated 330,000 lumpectomies performed annually in the United States. Of these lumpectomies, 20% need to be repeated because on pathological examination it is shown the procedure did not result in “clear margins,” thus suggesting not all the tumor was removed, according to a Johns Hopkins report. If a CTC test were performed at the time of initial diagnosis, at the time of surgery, or in lieu of, or as an adjunct to, a PET/CT scan (as a CTC test has the potential to identify a single tumor cell in a blood sample, while a scan requires a tumor mass of millions of cells to be detectable), to monitor disease progression or test for recurrence, thousands of tests, in breast cancer alone, could be performed per year with still relatively low market penetration. For comparison, it is estimated that there are between 50,000 and 60,000 CellSearch® CTC tests performed annually in the United States, which only provide for CTC enumeration without biomarker analysis, of which 75-80% are thought to be for breast cancer with the rest being for colorectal and prostate cancers.

Use of CTC- and ctDNA-Derived Biomarker Data in Cancer Treatment

CTCs and ctDNA are derived from, and are understood to be representative of, a solid tumor and its metastases and can be analyzed as adjuncts to or in place of the tumor, especially when a recent tumor biopsy is not available. Almost any analysis that can be performed on tumor tissue can also be performed on CTCs, while ctDNA, because it is only nucleic acid, is more limited. We have focused our analysis of CTCs and ctDNA on known biomarkers associated with specific therapies to support treatment decisions and therapy selection made by oncologists. The biomarkers we analyze consist of proteins or protein modifications that can be identified by immunocytochemical means, cytogenetic or chromosomal aberrations, which are detected by FISH, and gene mutations which are detected in CTCs or ctDNA by molecular diagnostic tests, including CEE-Selector techniques and gene sequencing. Specific examples include (i) for immunocytochemistry, the detection of the estrogen receptor protein in breast cancer, indicative of the likely responsiveness to hormonal therapies like tamoxifen, often sold under the trade name Nolvadex®, (ii) for FISH, the presence of an amplified HER2 gene in breast cancer, indicative of the likely responsiveness to HER2-targeted agents like Herceptin®, and (iii) for mutation detection, the presence of an EGFR activating mutation in NSCLC like L858R, indicative of the likely responsiveness to EGFR-targeted agents like Tarceva®. All of these biomarkers are currently tested on tumor tissue and can be tested on CTCs, and in the latter case on ctDNA. The resulting information could then be used to guide patient care, and specifically treatment selection.

To date these types of molecular and genetic detection methods have been successfully utilized to provide predictive information for several cancers, including breast, colon, NSCLC, melanoma and others in the form of companion diagnostics, typically performed on tumor tissue. CTC and ctDNA tests, which analyze the same biomarkers but in a more convenient standard blood sample test that also permits periodic monitoring, may be used in the same way.

Our Business Strategy

We plan to provide oncologists with a straightforward means to profile and characterize their patients’ tumors on a real-time basis by analyzing CTCs and ctDNA found in standard blood draws. Biomarkers are currently detected and analyzed primarily in tissue biopsy specimens. We believe that our technology, which not only provides information on CTC enumeration but also the assessment of treatment-associated biomarkers identified within the CTCs or in ctDNA, provides information to oncologists that improve patient treatment and management and will become a key component in the standard of care for personalized cancer treatment.

 

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Our approach is to develop and commercialize proprietary CTC and ctDNA tests and services to enable us to offer to oncologists standard blood sample based, real-time, testing solutions for a range of solid tumor types, starting with breast cancer and progressing to future launches of tests for NSCLC, gastric cancer, colorectal cancer, prostate cancer, melanoma and others, to improve patient treatment with better prognostic and predictive tools. To achieve this, we intend to:

 

   

Develop and commercialize a portfolio of proprietary CTC and ctDNA tests and services, to enable physicians to develop personalized treatment plans. We intend to continue the development of additional proprietary prognostic and predictive tests and services to provide information that is essential to personalized cancer treatment. By including predictive information on biomarkers linked to specific therapies in our analysis in addition to CTC enumeration, our tests are designed to provide a more complete profile of a patient’s disease than existing CTC tests. The biomarker information assists physicians in selecting appropriate therapies for individual patients. Our ctDNA tests are expected to offer enhanced sensitivity and specificity based on the CEE-Selector technology, enabling earlier detection of therapy-associated mutation targets or resistance markers, again supporting treatment decisions. We have launched our first proprietary CTC test, OncoCEE-BR for breast cancer, performed in our CLIA-accredited testing facility. We are also developing a number of other CTC and ctDNA tests, including OncoCEE-LU for non-small cell lung cancer, OncoCEE-CR for colorectal cancer, OncoCEE-GATM for gastric cancer, OncoCEE-PRTM for prostate cancer and OncoCEE-METM for melanoma. We plan to perform the necessary validation studies to allow us to commercialize these tests through our clinical laboratory.

 

   

Establish our internal sales and marketing capabilities in a scalable manner. We are actively seeking additional partners to increase our market reach. We intend to build our own specialized sales force with experience in cancer diagnostic testing, focusing on key identified territories in order to provide geographic coverage throughout the United States. We plan to start with 7 sales representatives, and depending on test volume, expect to increase this group to 15-20 within two years and potentially 40-50 within five years. This team will educate physicians directly on the benefits of our proprietary tests and the clinical data supporting them, as well as provide support to and serve as technical specialists for our partners such as Life Technologies.

 

   

Develop and expand our collaborations with leading university hospitals and research centers. We collaborate with key thought leaders, physicians and clinical researchers, including those at the MD Anderson Cancer Center, Columbia University and the University of California, San Diego. Our collaborations enable us to test new technologies, validate the effectiveness and utility of our planned proprietary tests in a clinical setting and provide us access to clinically well-characterized and highly annotated patient data. These samples and data accelerate our validation process and facilitate the testing and refinement of our planned new tests.

 

   

Enhance our efforts in reaching and educating community oncologists about CTC and ctDNA tests. According to the American Society for Clinical Oncology, in 2011 there were approximately 10,000 oncologists in the United States, or 12,500 if gynecologic and pediatric oncologists are included. Community oncologists represent a large target market for our CTC and ctDNA tests and services because approximately 85% of cancer patients in the United States are initially diagnosed by, and many treated by, these physicians as reported to the National Cancer Database. With the support of our key thought leader collaborators, we intend to focus on oncologists by targeting our sales and marketing efforts on this important customer segment. We believe this will expand and optimize the oncology testing services and personalization of cancer treatment provided by community oncologists so that they can better serve their cancer patients.

 

   

Increase our efforts to provide biopharmaceutical companies and clinical research organizations with our current and planned proprietary CTC and ctDNA tests and services. Oncology drugs have the potential to be among the most personalized of therapeutics, yet oncology drugs have one of the worst approval rates, hovering under 7% of cancer drug compounds from first administration in humans to approval (2004-2011, Biotechnology Industry Organization). In an effort to improve the outcome of clinical trials for oncology drugs, and more rapidly advance targeted therapeutics, pharmaceutical and biopharmaceutical companies are increasingly looking to companies that have proprietary cancer diagnostic tests that specifically address their needs, including the ability to characterize and monitor a patient’s tumor over time using CTC and ctDNA tests to analyze biomarkers of interest. There are over 5,000 active trials in the United States in breast, lung, colorectal, prostate and gastric cancers and melanoma according to clinicaltrials.gov. We expect to increase our

 

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sales and marketing focus in this business as well as seek additional collaborations and partnerships with pharmaceutical and biopharmaceutical companies.

 

   

Support our current and planned tests with clinical utility studies to drive adoption and facilitate reimbursement. Through our agreement with the Dana-Farber Cancer Institute, we are currently conducting testing for a study that we expect to provide clinical utility data for our OncoCEE-BR test, demonstrating that patients who are treated with targeted therapies based on biomarkers identified on their CTCs, when those biomarkers are absent on their tumor tissue, have better outcomes. In this study, we are specifically identifying patients with metastatic breast cancer that are HER2 negative, by analysis of their tumor tissue, and who have HER2 positive CTCs utilizing our OncoCEE-BR test on a standard blood sample. These patients are being randomized for treatment with chemotherapy, the current standard of care, with or without Herceptin®, and then evaluated for progression-free survival and overall survival. We intend to conduct additional studies in breast cancer, and similar studies for our NSCLC test and other CTC and ctDNA tests we plan to introduce. Clinical utility and validation studies for our planned ctDNA tests may rely on archived plasma or blood samples from clinical trials in which patient outcomes are already available, in a retrospective-prospective design that significantly shortens the length of such studies.

 

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Continue to enhance our current and planned proprietary CTC and ctDNA tests and reduce the costs associated with providing them through internal research and development and partnering with leading technology developers and reagent suppliers. We intend to work closely with select key technology developers and suppliers to further automate the optical interpretation of our CTC tests, including enumeration, immunocytochemical biomarker staining and FISH. We also intend to reduce the costs associated with key material components of these tests, including FISH probes. We have identified a technology group that, based on initial studies, can provide an automation system that will significantly reduce the hands-on time of our cytotechnicians for microfluidic channel analysis while increasing the uniformity, and potentially the sensitivity and quality, of the data we generate. This system is also expected to provide the ability to evaluate multiple fluorescent signals of different wavelengths simultaneously for multiplexed analysis, again enhancing efficiency. Similarly, we have identified suppliers that can provide FISH probes at reduced cost and with a broader choice of available fluors, enabling more extensive multiplexing of tests.

Our Competitive Advantages

We believe that the competitive advantages of our tests, including our tests which are still under development, would include:

Our current and planned proprietary CTC and ctDNA tests could enable detailed analysis of a patient’s cancer utilizing a standard blood sample, facilitating testing at any time, including when a biopsy is not available or inconclusive, offering real-time monitoring of the cancer and the response of the cancer to therapy, and allowing oncologists to select timely modifications to treatment regimens. Because CTCs and ctDNA are derived from the primary tumor or its metastases, they function as surrogates for the tumor, with the advantage of being readily accessible in a standard blood sample. This is especially important in situations where a biopsy is not available or advised. The simplicity of obtaining a standard blood sample permits repeat testing in a monitoring mode to detect recurrence or progression and to offer information on treatment modifications based on a current assessment of the cancer’s properties.

Our current and planned tests could provide more information than competitors’ existing tests, including predictive information on biomarkers linked to specific therapies. Such additional biomarker information enables a physician to develop a personalized treatment plan. By including biomarker information in our analysis, in addition to CTC enumeration, our current breast cancer test and our planned tests are designed to provide a more complete profile of a patient’s disease than existing CTC tests. We intend for our tests to contain actionable information to assist physicians in selecting appropriate therapies for individual patients. Our ctDNA tests are expected to offer enhanced sensitivity and specificity based on the CEE-Selector technology, enabling earlier detection of therapy-associated mutation targets or resistance markers, again supporting treatment decisions.

Our current and planned CTC tests are designed to capture and detect a broader range of CTCs than existing tests can, and are applicable to, or could be quickly modified for, a wide range of cancer types. Our CEE-Cap antibody capture cocktail includes antibodies targeting not only EpCAM, the traditional epithelial CTC capture antigen utilized in the CellSearch® system and in other platforms, but also other epithelial antigens as well as mesenchymal and cancer stem cell antigens, indicative of cells having undergone the epithelial-to-mesenchymal transition. These cells may be more relevant for metastasis. Our detection methods include cytokeratin staining with a broader range of cytokeratin isotypes than existing CTC tests, and we plan to introduce our CEE-Enhanced staining which would enable detection of cells specifically captured with our antibody cocktail, including EMT cells lacking cytokeratin. This means more CTCs and different types of CTCs can be identified and potentially at earlier stages of disease, resulting in fewer non-informative cases and more information for physicians.

Our current and planned CTC and ctDNA tests are expected to be flexible and we believe they could readily be configured to accommodate new biomarkers with clinical relevance as they are identified. Our CEE platform permits essentially any analysis that is currently performed on tumor tissue to be performed on CTCs, including immunocytochemical staining, FISH and molecular analysis. As new therapies are approved, and to the extent that they are targeted therapies for which knowledge of a particular gene amplification event, mutation or presence, absence or modification, such as phosphorylation, of a protein are indicative of likely response or resistance to that therapy, we will be able to include them in our tests with minimal changes. This is attractive to pharmaceutical and biopharmaceutical companies that are developing such therapies, and seeking ways to make their clinical trials more efficient, as it could enable them to focus on patients more likely to respond to a particular therapy and demonstrate a benefit from that therapy.

 

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Collaborative relationships with physicians at MD Anderson Cancer Center. We have worked closely with a number of physicians at the MD Anderson Cancer Center in Houston, Texas, on various collaborative projects in different cancer types including breast, NSCLC, prostate, colorectal, ovarian, bladder, renal and endometrial. These projects provide us access to leading researchers, clinicians and key thought leaders, access to valuable patient samples and insight into clinical applications for our tests. Some of these projects have resulted in publications in leading journals, such as Cancer Discovery and Cancer Medicine, which enhances our standing in the oncology community and supports our marketing efforts.

Our planned CEE-Selector mutation tests have enhanced sensitivity and specificity, and are not platform dependent. These tests can be performed on almost any molecular instrument, which provides flexibility to us in our laboratory operations. To the extent we elect to develop these tests as IVDs, including pursuing CE marks for them to be marketed outside the United States, the ability to rapidly deploy them on different approved instrument platforms already in many laboratories should greatly simplify their distribution and commercialization.

Focus on targeting oncologists at private and group practices and at community hospitals, where approximately 85% of all cancer patients in the United States are initially diagnosed. Our sales and marketing efforts will be directed primarily at oncologists in group practices and at community hospitals to better service their oncology patients. Our current test and our planned proprietary tests and testing services should be able to help oncologists in group practices and at community hospitals deliver a higher value of service to their cancer patients.

Our Proprietary Tests and Services

We have launched our first product, OncoCEE-BR for breast cancer, and plan to continue to launch a series of tests for CTCs in different tumor types, including NSCLC, gastric, colorectal and prostate cancers and melanoma, incorporating analyses for different biomarkers, at the rate of at least 1-2 per year for the next 3 years. OncoCEE-BR is and the planned tests will be based on the CEE technology platform. The CEE system isolates CTCs from blood samples of cancer patients for enumeration (or count) and genetic analysis. A sample is shipped to us in our proprietary blood collection tube, called the CEE-Sure tube, for recovery and analysis of CTCs. When performing the CTC assay, the sample is processed in our laboratory. The specimen of blood is separated into its parts (red blood cells, buffy coat and plasma). The buffy coat is incubated with the antibody solution and passed through a proprietary microfluidic channel containing 9,000 microscopic posts coated with reagents to capture antibody-labeled tumor cells. The captured cells are suitable for further testing of whole cells directly in the microfluidic channel or by releasing the cells from the microfluidic channel and performing CEE-Selector or similar techniques.

Clinicians acknowledge limitations of currently available CTC test systems such as the CellSearch® that rely on capture solely by anti-EpCAM antibodies and detection by anti-cytokeratin antibodies. Capture and detection based only on these two antigens is unlikely to identify all CTCs, and clinically this may result in no CTCs being detected in cases in which they are present. For example, some tumor cells that have been released into the circulatory system have undergone an EMT. These mesenchymal cells are less differentiated than epithelial cells and more similar to stem cells. We have developed several assays that have enabled the capture of significantly more CTCs than is accomplished through the use of traditional anti-EpCAM immuno-capture alone.

In addition to enhanced capture, our technology also improves the detection of CTCs. As with EpCAM, tumor cells that have undergone EMT can down-regulate the synthesis of cytokeratin, leading to an underestimate or even an apparent absence of CTCs since their positive identification has traditionally relied on anti-cytokeratin staining. We have developed alternative methods of fluorescent cell staining that are uniquely possible within the CEE system to enhance or enable detection of CTCs with low or no cytokeratin signal. This technology is called CEE-Enhanced. We believe that the

 

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combination of specific cocktails of tumor-associated capture antibodies and more sensitive fluorescent detection of CTCs through CEE-Enhanced methodology will lead to major advances in the capture, enumeration and analysis of CTCs. CEE-Enhanced methodology is expected to be included in our commercially available tests by mid-2014.

Analysis of CTCs performed by us incorporates both standard and novel methods. Immunocytochemistry which looks at proteins, analogous to the immunohistochemistry performed on tissues, can be readily applied and performed in the microfluidic channel, dependent only on suitable biomarkers. Similarly, FISH, used to evaluate cytogenetic abnormalities in cells, may be performed in our microfluidic channel using validated assays available from a number of vendors. For genetic mutation analysis, standard technologies can be applied. We have also developed proprietary CEE-Selector technology for mutation analysis in CTCs and ctDNA, with enhanced sensitivity and specificity.

As indicated, CEE-Selector staining was developed specifically for analysis of CTCs, which are generally very rare and outnumbered many-fold by white blood cells. This complexity has been a challenge for standard technologies. Our CEE-Selector technology offers enhanced specificity and sensitivity (greater than 1-in-10,000 of mutated sequence to normal sequence in a complex genetic background) compared to other approaches, and potentially has broader application than just CTC analysis, including analysis of ctDNA in plasma, both in a CLIA lab setting and as an IVD.

We are developing and offering Laboratory Developed Tests for CTCs and ctDNA. FDA clearance or approval is not currently required to offer these types of tests in our laboratory once they have been clinically and analytically validated. We seek licenses and approvals for our laboratory facility and for our LDTs from the appropriate regulatory authorities, such as the Centers for Medicare & Medicaid Services, which oversees CLIA, and various state regulatory bodies. Certain states, such as New York and Florida, require us to obtain approval of our proprietary tests in order for us to be paid for testing patient specimens from such state. We are currently in the process of addressing the requirements for licensure in New York, and we have all required licenses and approvals from all other states.

The following outline indicates our current (OncoCEE-BR) and planned proprietary tests:

 

Test Name

  

Solid Tumor Type and

Biomarkers

  

Indication

  

Status of Test or Projected Year

of Commercialization

OncoCEE-BRTM    Breast Cancer- Enumeration; HER2, ER, PR    Prognosis, therapy selector, monitoring    Already on the market
OncoCEE-LUTM    Lung Cancer- Enumeration; EML4/ALK and ROS1 by FISH, K-ras, B-raf and EGFR mutations by CEE-SelectorTM    Prognosis, therapy selector, monitoring    2014

 

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Test Name

  

Solid Tumor Type and

Biomarkers

  

Indication

  

Status of Test or Projected Year

of Commercialization

OncoCEE-GATM    Gastric Cancer- Enumeration; HER2 by FISH    Prognosis, therapy selector, monitoring    2014
OncoCEE-CRTM    Colorectal Cancer- Enumeration; K-ras, B-raf and EGFR mutations by CEE-SelectorTM    Prognosis, therapy selector, monitoring    2015
OncoCEE-PRTM    Prostate Cancer- Enumeration; PTEN deletion and AR by FISH    Prognosis, therapy selector, monitoring    2015
OncoCEE-METM    Melanoma- Enumeration and B-raf and N-ras mutations by CEE-SelectorTM    Prognosis, therapy selector, monitoring    2015
OncoCEE-DTCTM    Breast and Prostate Cancer- DTC analysis in bone marrow; HER2 and AR/PTEN by FISH, respectively    Prognosis, therapy selector, monitoring    2014
CEE-SelectorTM    Multiple cancer types- K-ras, B-raf, EGFR and other mutations detected in plasma    Therapy selector, monitoring    2014

Our Marketed OncoCEE CTC Test: OncoCEE-BR

Our OncoCEE-BR breast cancer test is the first CTC test we developed and we are currently offering it to physicians through our CLIA laboratory. It is based on a standard blood sample and can be used at the time of diagnosis and for monitoring, including at the time of progression or recurrence. This allows the physician to characterize the tumor to help define treatment options, either augmenting tissue analysis or replacing it when a tumor biopsy is not available. The test currently includes CTC enumeration and determination of HER2 status by FISH on the captured CTCs, and then more broadly to any cell captured on our CEE microfluidic channels that is not a white blood cell. HER2 status is used by oncologists to determine suitability of a patient for treatment with HER2-targeted therapeutics, which include Herceptin®, as well as Kadcyla® and Perjeta®, monoclonal antibodies directed to HER2, and Tykerb®, a kinase inhibitor with activity against HER2. We plan to add immunocytochemistry analysis of CTCs for estrogen receptor and progesterone receptor to our OncoCEE-BR test, which will provide information on suitability of breast cancer patients for endocrine or hormonal therapies such as selective estrogen receptor modulators, including tamoxifen, aromatase inhibitors that block the

 

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synthesis of estrogen, including Femara® (Novartis) and Arimidex® (AstraZeneca) or other therapeutics that block estrogen production, including Zoladex® (AstraZeneca) and Lupron® (AbbVie).

Other OncoCEE CTC Tests in Development

We are now following a similar development path for additional OncoCEE CTC tests for cancer types other than breast cancer, with a focus on large population solid tumor types, or cancers for which there are approved therapies that rely on biomarker tests we have previously developed. Examples of these tests include OncoCEE-LU for lung cancer, OncoCEE-GA for gastric cancer, OncoCEE-CRTM for colorectal cancer, OncoCEE-PR for prostate cancer, and OncoCEE-ME for melanoma, each described below.

OncoCEE-LU

Up to 25% of lung cancer patients, especially those diagnosed at Stage IIIB or Stage IV, are not treated surgically for various reasons, including tumor accessibility and status of the patient. In these cases, CTC and ctDNA tests are alternatives for obtaining more detailed information about the molecular status of the tumor that helps the physician select appropriate therapy. This is even more important as the number of targeted therapies for lung cancer with associated biomarkers increases. Our OncoCEE-LU test would include several components: CTC enumeration, FISH analysis for EML4/ALK and ROS1, and potentially for ret proto-oncogene, all linked to the drug Xalkori® (Pfizer), mutation analysis for the EGFR gene, the K-ras gene and the B-raf gene. The L858R mutation of the EGFR gene and D747-751 deletions are activators of EGFR kinase activity and are linked to the drugs Tarceva® (Astellas/Genentech/Roche) and Iressa® (AstraZeneca). The T790M mutation of the EGFR gene is a resistance marker for EGFR tyrosine kinase inhibitors and is linked to drugs in development that address this resistance, such as Gilotrif® (Boehringer-Ingelheim) and dacomitinib (Pfizer). The codon 12 and 13 mutations of the K-ras gene are linked to non-responsiveness to the EGFR kinase inhibitors such as Tarceva® and Iressa®, and the codon 600 mutations of the B-raf gene are linked to Zelboraf® and Tafinlar®, which are both approved for melanoma and are in clinical trials for lung cancer. Our OncoCEE-LU test would be performed on a standard blood sample.

In parallel, we plan to offer ctDNA tests for mutation analysis of, for example, EGFR, K-ras and B-raf genes, to provide information in situations where CTCs are not identified. In our development of this technology platform we have generated data showing detection of the T790M mutation in ctDNA from the blood plasma of lung cancer patients progressing on tyrosine kinase inhibitors in which no CTCs were detected.

OncoCEE-GA

We are developing our OncoCEE-GA test for gastric cancer based on the identification of HER2 as a biomarker for this disease. We plan to employ our CTC HER2 FISH test, which we had previously developed for breast cancer, for the analysis of gastric cancer CTCs. The presence of HER2 positive cells is an indication for likely benefit from the use of Herceptin®, which has been approved for the treatment of metastatic gastric cancer. Current clinical practice relies on a biopsy for tumor tissue analysis to detect elevated HER2, in the same manner as is done for breast cancer. Our test would circumvent this need for tissue, as well as providing straightforward monitoring of HER2 status from a standard blood sample, on a real-time basis during treatment. Our OncoCEE-GA test would include CTC enumeration and HER2 analysis of CTCs by FISH.

OncoCEE-CR

Our current plan for our OncoCEE-CR test for colorectal cancer is to offer mutation testing analogous to that performed on lung cancer CTCs, namely detection of key mutations in the EGFR, K-ras and B-raf genes, along with CTC enumeration. Testing of the EGFR gene would focus on the L858R mutation and D747-751 deletions as activators of EGFR kinase activity, and the T790M mutation as a resistance marker for certain EGFR tyrosine kinase inhibitors. Testing on the K-ras gene would focus on codons 12 and 13 mutations. Testing on the B-raf gene would focus on V600 mutations. Our OncoCEE-CR test would be run against a standard blood sample.

This testing is important because certain targeted therapies for colorectal cancer, including the monoclonal antibodies targeting EGFR, Erbitux® (Lilly/Bristol-Myers Squibb/Merck Serono) and Vectibix® (Amgen), and the kinase inhibitor

 

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Stivarga® (Onyx/Bayer) targeting vascular endothelial growth factor receptor kinases, but also ret proto-oncogene, KIT, platelet-derived growth factor receptor, or PDGF-R, and fibroblast growth factor receptor kinases, have been shown to be ineffective in patients who have a K-ras mutation, which is found in up to 40% of cases according to the National Comprehensive Cancer Network. While up to 20 different mutations have been reported at codons 12 and 13 in K-ras, there are reports in the scientific literature that patients with one particular mutation, G13D, do respond well to Erbitux®, and that there may be variability in response to different chemotherapies based on the specific K-ras mutation, suggesting that detailed information on mutation status is clinically relevant.

OncoCEE-PR

Our OncoCEE-PR test for prostate cancer would be based on the analysis of CTCs found in a standard blood sample by FISH for key biomarkers: the androgen receptor, and phosphatase and tensin homolog. The test would also include CTC enumeration, and our CEE-Cap antibody capture cocktail would be modified from that used for breast and lung cancer to include prostate specific membrane antigen.

The androgen receptor normally binds the hormones testosterone and dihydrotestosterone, and is the target for several drug molecules, including those acting directly as antagonists for the receptor, such as Casodex® (AstraZeneca), and those acting indirectly through inhibition of androgen synthesis, such as Zytiga® (Janssen).

Phosphatase and tensin homolog, an enzyme that functions as a tumor suppressor, if mutated, deleted or otherwise functionally disrupted, removes a brake from cell replication and allows uncontrolled growth, which is seen in many cancers. If phosphatase and tensin homolog is mutated, deleted or disrupted, chemotherapy or polytherapy is usually recommended.

OncoCEE-ME

Our OncoCEE-ME melanoma test, performed on a standard blood sample, would provide information on the presence or absence and specific nature of the V600 mutation in the B-raf gene, which indicates whether the B-raf inhibitors Xelboraf® or Tafinlar® are candidate therapies for the patient. CTC enumeration would also be a component of our test.

Disseminated Tumor Cell (DTC) Assays Performed on Bone Marrow

We have shown that our CEE-Sure blood collection tubes and CEE microfluidic channels work well with bone marrow samples, and we have further demonstrated the ability to perform FISH on disseminated tumor cells, or DTCs, from bone marrow that are isolated in this way. While bone marrow biopsies are not performed routinely in the United States, they are utilized in Europe, especially in prostate cancer. In addition, we were involved in a study at MD Anderson Cancer Center in which bone marrow was isolated from early stage operable breast cancer patients at the time of surgery. In this later study, published in Cancer Medicine (2013, 2(2) 226-233), we found a significant percentage of patients classified as HER2 negative by their primary tumor had HER2 positive DTCs, and hence could be considered for Herceptin® therapy. DTCs provide an interesting adjunct to CTC analysis that is well suited for our technology platform, and we plan to work with collaborators and key thought leaders to determine how best to introduce a series of tests based on a bone marrow sample type.

ctDNA Tests

We plan to introduce ctDNA tests for mutation analysis performed on blood plasma isolated from a standard blood sample using the CEE-Selector technology, based on increasing interest in the research community in this type of analysis. We plan to launch the first tests, for K-ras, B-raf and EGFR mutations, in conjunction with, or as a complement to, our OncoCEE-LU test. Tests for other mutations will be added as they are developed. These tests would be similar to those performed on CTCs but would instead focus on ctDNA in plasma. These tests lack the cellular context provided by CTCs but don’t require CTC isolation and are simpler to perform. In addition, one of the benefits of this technology is its ability to detect and identify mutations in blood plasma from cancer patients in whom we were not able to isolate CTCs. This indicates the importance of the enhanced sensitivity of the CEE-Selector technology and the ability of ctDNA tests to complement CTC tests.

 

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Laboratory Testing

From our CLIA laboratory in San Diego, California, we plan to provide test results from our current and planned proprietary CTC and ctDNA tests to oncologists in community hospitals, cancer centers, group practices and offices. At the federal level, clinical laboratories, such as ours, must be certified under CLIA in order for us to perform testing on human specimens. Our laboratory is also accredited by CAP, which is one of six accreditation organizations approved by CMS under CLIA. Our clinical laboratory is located in California and we hold the requisite license from the California Department of Public Health to operate our laboratory. In addition, Florida, Maryland, New York and Rhode Island require that we hold licenses to test specimens from patients in those states; Pennsylvania licensure or registration may be required as well, depending on the circumstances. We are currently in the process of addressing the requirements for licensure in New York, and we have all required licenses and approvals in all other states.

Clinical Trials Services

Industry research has shown many promising drugs have produced disappointing results in clinical trials. For example, a study by Princess Margaret Hospital in Toronto estimated that 85% of the phase III trials testing new therapies for solid tumors studied over a five-year period failed to meet their primary endpoint. Given such a high failure rate of oncology drugs in clinical development, combined with constrained budgets for pharmaceutical and biopharmaceutical companies, there is a significant need for drug developers to utilize molecular diagnostics to help decrease these failure rates. For specific molecular-targeted therapeutics, the identification of appropriate biomarkers may help to optimize clinical trial patient selection and success rates by helping clinicians identify patients that are most likely to benefit from a therapy based on their individual genetic profile.

In addition to testing for oncologists and their patients, we plan to offer clinical trials testing services to help increase the efficiency and economic viability of clinical trials for pharmaceutical and biopharmaceutical companies and clinical research organizations. Our clinical trial services will be aimed at developing customizable tests and techniques utilizing our proprietary CTC and ctDNA technologies to provide sensitive, real-time characterization of individual patient’s tumors using a standard blood sample. These tests may be useful as, and ultimately developed into, companion diagnostics associated with a specific therapeutic. Additionally, through our services we may gain further insights into biomarkers for disease progression and drug resistance, as well as those associated with current drug development efforts, which we can incorporate into proprietary tests.

Test Development Process

Our OncoCEE-BR test was, and our planned additional proprietary CTC and ctDNA tests are being, developed and validated in conjunction with leading academic and clinical research centers to ensure that the needs of the clinical community are being met with the latest research on key biomarkers that affect patient care. We utilize a research and validation process to help ensure that we are providing diagnostic, prognostic and predictive information that is clinically relevant and accurate. In our experience the time-frame for this process from design through development and market launch is usually between 6 to 18 months. This is dependent on the biomarkers in question having been discovered and validated before we incorporate them in a test, the specific clinical claims we plan to pursue, and the availability of high quality samples for validation. Our development protocol calls for us to monitor and review the process in four stages as detailed below:

 

   

Stage 1, Research. We review known, validated biomarkers, preferably linked to a specific therapeutic or other high value treatment decision, and discuss with clinical collaborators and key thought leaders to characterize the opportunity, the specific clinical setting and the product profile of the candidate test.

 

   

Stage 2, Test Development. We design the test, which typically has two parts: efficient capture of CTCs from the targeted cancer type and development of the biomarker assays that will be included. For example, the first part may involve modification of the antibody capture cocktail and the second could include development of specific CEE-Selector mutation tests or testing of FISH probes. The test will be used on normal control specimens and clinical samples to assure performance and the process includes defining the performance characteristics of the test as well as developing standard protocols for our CLIA laboratory, where the test will

 

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ultimately be performed. This assessment includes such features as reproducibility, accuracy, sensitivity, and specificity.

 

   

Stage 3, Clinical Validation. When the assay is performing as desired in the research laboratory, it is then transferred to the CLIA laboratory and validated on clinical samples, typically in comparison to the existing gold standard for that biomarker, which is usually tumor tissue analysis. Depending on the tumor type and specimen requirement, samples are collected from patients through collaborators, or in the case of ctDNA tests, from sample banks, where clinical information on the patients, including outcomes, is already available.

 

   

Stage 4, Market Entry, Launch and Commercialization. As clinical validation is completed and before launch, we take several steps to prepare our tests for marketing as LDTs. We create standard operating procedures and quality assurance and quality control measures to ensure repeatability and high standards of quality. We train both our commercial and laboratory staff on the interpretation and use of the data. Licenses and approvals for our laboratory to perform or use LDTs are obtained from the appropriate regulatory authorities, such as CMS, which oversees CLIA, and different state regulatory bodies.

Our OncoCEE-BR test, which has already launched, is considered to have completed this test development process. All other planned tests which are mentioned in this prospectus are all considered to currently be in Stage 2 of this test development process.

As part of our long-term strategy, we may seek FDA clearance or approval to expand the commercial use of tests to other laboratories and testing sites in the United States. We will also need to complete additional activities to submit each of these tests for regulatory clearance or approval before commercialization in each of the international markets where we would plan to introduce them.

Research and Development

We incurred research and development expenses of $8.9 million, which represents 8852% of our net revenue, for the year ended December 31, 2011 and $6.6 million, which represents 6010% of our net revenue, for the year ended December 31, 2012. Research and development expenses represented 72% of our total operating expenses for the year ended December 31, 2011 and 62% of our total operating expenses for the year ended December 31, 2012. Major components of the research and development expenses were direct personnel costs, laboratory equipment and consumables and overhead expenses.

Technology Development

In addition to developing new CTC and ctDNA tests for different cancers to be offered through our CLIA testing laboratory, and adapting additional predictive biomarkers to these tests as their importance is demonstrated by the scientific and clinical research communities, we continue to focus on improving the base technologies underlying our tests and processes. We are exploring various ways to improve CTC capture efficiency and detection, as well as approaches to sub-categorize CTCs into different populations that may have clinical relevance. For example, by determining which antigens individual CTCs expressed that enabled their capture, we could differentiate, and enumerate, various CTC phenotypes, for example, epithelial versus mesenchymal. We are also working to simplify the test process, and in general to provide a broader range of useful data on a patient’s cancer to assist the oncologist in determining an appropriate treatment. Some of these projects and initiatives include:

 

   

Improve Ability to Capture CTCs

 

   

Continued modification and optimization of our CEE microfluidic channel as a way to further enhance CTC capture efficiency. Capture efficiency directly impacts sensitivity, informative rate, and the ability to perform accurate and reliable biomarker analyses on the CTCs, all of which increase the value of our offering. We are utilizing some of our early research experience to improve CTC capture rates and reduce background contamination from normal white blood cells.

 

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Automation of Our Test Process

 

   

Development of automation throughout the test process, but particularly at the visual evaluation steps, which include enumeration, any immunocytochemistry for biomarkers beyond those used to identify CTCs, for example protein biomarkers, and FISH analysis, is a way to drive efficiencies, reduce costs, speed up turnaround time, and generate more reliable, uniform, and in some cases more sensitive data. We have identified an automation solution for the visual analysis, which needs to be optimized and then transferred to and validated in our CLIA laboratory. We have also adapted a semi-automated system for the separation, processing and washing steps before running a sample on the microfluidic channel, which is now being used in the research laboratory and similarly needs to be transferred and validated in the CLIA laboratory. These measures will reduce costs and time as well as allow for higher-throughput as sample volumes increase.

 

   

Development of Second Generation Platform for CTC Testing

 

   

Evaluating and developing techniques for CTC capture that take advantage of our CEE-Cap antibody capture cocktail and CEE-Enhanced staining technology to modify our current CTC process to a simpler, essentially IVD, format. In addition to reducing internal costs, such an advance would offer the opportunity for us to offer a product format that enable us to access the worldwide CTC testing market. The distribution of such kits could create a new business opportunity for Biocept.

 

   

Utilization of CEE-Selector Technology for Highly Multiplexed Mutation Testing

 

   

The CEE-Selector technology should enable us to multiplex mutation testing such that larger panels of genes can be analyzed in a single step. This should position us for the analysis at the molecular level of whole signaling pathways or enzyme cascades. We plan to take advantage of the sensitivity and specificity of the CEE-Selector technology and leverage interest in the clinical research community for detecting any actionable biomarker in a particular tumor, as opposed to only those that are known to occur at relatively higher frequencies in that type of tumor. Such multiplexed mutation tests, relying on our CEE-Selector technology, could provide a more global evaluation of a tumor through analysis of either CTCs or ctDNA. This would offer a broader range of potential treatment options as well as enable the monitoring of the effectiveness of those treatments over time.

 

   

Development of Single Cell CTC Isolation Techniques for Molecular Analysis

 

   

Tumor heterogeneity is a well-recognized problem for tissue analysis and is in part addressed by focusing on CTCs, which may provide a more universal sampling of a tumor. One result of this can be a diverse population of CTCs in a sample, with different phenotypes and genotypes represented. We are working with a collaborator on techniques for subsequent sorting of our highly enriched CTC samples released from our CEE microfluidic channels into pools of CTCs with similar phenotypes, and ultimately to single CTCs, for molecular analysis.

Translational/Clinical Research

In the course of our research and validation studies, we have processed several hundred cancer patient samples and normal control samples for CTC enumeration and analysis. Our initial focus has been on breast cancer, where validation studies for the OncoCEE-BR test, including enumeration of CTCs compared to the CellSearch® system, and HER2 FISH performed on CTCs and compared with HER2 analysis performed on tumor tissue from the same patients, involved over 120 patient samples. The results of our validation studies, and the demonstration of a reliable and reproducible method for CTC capture and analysis using the OncoCEE platform were published in a paper entitled “Novel Platform for the Detection of Cytokeratin Positive (CK+) and Cytokeratin Negative (CK+) CTCs” appearing in the December 2011 issue of Cancer Discovery and a paper entitled “Efficient capture of circulating tumor cells with a novel immunocytochemical microfluidic device” appearing in the September 2011 issue of BioMicrofluidics.

Additional studies were conducted in breast and other tumor types, including lung, prostate and colorectal cancers, utilizing patient samples for comparison to the CellSearch® system. In head-to-head studies, the CEE system detected cytokeratin positive CTCs in comparable numbers of breast cancer patients, and in considerably more patients in the other cancer types (Cancer Discovery, December 2011). Moreover, the results clearly demonstrated that our use of the CEE-Cap

 

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capture antibody cocktail enabled recovery of more CTCs as compared to using only anti-EpCAM antibodies. This data served as a clinical validation study for CTC enumeration. When CEE-Enhanced staining is applied to detect cytokeratin-negative CTCs, we expect to see far more CTCs based on preliminary studies reported in a paper entitled “Detection of EpCAM-Negative and Cytokeratin-Negative CTCs in Peripheral Blood” appearing in the 2011 issue of the Journal of Oncology.

The CEE system has the added advantage of post-capture immunocytochemical, cytogenetic and molecular genomic analyses of the CTCs. The CEE system captured cells can be analyzed directly within the microfluidic channel, thereby removing the need to re-deposit cells on a slide, which could result in cell loss or damage. Furthermore, given the transparency of the microfluidic channel, it can be immediately analyzed on a microscope. Together these two important features allow for a very efficient process that is well suited for a LDT performed in a CLIA laboratory. The post-capture analyses, which focus on the evaluation of biomarkers, are particularly important and valuable to physicians and patients, as they focus on actionable information related to therapy selection. We have performed a number of clinical research studies in collaboration with MD Anderson Cancer Center investigators involving various tumor types, including breast, ovarian, endometrial, lung, colorectal, bladder and prostate cancers.

In a collaboration with physicians and researchers at MD Anderson Cancer Center, we evaluated matched samples of tumor tissue, blood for CTCs and bone marrow for DTCs in early stage breast cancer patients for evidence of HER2 amplification, which would indicate eligibility for HER2-targeted therapies like Herceptin®, a potentially life-saving treatment. In this study involving over 100 patients and an expanded data set, HER2 positive CTCs and/or DTCs were identified in more than twice as many women as tumor tissue alone, with very little overlap, suggesting their eligibility for HER2-targeted therapy. These results were presented at both the 2011 and 2012 annual meetings of the American Society of Clinical Oncology and are now published in Cancer Medicine (2013, 2(2) 226-233). Patients classified as HER2 negative based on tumor tissue and found to have HER2 positive CTCs and/or DTCs will continue to be followed by our collaborators at MD Anderson Cancer Center to assess their overall and progression-free survival. Tumor heterogeneity is one likely cause of the discordance for HER2 status between tumor tissue and our test performed on blood and bone marrow samples. Tumor heterogeneity indicates an important clinical application for the OncoCEE-BR test, confirmation and crosschecking of the tissue analysis performed by the pathologist at the time of biopsy or surgery, especially if HER2 negative, with a CTC analysis derived from a standard blood sample.

Clinical utility studies, which demonstrate the specific clinical setting in which a particular CTC or ctDNA test is used, and how to use the information generated for medical, specifically treatment-related, decision making is a key part of our strategy and research and development plan. Data resulting from such studies is critical not only in the sales and marketing process, but also for reimbursement, as many payors now ask for peer-reviewed publications describing such studies and results before agreeing to coverage of a specific test. The study with Dana-Farber Cancer Institute is the first example of a clinical utility study for one of our tests and we plan to conduct additional studies in breast cancer and similar studies in NSCLC and other cancers for which we develop tests, including sponsoring such studies ourselves with some of the proceeds from this offering.

Sales and Marketing

Our sales and marketing efforts consist of working with our partners such as Life Technologies and establishing our own direct sales force in the United States focused on selling directly to community oncologists in hospitals, cancer centers and offices, and supporting our partners as technical specialists and medical science liaisons.

To date, we have engaged in only limited sales and marketing activities, primarily through an agreement with Clarient Diagnostic Services, Inc., a GE Healthcare Company, for the OncoCEE-BR test. We also have an agreement with Life Technologies Corporation for the commercialization of the OncoCEE-LU test. With the proceeds of this offering we plan to build an internal sales and marketing team that will sell directly to community oncologists and serve as technical experts and clinical specialists to support the sales representatives of our partners. Under the arrangement with Clarient, as recently renegotiated, Clarient’s sales force sells the test on a nonexclusive basis, and we are responsible for performing the test, reporting the results, billing, and obtaining reimbursement for the test. Under the agreement with Life Technologies, when our OncoCEE-LU test is commercially launched, Life Technologies’ Medical Science Division sales force would sell the

 

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tests and Life Technologies’ pathologists would perform the pathology review component, otherwise called the professional component of the test, in Life Technologies’ laboratory. We would perform the technical component of the test in our laboratory. Life Technologies would bill payors for the entire test, pay us for the technical component of the test at an agreed upon rate and keep the professional component. Reimbursement and pricing are based on Current Procedural Terminology, or CPT, codes. Under the Life Technologies agreement, the parties would share the payment and reimbursement risk, as we would be paid an agreed upon fee for the technical component of tests performed, and there would be a quarterly adjustment based on amounts actually received from payors. We will look to identify and engage additional groups with appropriately targeted sales efforts as partners for these and future tests and have initiated discussions with other companies.

Our plan for a Biocept sales organization calls for an initial group of 7 sales representatives placed in strategic locations around the country that have high concentrations of cancer patients, and potentially growing this number to 15-20 sales representatives within two years, and to 40-50 within five years. We have defined the initial sales territories and are targeting sales professionals with an average of 5-10 years of successful experience in clinical oncology sales or oncology diagnostic testing sales from leading biopharmaceutical, pharmaceutical or specialty reference laboratory companies. We plan on growing this specialized, oncology-focused sales force and supporting it with clinical specialists who bring significant technical knowledge in the use of CTC and ctDNA tests.

We will also be investing in sales headcount to focus on biopharma clinical trial opportunities. We plan to hire one additional representative for this initiative in the Northeast US and eventually add coverage in other areas with a large concentration of biotech and pharmaceutical companies.

Finally, we plan to invest in managed care sales and marketing in order to ensure adequate payment and coverage for our testing. The key value proposition for these customers will be focused on cost savings by offering alternatives to expensive surgeries when tumor biopsy tissue is not available.

Our sales and marketing efforts are and will be based on a five-part marketing strategy:

 

   

Work with oncologists and group practices at community hospitals and community-based cancer centers to educate them on the advantages and opportunities that CTC and ctDNA tests provide for better information, allowing them to select the most appropriate therapy for their patients, and how and when these testes are most effectively used;

 

   

Build relationships with key thought leaders in oncology, specifically in the cancers for which we are offering or plan to offer tests, to educate and support community oncologists;

 

   

Collaborate with leading research universities and institutions that enable the validation of our new tests, as well as the generation of clinical utility data;

 

   

Partner with pharmaceutical companies for clinical trial work focusing on CTC and ctDNA testing and analysis; and

 

   

Add value for the payor community by avoiding costly surgeries by providing the option of a simple blood test.

We also take advantage of customary marketing channels commonly used by the diagnostic and pharmaceutical industries, such as medical meetings, broad-based publication of our scientific and clinical data, and the Internet. In addition, we provide easy-to-access information to our customers through our website and a data portal for physicians who wish to access test results electronically. Our customers value easily accessible information in order to quickly review their patients’ information and begin developing a treatment protocol.

Outside the United States

Outside the United States, where a central laboratory business model is less developed, we will evaluate opportunities with our existing and other partners for the conversion and/or development of our current and planned CTC and ctDNA tests to test systems or IVDs, and related strategies to develop and serve such regional oncology markets. We also plan to sell our clinical trial services to biopharmaceutical companies and research organizations outside the United States.

While the initial focus of our agreement with Life Technologies for OncoCEE-LU tests is on customers in the United States, the parties plan to cooperate on accessing markets internationally. We plan for this to be accomplished either through partnerships with local groups and distributors or the development of IVDs and/or test systems, including instrumentation.

Competition

As a cancer diagnostics company focused on current and planned tests for CTCs and ctDNA from standard blood samples, we rely extensively on our ability to combine novel technology and biomarker information with high-quality, state-of-the art clinical laboratory testing. We believe that we compete principally on the basis of:

 

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our ability to utilize standard blood samples, enabling testing of patients frequently through the course of their disease without a biopsy, thereby reducing cost and trauma, saving time, and providing real-time information on the current status of the tumor;

 

   

our ability to include biomarker information in our analysis, in addition to CTC enumeration, thereby providing a more complete profile of a patient’s disease than existing CTC tests can. This is actionable information that can assist physicians in selecting more personalized treatment plans for individual patients;

 

   

our current and planned CTC tests’ ability to capture and detect a broader range of CTC phenotypes than existing tests, and potentially at earlier stages of disease, resulting in fewer non-informative cases and more information for physicians. For example, our antibody capture cocktail targets not only EpCAM but also other epithelial antigens as well as mesenchymal and cancer stem cell antigens, indicative of cells having undergone the epithelial-to-mesenchymal transition. These cells may be more relevant for metastasis;

 

   

our ability to rapidly integrate new biomarkers, either validated in academic laboratories or of interest to pharmaceutical and biopharmaceutical companies in the context of their new therapies, into our current and planned tests, facilitating the expansion of actionable information for oncologists;

 

   

our research and clinical collaborations with key academic and clinical study groups, which enhance our research and development resources and, by enhancing our standing in the oncology community, support our marketing efforts; and

 

   

our planned ctDNA tests based on the CEE-Selector technology are expected to offer enhanced sensitivity and specificity in detecting mutation targets or resistance markers, again supporting treatment decisions.

We believe that we compete favorably with respect to these factors, although we cannot assure you that we will be able to continue to do so in the future or that new products or tests that perform better than our current and planned proprietary tests and services will not be introduced. We believe that our continued success depends on our ability to:

 

   

expand and enhance our current and planned OncoCEE tests to provide clinically meaningful information in additional cancers;

 

   

work with clinicians to design and implement clinical studies that demonstrate the clinical utility of our products;

 

   

continue to innovate and maintain scientifically advanced technology;

 

   

successfully market and sell proprietary tests;

 

   

continue to comply with regulatory guidelines and obtain appropriate regulatory approvals in the United States and abroad as applicable;

 

   

continue to validate our pipeline of tests;

 

   

conduct or collaborate with clinical utility studies to demonstrate the application and medical value of our tests;

 

   

seek to obtain positive reimbursement decisions from Medicare and private third-party payors;

 

   

continue to enter into sales and marketing partnerships;

 

   

maintain existing and enter into new research and clinical collaborations with key academic and clinical study groups;

 

   

continue to attract and retain skilled scientific and clinical personnel;

 

   

continue to participate and gain clinical trial work through biopharma partnerships;

 

   

gain payment for the testing we provide for patients;

 

   

obtain patents or other protection for our proprietary technologies, tests and services; and

 

   

obtain and maintain our clinical reference laboratory accreditations and licenses.

 

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Our principal competition comes from mainstream diagnostic methods, used by pathologists and oncologists for many years, which focus on tumor tissue analysis. It may be difficult to change the methods or behavior of oncologists to incorporate our CTC and ctDNA testing, including molecular diagnostic testing, into their practices in conjunction with or instead of tissue biopsies and analysis. In addition, companies offering capital equipment and kits or reagents to local pathology laboratories represent another source of potential competition. These kits are used directly by the pathologist, which can facilitate adoption. We plan to focus our marketing and sales efforts on medical oncologists rather than on pathologists.

We also face competition from companies that offer products or are conducting research to develop products for CTC or ctDNA testing in various cancers. In particular, Janssen Diagnostics, LLC markets its CellSearch® test and Atossa Genetics markets its ArgusCYTE® test, which are competitive to our OncoCEE-BR test for CTC enumeration, and HER2 analysis, respectively. However, the ArgusCYTE® test measures HER2 mRNA, which is not typically used for HER2 analysis, while we employ FISH for this analysis. FISH is generally considered to be the gold standard. CTC and ctDNA testing is a new area of science and we cannot predict what tests others will develop that may compete with or provide results similar or superior to the results we are able to achieve with the tests we develop. In addition to Janssen Diagnostics and Atossa Genetics, our competitors include public companies such as Alere (Adnagen) and Illumina as well as many private companies, including Apocell, EPIC Sciences, Clearbridge Biomedics, Cynvenio Biosystems, Fluxion Biosciences, RareCells, ScreenCell and Silicon Biosystems. Many of these groups, in addition to operating research and development laboratories, are establishing CLIA-certified testing laboratories while others are focused on selling equipment and reagents.

We expect that pharmaceutical and biopharmaceutical companies will increasingly focus attention and resources on the personalized cancer diagnostic sector as the potential and prevalence increases of molecularly targeted oncology therapies approved by the FDA along with companion diagnostics. For example, the FDA has recently approved two such agents—Xalkori® from Pfizer Inc. along with its companion anaplastic lymphoma kinase FISH test from Abbott Laboratories, Inc., Zelboraf® from Daiichi-Sankyo/Genentech/Roche along with its companion B-raf kinase V600 mutation test from Roche Molecular Systems, Inc. and Tafinlar® from GlaxoSmithKline along with its companion B-raf kinase V600 mutation test from bioMerieux. These recent FDA approvals are only the second, third and fourth instances of simultaneous approvals of a drug and companion diagnostic. The first approval was the 1998 approval of Genentech’s Herceptin® for HER2 positive breast cancer along with the HercepTest from partner Dako A/S. Our competitors may invent and commercialize technology platforms or tests that compete with ours.

There are a number of companies which are focused on the oncology diagnostic market, such as Biodesix, Caris, Clarient, Foundation Medicine, Response Genetics, Neogenomics, Agendia, Genomic Health, and Genoptix, and which, while not currently offering CTC or ctDNA tests which are truly competitive with ours, are selling to the medical oncologists and pathologists. Large laboratory services companies, such as Sonic USA, Quest and LabCorp, provide more generalized cancer diagnostic testing.

Additionally, projects related to cancer diagnostics and genomics have received increased government funding, both in the United States and internationally. As more information regarding cancer genomics becomes available to the public, we anticipate that more products aimed at identifying targeted treatment options will be developed and that these products may compete with ours. In addition, competitors may develop their own versions of our current and planned tests in countries where we did not apply for patents or where our patents have not issued and compete with us in those countries, including encouraging the use of their test by physicians or patients in other countries.

Third-Party Suppliers and Manufacturers

Some of the components used in our current or planned products are currently sole-source, and substitutes for these components might not be able to be obtained easily or may require substantial design or manufacturing modifications. Any significant problem experienced by one of our sole source suppliers (particularly K.R. Anderson, Inc., which supplies a custom-packaged silicone compound used in our manufacturing) may result in a delay or interruption in the supply of components to us until that supplier cures the problem or an alternative source of the component is located and qualified. Any delay or interruption would likely lead to a delay or interruption in our manufacturing operations. The

 

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inclusion of substitute components must meet our product specifications and could require us to qualify the new supplier with the appropriate government regulatory authorities.

Patents and Proprietary Technology

Our business is dependent upon our ability to develop and perform proprietary CTC and ctDNA tests that enable oncologists at hospitals, cancer centers and physician offices to receive information on properly characterized samples from individual cancer patients to select the most appropriate therapy for those patients. We rely on a combination of patents, patent applications, trademarks, trademark applications, trade secrets and industry know-how, in order to protect the proprietary aspects of our technology and assure that we can perform our tests.

Our patent portfolio consists of two patents issued by the USPTO and a number of filed patent applications pending before the USPTO and a number of filed Patent Cooperation Treaty applications pending before the World Intellectual Property Organization. These patents and patent applications are related to various aspects of our current and planned CTC and ctDNA tests, including our CEE microfluidic channels, our CEE-Sure blood collection tubes, CEE-Cap antibody capture cocktail, CEE-Enhanced staining methodology, and CEE-Selector technology for mutation detection.

CEE Microfluidic Channels. We have two issued U.S. patents that are directly applicable to our current business (U.S. Patent Nos. 7,695,956 and 8,158,410), and a number of additional U.S. and foreign patent applications, which cover our microfluidic channel technology. Our microfluidic channels are differentiated from other microfluidic channels used for CTC capture based on their unique geometry, particularly the arrangement of posts within the flow channel. The posts are chemically derivatized to enable capture of antibody-tagged CTCs, and are positioned to disrupt streamline or laminar flow of cells through the microfluidic channel to assure they come in contact with the posts for capture. Because the capture area of the microfluidic channel is sealed on one side with a glass cover slip, immunocytochemical and cytogenetic staining and analysis can occur within the microfluidic channel.

CEE-Sure Blood Collection Tubes. We have a U.S. patent application (13/243,432) in prosecution for our CEE-Sure blood collection tubes, which contain reagents designed to prevent clumping of blood cells and CTCs that could clog the microfluidic channels and disrupt our assays. These reagents also provide stability to the sample for shipping and transport, enabling blood samples to be shipped at ambient temperature from a collection site anywhere in the United States, and even outside the United States, to our laboratory in San Diego, California, and perform well in our assays for up to 96 hours after collection. Nucleic acid (both DNA and RNA) has been shown to be stable and accessible in cells under these conditions, and preliminary work suggests the same may be true for ctDNA, with more research required.

CEE-Cap Antibody Capture Cocktail. Our antibody capture cocktail, which includes antibodies to a number of tumor-associated antigens from cancer cells of both epithelial and mesenchymal phenotype, as well as cancer stem cells, is the subject of U.S. patent applications (12/730,738 and 13/269,532) and foreign equivalents. In addition to the sets of specific antigens targeted by the cocktail, the application covers the binding of the antibodies to the target CTCs in solution, which we have shown greatly improves the capture efficiency because of superior binding kinetics and the lack of spatial constraints imposed by attachment of the antibodies to a solid surface.

CEE-Enhanced Staining. This technology was developed to enable detection of CTCs that do not express sufficient amounts of cytokeratin, an epithelial marker that, in conjunction with DAPI and CD45 staining, is used to identify CTCs. It has made it possible to detect non-traditional CTCs, including mesenchymal types such as result from EMT, which, in conjunction with the antibody capture cocktail, has significantly increased the sensitivity of our CTC assays, and the informative rate for clinical samples. CEE-Enhanced staining, along with the use of certain types of chromosomal aneuploidy, such as “complex” aneuploidy, to identify CTCs, is being pursued in a U.S. patent application (13/241,083) and foreign equivalents.

CEE-Selector Mutation Detection Technology. This technology was developed to perform mutation analysis on CTCs, ctDNA or other sample types. It addresses the challenge of a sample in which copies of the normal gene locus vastly exceed

 

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the copies of the mutant gene locus. The technology has been demonstrated to have utility for more-sensitive mutation detection in ctDNA as well as CTC analysis. It is co-owned with Aegea Biotechnologies, Inc., with Biocept having exclusive commercial rights for clinical oncology applications, including LDTs and IVDs. We are prosecuting two U.S. patent applications (13/841,842 and 61/784,101) with Aegea, with Biocept responsible for the former and Aegea the latter, and expect to file these cases in foreign jurisdictions as well. Lyle J. Arnold, Ph.D., our Senior Vice-President of Research & Development and Chief Scientific Officer, is the controlling person of Aegea.

In 2013, in Association for Molecular Pathology v. Myriad Genetics, the Supreme Court unanimously ruled that a “naturally occurring DNA segment is a product of nature and not patent eligible merely because it has been isolated,” invalidating Myriad Genetics’ patents on the BRCA1 and BRCA2 genes. This case removed some of the risk associated with testing laboratories like ours using isolated nucleic acid fragments for molecular analysis. Testing laboratories have been uncertain as to whether analysis of gene mutations covered by third party patents would violate such patents. We will continue to monitor developments in this area.

In addition to patents, we hold five U.S. registered trademarks, including a federal registration for the “CEE” mark, as well as several foreign registered trademarks and U.S. trademark applications for certain of our current and planned proprietary tests.

Through our clinical laboratory, we provide diagnostic testing and clinical services that utilize our proprietary trade secrets. In particular, we maintain trade secrets with respect to specimen accessioning, sample preparation and certain aspects of cytogenetic analysis. All of our trade secrets are kept in confidence and we take steps to ensure that our confidential information is not disseminated, including the use of non-disclosure agreements and confidentiality agreements.

Operations and Production Facilities

Our research and development laboratories, our CLIA-certified diagnostic testing laboratory and our manufacturing facility are located in our San Diego, California headquarters. The laboratories employ commercial state-of-the-art equipment as well as custom-made components specific to our CTC process that are generated in a small in-house engineering shop. The manufacturing facility used for the production of our CEE microfluidic channels is a Class 10,000 suite in which polydimethylsiloxane is formed into the base of our proprietary microfluidic channels in a molding process. A glass cover slip suitable for optical analysis is added to seal the channels and make them watertight by making them reactive using plasma techniques. The inside of the microfluidic channels is subsequently chemically derivatized to enable the attachment of binding elements that strongly bind to antibody-tagged or coated CTCs. Because the microfluidic channels have micrometer dimensions, and we are seeking individual cells in a blood sample to interact with the surface of the microfluidic channel, dust particles and other microscopic debris that could clog the channel needs to be avoided.

The process of performing our test is straightforward. When a health care professional takes a standard blood sample from a patient for CTC or ctDNA testing, he or she will place the blood sample in our CEE-Sure blood collection tubes, complete a requisition form, and package the specimen in our shipping kit for direct shipment to us. Once we receive the specimen at our laboratory and we enter all pertinent information about the specimen into our clinical laboratory information system, our laboratory technologists prepare the specimen for processing and analysis. Laboratory technologists, including clinical laboratory technologists and clinical laboratory scientists then conduct the analysis, including enumeration of CTCs and biomarker analysis such as FISH. The data, including images and the processed cells, are sent to our in-house or contracted pathologists or a commercialization partner’s pathologists who are experienced in the analysis and evaluation requested by the referring oncologist or pathologist.

After analysis, our in-house or contracted pathologists or a commercialization partner’s pathologists use laboratory information systems to prepare a comprehensive report, which includes selected relevant images associated with the specimen. Our Internet reporting portal allows a referring oncologist or pathologist to access his or her patient’s test results in real time in a secure HIPAA compliant manner. The reports are generated in industry standard .pdf formats which allows for high definition color images to be reproduced clearly. This portal has been fully operational at our facilities since the fourth quarter of 2011.

 

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In all cases, we provide the technical analysis, and in the case of our OncoCEE-BR test under our 2013 agreement with Clarient, we also provide the professional analysis. For our OncoCEE-LU test, while we would perform all of the technical analysis, the pathologists at our partner Life Technologies’ CLIA laboratory would provide the professional evaluation of the laboratory data. For OncoCEE-BR tests, we will send the results to the ordering oncologist and bill the payor through an arrangement we have with Xifin, Inc. For OncoCEE-LU tests, Life Technologies would send out the report and bill the appropriate parties, then pay us a predetermined fee for the technical analysis with a subsequent quarterly adjustment of that fee based on payments actually received by Life Technologies from payors.

Quality Management Program

We are committed to providing reliable and accurate diagnostic testing to our customers. Accurate specimen identification, timely communication of test results, and prompt correction of errors, is critical. We monitor and improve our performance through a variety of methods, including performance improvement indicators, internal proficiency testing and external quality audits conducted by CAP. All quality concerns and incidents are subject to review and analysis, and our procedures are designed to ensure that we are providing the best services possible to our patients and customers. Protection of patient results from misuse and improper access is imperative and electronic and paper results are guarded via password-protection and identification cards.

We have established a Quality Management Program for our laboratory designed to help ensure accurate and timely test results, a consistent high quality of our testing services. The Quality Management Program documents the quality assurance and performance improvement plans and policies, the laboratory quality assurance and quality control procedures that are necessary to ensure that we offer the highest quality of diagnostic testing services. This program is designed to satisfy all the requirements necessary for local and state licensures and accreditation for clinical diagnostic laboratories by CAP. We follow the policies and procedures for patient and employee safety, hazardous waste disposal and fire codes stated in the general laboratory procedure manual. We believe that all pertinent regulations of CLIA, the Occupational Safety and Health Administration, the Environmental Protection Agency and the FDA are satisfied by following the established guidelines and procedures of our Quality Management Program.

In addition to the compulsory proficiency programs and external inspections required by CMS and other regulatory agencies, we have developed a variety of internal systems and procedures to emphasize, monitor and continuously improve the quality of our operations. We maintain internal quality controls by routinely processing specimens with known diagnoses in parallel with patient specimens. We also have an internally administered proficiency program for specimen testing.

The CAP accreditation program involves unannounced on-site inspections of our laboratories. CAP is an independent, non-governmental organization of board-certified pathologists that accredits laboratories nationwide on a voluntary basis and that has been recognized by CMS as an accreditation organization to inspect laboratories to determine adherence to the CLIA standards.

Third-party Payor Reimbursement

Revenues from our clinical laboratory testing are derived from several different sources. Depending on the billing arrangement, the instruction of the ordering physician and applicable law, parties that reimburse us for our services include:

 

   

third-party payors that provide coverage to the patient, such as an insurance company, a managed care organization or a governmental payor program;

 

   

physicians or other authorized parties, such as hospitals or independent laboratories, that order the testing service or otherwise refer the services to us;

 

   

the patients in cases where the patient has no insurance or inadequate insurance or must pay co-pay or deductible amounts;

 

   

collaboration partners (e.g., Life Technologies for our anticipated OncoCEE-LU test); or

 

   

biopharmaceutical companies, universities or researchers for clinical trial work.

We are reimbursed for two categories of testing, anatomic pathology, which includes cell staining and the enumeration component of CTC tests, FISH, immunocytochemistry and immunofluorescence, and molecular pathology, which includes mutation analysis. Reimbursement under the Medicare program for the diagnostic services that we offer is based on either the Medicare Physician Fee Schedule or the Medicare Clinical Laboratory Fee Schedule, each of

 

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which is subject to geographic adjustments and is updated annually. Medical services provided to Medicare beneficiaries that require a degree of physician supervision, judgment or other physician involvement, such as pathology services, are generally reimbursed under the Medicare Physician Fee Schedule, whereas clinical diagnostic laboratory tests are generally reimbursed under the Medicare Clinical Laboratory Fee Schedule. Some of the services that we provide are genetic and molecular testing, which are reimbursed as clinical diagnostic laboratory tests.

Regardless of the applicable fee schedule, Medicare payment amounts are established for each billing code, or CPT code. In addition, under the Clinical Laboratory Fee Schedule, Medicare also sets a cap on the amount that it will pay for any individual test. This cap, usually referred to as the National Limitation Amount, is set at a percentage of the median of all the contractor fee schedule amounts for each billing code. In the past, Congress has lowered the percentage of the median used to calculate the National Limitation Amount in order to achieve budget savings. Currently, the National Limitation Amount ceiling is set at 74% of the median for established tests and 100% of the median for certain new tests that were not previously reimbursed. In billing Medicare for clinical laboratory services, we are required to accept, as payment in full, the lowest of our actual charge, the fee schedule amount for the state or local geographical area or the National Limitation Amount.

Medicare also has policies that may limit when we can bill directly for our services and when we must instead bill another provider, such as a hospital. When the testing that we perform is done on a specimen that was collected while the patient was in the hospital, as either an inpatient or outpatient, we may be required to bill the hospital for clinical laboratory services and for the technical component of pathology services, rather than the Medicare program, depending primarily on whether the service was ordered at least 14 days after the patient’s discharge from the hospital. Complying with these requirements is complex and time-consuming and may affect our ability to collect for our services.

Our reimbursement rates can vary based on whether we are considered by private third-party payors to be an “in-network” provider, a participating provider, a covered provider or an “out-of-network” provider. These definitions can vary from insurance company to insurance company, but we are generally considered an “out of network” or non-participating provider by the vast majority of private third-party payors. It is not unusual for a company that offers highly specialized or unique testing to be an “out of network” provider. An “in-network” provider usually has a contracted arrangement with the insurance company or benefits provider. This contract governs, among other things, service-level agreements and reimbursement rates. In certain instances an insurance company may negotiate an “in-network” rate for our testing rather than pay the typical “out-of-network” rate. An “in-network” provider usually has rates that are lower per test than those that are “out-of-network”, and that rate can vary from a single digit percentage deduction discount to upwards of 25% to 30% percent lower than an “out-of-network” provider. The discount rate varies based on the insurance company, the testing type and often times the specifics of the patient’s insurance plan.

Billing and Billing Codes for Third-party Payor Reimbursement

CPT codes are the main data code set used by physicians, hospitals, laboratories and other health care professionals to report separately-payable clinical laboratory tests for reimbursement purposes. The CPT coding system is maintained and updated on an annual basis by the American Medical Association. Although there is no specific code applicable to the specific CTC testing we perform, such as our OncoCEE-BR test, there are existing codes that describe nearly all of the steps in our testing process. We currently use a combination of different codes to describe the various steps in our testing process. Many of the CPT codes used to bill for molecular pathology tests such as those planned in our OncoCEE-LU test have been significantly revised by the CPT Code Editorial Panel. These new codes replace the more general “stacking” codes that were previously used to bill for these services with more test-specific codes, which were effective January 2013. In the Final Physician Fee Schedule Rule, which was issued in November 2012, CMS stated that it had determined it would pay for the new codes as clinical laboratory tests, which are payable on the Medicare Clinical Laboratory Fee Schedule. CMS has also started a process to “gapfill” the new codes. In other words, it will ask each of the MACs to determine a reasonable price for the new codes.

Changes in coding and reimbursement methods could have an adverse impact on our revenues going forward. However, we are currently working with our billing consultants to determine what changes will be required by the new coding changes. The elimination of the “stacking” codes will require us to either use the new more specific codes where applicable effective January 2013, or to use other “Not Otherwise Classified” codes when billing. The implementation of these new codes will vary from payor to payor, and it is too early to assess the impact, if any,

 

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that the migration to the new codes may have on our results of operations. The introduction of the new codes by CMS, in combination with the other actions it is considering with regard to pricing, could result in a reduction in the payments that we receive for our current breast cancer test and our planned future tests and make it more difficult to obtain coverage from Medicare or other payors. There can be no guarantees that Medicare and other payors will establish positive or adequate coverage policies or reimbursement rates. We are moving forward with plans to obtain billing codes for the capture/enumeration components of our current and planned CTC tests. For other components and types of testing provided or anticipated to be provided by us, specific CPT codes were provided by the American Medical Association in January 2013 or we are able to utilize existing CPT coding located on the Medicare Physician Fee Schedule. For these established CPT codes, we have the benefit of positive coverage determinations which were adopted as part of national Medicare policy or under applicable Local Coverage Determinations. Specific codes for our tests, however, do not assure an adequate coverage policy or reimbursement rate. Please see the section entitled “Legislative and Regulatory Changes Impacting Clinical Laboratory Tests” for further discussion of certain legislative and regulatory changes to these billing codes and the impact on our business.

Coverage and Reimbursement for our Current Breast Cancer Test and our Planned Future Tests

OncoCEE-BR is a new test, and because of our previous relationship with Clarient, under which it had responsibility for billing and reimbursement until mid-2013, we do not have established coverage and reimbursement policies set with all third-party payors. While Palmetto GBA, our Medicare Administrative Contractor (until it was replaced in that role by Noridian Healthcare Solutions, LLC in September 2013), has a negative coverage determination for the capture/enumeration component of all CTC tests except the CellSearch® test, we have submitted a new dossier to Palmetto GBA regarding CTC capture/enumeration based on our CEE platform. We have received reimbursement for the capture/enumeration component of our tests from some payors, including major commercial third-party payors, based on submission of standard CPT codes. We have the benefit of specific CPT codes and positive coverage determinations, which were adopted as part of national Medicare policy or under applicable Local Coverage Determinations, for the analysis components of our current and anticipated tests. These components have a significantly greater billing value than the capture/enumeration components of our current and anticipated CTC tests.

The current landscape with payors is generally as follows:

Commercial Third-party Payors and Patient Pay. Where there is a coverage policy in place, we bill the payor and the patient in accordance with the established policy. Where there is no coverage policy in place, we pursue reimbursement on behalf of each patient on a case-by-case basis. Our efforts in obtaining reimbursement based on individual claims, including pursuing appeals or reconsiderations of claims denials, take a substantial amount of time, and bills may not be paid for many months, if at all. Furthermore, if a third-party payor denies coverage after final appeal, payment may not be received at all. We are working to decrease risks of nonpayment by implementing a revenue cycle management system.

Medicare. We believe that as much as approximately 50% of our future market for our current breast cancer test and our planned future tests may be derived from patients covered by Medicare.

We cannot predict whether, or under what circumstances, payors will reimburse for all components of our tests. Payment amounts can also vary across individual policies. Full or partial denial of coverage by payors, or reimbursement at inadequate levels, would have a material adverse impact on our business and on market acceptance of our tests.

Legislative and Regulatory Changes Impacting Clinical Laboratory Tests

From time to time, Congress has revised the Medicare statute and the formulas it establishes for both the Medicare Clinical Laboratory Fee Schedule and the Medicare Physician Fee Schedule. The payment amounts under the Medicare fee schedules are important because they determine not only our reimbursement under Medicare, but also because those payment amounts are often used as a basis for payment amounts set by other third party payors. For example, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients.

Under the statutory formula for Medicare Clinical Laboratory Fee Schedule amounts, increases are made annually based on the Consumer Price Index for All Urban Consumers as of June 30 for the previous twelve-month period. From 2004-2008, Congress eliminated the Consumer Price Index for All Urban Consumers update in the Medicare Prescription

 

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Drug, Improvement and Modernization Act of 2003. In addition, for years 2009 through 2013, the Medicare Improvements for Patients and Providers Act of 2008 mandated a 0.5% cut to the Consumer Price Index for All Urban Consumers. Accordingly, the update for 2009 was reduced to 4.5% and negative 1.9% for 2010. The ACA has, among other things, imposed additional cuts to the Medicare reimbursement for clinical laboratories. The ACA replaced the 0.5% cut enacted by the Medicare Improvements for Patients and Providers Act with a “productivity adjustment” that will reduce the Consumer Price Index update in payments for clinical laboratory tests. In 2011, the productivity adjustment was -1.2%. In addition, the ACA includes a separate 1.75% reduction in the CPI update for clinical laboratories for the years 2011 through 2015. The MCTRJCA, enacted in 2012, mandated an additional change in reimbursement for clinical laboratory service programs. This legislation requires CMS to reduce the Medicare Clinical Laboratory Fee Schedule by 2% in 2013, which in turn will serve as a base for 2014 and subsequent years. CMS has projected that because of the changes required by ACA and MCTRJCA, payment for clinical laboratory services will go down by approximately 3% by 2013.

With respect to our diagnostic services for which we are reimbursed under the Medicare Physician Fee Schedule, because of the statutory formula, the rates would have decreased for the past several years if Congress failed to intervene. In the past, when the application of the statutory formula results in lower payment, Congress has passed interim legislation to prevent the reductions. In November 2012, CMS issued its 2013 Physician Fee Schedule Final Rule, or the 2013 Final Rule. In the 2013 Final Rule, CMS called for a reduction of approximately 26.5% in the 2013 conversion factor that is used to calculate physician reimbursement. However, the American Taxpayer Relief Act of 2012, which was signed into law on January 2, 2013, prevents this proposed reduction and keeps the current reimbursement rate in effect until December 31, 2013. If Congress fails to act in future years to offset similar deductions, the resulting decrease in payment could adversely impact our revenues and results of operations. In addition, for 2012, CMS requested that the American Medical Association’s Relative Value Scale Update Committee reexamine the relative values of certain codes, including FISH codes. The Relative Value Scale Update Committee is an expert panel that provides relative value recommendations to CMS for use in annual updates to the Medicare Physician Fee Schedule. These relative values are used by CMS to determine payments, and CMS seeks to assess whether such codes are misvalued and an adjustment is necessary.

In addition, the 2013 Final Rule included a reduction of certain relative value units and geographic adjustment factors used to determine reimbursement for a number of codes used in our current breast cancer test and our planned future tests. These codes describe services that we must perform in connection with our tests and we bill for these codes in connection with the services that we provide.

Further, with respect to the Medicare program, Congress has proposed on several occasions to impose a 20% coinsurance charge on patients for clinical laboratory tests reimbursed under the Medicare Clinical Laboratory Fee Schedule, which would require us to bill patients for these amounts. Because of the relatively low reimbursement for many clinical laboratory tests, in the event that Congress were to ever enact such legislation, the cost of billing and collecting for these services would often exceed the amount actually received from the patient and effectively increase our costs of billing and collecting.

In addition, in July 2013 CMS released for comment a proposed pathology Physician Fee Schedule revision that would pay independent laboratories and physicians the same rates (under Ambulatory Procedure Codes) as Medicare pays for hospital outpatient departments for the same services. These proposed rates are generally lower than the current rates paid to independent laboratories and physicians for the same services. If all of such cuts go into effect, the resulting decrease in payment could adversely impact our revenues and results of operations. We do not know whether or when this proposed fee schedule will take effect, in full or in part and with or without modifications.

Some of our Medicare claims may be subject to policies issued by Palmetto GBA and Noridian Healthcare Solutions, our former and current Medicare Administrative Contractor for California, respectively. Palmetto GBA, acting on

 

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behalf of many MACs, recently issued a Local Coverage Decision that affects coverage, coding and billing of many molecular diagnostic tests. Under this Local Coverage Determination, Palmetto GBA will not cover any molecular diagnostic tests, including our current breast cancer test and our planned future tests, unless the test is expressly included in a National Coverage Determination issued by CMS or a Local Coverage Determination or coverage article issued by Palmetto GBA. Currently, laboratories may submit coverage determination requests to Palmetto GBA for consideration and apply for a unique billing code for each test (which is a separate process from the coverage determination). In the event that a non-coverage determination is issued, the laboratory must wait six months following the determination to submit a new request. In addition, effective January 1, 2013, Palmetto GBA implemented its new Molecular Diagnostic Services Program, under which, among other things, laboratories must use the newly-assigned billing codes specific to the test (as implemented by the American Medical Association), in order to receive the indicated reimbursement amounts. CMS has not provided a fee schedule for these new codes and instead has ordered the MACs to “gapfill” in order to establish payment values. Reimbursement amounts under these new single molecular diagnostics billing codes were in some cases lower, and in some cases higher, than prior amounts, but most were at significantly lowered rates. Palmetto GBA currently has a negative coverage determination for the capture/enumeration component of CTC tests such as our current anticipated CTC tests, but there is no such negative coverage determination for the analysis component of such CTC tests. Denial (or continuation of denial) of coverage for the capture/enumeration component of our current and anticipated CTC tests by Palmetto GBA or Noridian Healthcare Solutions, its successor MAC, or reimbursement at inadequate levels, would have a material adverse impact on our business and on market acceptance of our current breast cancer test and our planned future tests. Our current understanding is that Noridian Healthcare Solutions’ intention is to follow, for CTC tests, the positive or negative coverage determinations which from time to time Palmetto GBA makes.

Governmental Regulations

Clinical Laboratory Improvement Amendments of 1988 and State Regulation

As a provider of laboratory testing on human specimens for the purpose of diagnosis, prevention, or treatment, we are required to hold certain federal, state and local licenses, certifications and permits to conduct our business. In 1988, Congress enacted CLIA, which established quality standards for all laboratories providing testing to ensure the accuracy, reliability and timeliness of patient test results regardless of where the test was performed. Our laboratory holds a CLIA certificate of accreditation. As to state laws, we are required to meet certain laboratory licensing and other requirements. Our laboratory holds the required licenses from the applicable state agencies in which we operate. For more information on state licensing requirements, see the sections entitled see the section entitled “Description of the Business—Governmental Regulations—California State Laboratory Testing” and “Description of the Business—Governmental Regulations—Other States’ Laboratory Testing.”

Under CLIA, a laboratory is defined as any facility which performs laboratory testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease, or the impairment of, or assessment of health of human beings. CLIA also requires that we hold a certificate applicable to the complexity of the categories of testing we perform and that we comply with certain standards. CLIA further regulates virtually all clinical laboratories by requiring they comply with various operational, personnel, facilities administration, quality and proficiency testing requirements intended to ensure that their clinical laboratory testing services are accurate, reliable and timely. CLIA certification is also a prerequisite to be eligible to bill for services provided to state and federal health care program beneficiaries. CLIA is user-fee funded. Therefore, all costs of administering the program must be covered by the regulated facilities, including certification and survey costs.

We are subject to survey and inspection every two years to assess compliance with program standards, and may be subject to additional unannounced inspections. Laboratories performing high complexity testing are required to meet more stringent requirements than laboratories performing less complex tests. In addition, a laboratory like ours that is certified as “high complexity” under CLIA may obtain analyte specific reagents, which are used to develop LDTs.

In addition to CLIA requirements, we must comply with the standards set by CAP, which accredits our laboratory. Under CMS requirements, accreditation by CAP is sufficient to satisfy the requirements of CLIA. Therefore, because we are

 

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accredited by CAP, we are deemed to also comply with CLIA. CLIA also provides that a state may adopt laboratory regulations that are more stringent than those under federal law, and certain states have implemented their own more stringent laboratory regulatory schemes.

Federal, State and Foreign Fraud and Abuse Laws

A variety of federal and state laws prohibit fraud and abuse. These laws are interpreted broadly and enforced aggressively by various state and federal agencies, including CMS, the Department of Justice, the Office of Inspector General for HHS, and various state agencies. In addition, the Medicare and Medicaid programs increasingly use a variety of contractors to review claims data and to identify improper payments as well as fraud and abuse. These contractors include Recovery Audit Contractors, Medicaid Integrity Contractors and Zone Program Integrity Contractors. In addition, CMS conducts Comprehensive Error Rate Testing audits, the purpose of which is to detect improper Medicare payments. Any overpayments identified must be repaid unless a favorable decision is obtained on appeal. In some cases, these overpayments can be used as the basis for an extrapolation, by which the error rate is applied to a larger universe of claims, and which can result in even higher repayments.

The federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting, receiving, or providing remuneration, directly or indirectly, to induce or in return for either the referral of an individual, or the furnishing, recommending, or arranging for the purchase, lease or order of any health care item or service reimbursable, in whole or in part, under a federal health care program. The definition of “remuneration” has been broadly interpreted to include anything of value, including gifts, discounts, credit arrangements, payments of cash, ownership interests and providing anything at less than its fair market value. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements within the health care industry, the Office of Inspector General for HHS has issued a series of regulatory “safe harbors.” These safe harbor regulations set forth certain requirements that, if met, will assure immunity from prosecution under the federal Anti- Kickback Statute. Although full compliance with these provisions ensures against prosecution under the federal Anti-Kickback Statute, the failure of a transaction or arrangement to fit within a specific safe harbor does not necessarily mean that the transaction or arrangement is illegal or that prosecution under the federal Anti-Kickback Statute will be pursued. For further discussion of the impact of federal and state health care fraud and abuse laws and regulations on our business, see the section entitled “Risk Factors—Regulatory Risks Relating to Our Business.” We are subject to federal and state health care fraud and abuse laws and regulations and could face substantial penalties if we are unable to fully comply with such laws.

In addition to the administrative simplification regulations discussed above, HIPAA also created two new federal crimes; health care fraud and false statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health care benefit program, including private third-party payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from federal health care programs, such as the Medicare and Medicaid programs. The false statements statute prohibits 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 health care benefits, items or services. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from federal health care programs.

Finally, another development affecting the health care industry is the increased enforcement of the federal False Claims Act and, in particular, actions brought pursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. The False Claims Act imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment to the federal government. The qui tam provisions of the False Claims Act allow a private individual to bring actions on behalf of the federal government and permit such individuals to share in any amounts paid by the entity to the government in fines or settlement. In addition, various states have enacted false claim laws analogous to the federal False Claims Act, and some of these state laws apply where a claim is submitted to any third-party payor. When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties ranging from $5,500 to $11,000 for each false claim.

Additionally, in Europe various countries have adopted anti-bribery laws providing for severe consequences, in the form of criminal penalties and/or significant fines for individuals and/or companies committing a bribery offence. Violations of these anti-bribery laws, or allegations of such violations, could have a negative impact on our business, results

 

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of operations and reputation. For instance, in the United Kingdom, under the Bribery Act 2010, a bribery occurs when a person offers, gives or promises to give a financial or other advantage to induce or reward another individual to improperly perform certain functions or activities, including any function of a public nature. Bribery of foreign public officials also falls within the scope of the Bribery Act 2010. Under the new regime, an individual found in violation of the Bribery Act 2010 faces imprisonment of up to 10 years. In addition, the individual can be subject to an unlimited fine, as can commercial organizations for failure to prevent bribery.

Physician Referral Prohibitions

Under a federal law directed at “self-referral,” commonly known as the Stark Law, there are prohibitions, with certain exceptions, on Medicare and Medicaid payments for laboratory tests referred by physicians who personally, or through a family member, have a “financial relationship” – including an investment or ownership interest or a compensation arrangement – with the clinical laboratory performing the tests. Several Stark Law exceptions are relevant to arrangements involving clinical laboratories, including: (1) fair market value compensation for the provision of items or services; (2) payments by physicians to a laboratory for clinical laboratory services; (3) certain space and equipment rental arrangements that satisfy certain requirements, and (4) personal services arrangements. The laboratory cannot submit claims to the Medicare Part B program for services furnished in violation of the Stark Law, and Medicaid reimbursements may be at risk as well. Penalties for violating the Stark Law include the return of funds received for all prohibited referrals, fines, civil monetary penalties and possible exclusion from the federal health care programs. Many states have comparable laws that are not limited to Medicare and Medicaid referrals.

Corporate Practice of Medicine

Numerous states have enacted laws prohibiting business corporations, such as us, from practicing medicine and employing or engaging physicians to practice medicine, generally referred to as the prohibition against the corporate practice of medicine. These laws are designed to prevent interference in the medical decision-making process by anyone who is not a licensed physician. Violation of these laws may result in civil or criminal fines, as well as sanctions imposed against us and/or the professional through licensure proceedings.

Direct Billing Laws and Other State Law Restrictions on Billing for Laboratory Services

Laws and regulations in certain states prohibit laboratories from billing physicians for testing that they order. Some of those laws and regulations apply only to anatomic pathology services while others extend to other types of testing as well. Some states may allow laboratories to bill physicians directly but may prohibit the physician (and, in some cases, other purchasers) from charging more than the purchase price for the services (or may allow only for the recovery of acquisition costs) or may require the physician to disclose certain information on the invoice. In some cases, and if not prohibited by law or regulation, we may bill physicians directly for the services that they order.

California State Laboratory Licensing

Our laboratory is licensed and in good standing under the State of California Department of Public Health standards. Our current licenses permit us to receive specimens obtained in California.

California state laws and regulations also establish standards for the day-to-day operations of clinical laboratories, including physical facility requirements and equipment, quality control and proficiency testing requirements. If we are found to be out of compliance with California statutory or regulatory standards, we may be subject to suspension, restriction or revocation of our laboratory license or assessed civil money penalties. The operator of a noncompliant laboratory may also be found guilty of a misdemeanor under California law. A finding of noncompliance, therefore, may result in harm to our business.

Other States’ Laboratory Testing

Several states require the licensure of out-of-state laboratories that accept specimens from those states. We are currently in the process of addressing the requirements for licensure in New York, and we have all required licenses and approvals from all other states.

 

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From time to time, other states may require out of state laboratories to obtain licensure in order to accept specimens from such states. If we identify any other state with such requirements or if we are contacted by any other state advising us of such requirements, we intend to follow instructions from the state regulators as to how we should comply with such requirements.

Other Regulatory Requirements

Our laboratory is subject to federal, state and local regulations relating to the handling and disposal of regulated medical waste, hazardous waste and biohazardous waste, including chemical, biological agents and compounds, blood and bone marrow samples and other human tissue. Typically, we use outside vendors who are contractually obligated to comply with applicable laws and regulations to dispose of such waste. These vendors are licensed or otherwise qualified to handle and dispose of such waste.

The Occupational Safety and Health Administration has established extensive requirements relating to workplace safety for health care employers, including requirements to develop and implement programs to protect workers from exposure to blood-borne pathogens by preventing or minimizing any exposure through needle stick or similar penetrating injuries.

Segment and Geographical Information

We operate in one reportable business segment and historically have derived revenues only from the United States.

Employees

As of June 30, 2013, we had a total of 27 full-time and one part time employee, five of whom hold doctorate degrees and seven of whom are engaged in full-time research and development activities. We plan to expand production, sales and marketing and our research and development programs, and we plan to hire additional staff as these initiatives are implemented. None of our employees is represented by a labor union.

Properties

We have a lease for approximately 48,000 square feet of space in San Diego, California for use as a clinical reference laboratory and corporate headquarters, including manufacturing and research laboratories. The average rent for the remaining lease period is approximately $106,500 per month. This lease expires in 2020.

In September 2013, we entered into an amendment of the lease, extending the term for 21 months so that it now ends on July 31, 2020 and providing for five months of free base rent (August 2013 – December 2013). In return, we agreed, among other things, to forfeit our security deposit and to issue common stock warrants to the landlord. The number of shares subject to the common stock warrants will be determined by dividing the warrant coverage amount of $502,605, which is 100% of the five months of base rent forgone, by the exercise price, which will be set at the price per share of our common stock sold in our initial public offering. The warrants will be exercisable for a five-year period beginning on the closing of our initial public offering.

In September 2012, in connection with an amendment of the lease, which included a rent deferral through December 31, 2012, we issued to our landlord warrants to purchase an aggregate of 66,666 shares of our Series A preferred stock at an exercise price of $0.60 per share. These warrants are exercisable through September 2019 and, in connection with the closing of this offering, will become exercisable for 2,222 shares of our common stock at an exercise price of $18.00 per share.

 

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Legal Proceedings

In the normal course of business, we may be involved in legal proceedings or threatened legal proceedings. We are not party to any legal proceedings or aware of any threatened legal proceedings which are expected to have a material adverse effect on our financial condition, results of operations or liquidity.

Thomas Burns, our former Vice President of Operations, filed an administrative proceeding against us with the California Labor Commissioner in June 2013, seeking damages for alleged unpaid wages and penalties. After a hearing held on August 19, 2013, the California Labor Commissioner ruled that Mr. Burns was entitled to an award of approximately $62,000 against us.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth the name, age and position of each of our directors and executive officers.

 

Name

   Age   

Position

   Served as an
Officer  or Director
Since
 

David F. Hale

   64    Executive Chairman of the Board of Directors      2011   

Marsha A. Chandler(3)

   68    Director      2013   

Bruce E. Gerhardt, CPA(1)

   62    Director      2010   

Bruce A. Huebner

   63    Director      2013   

Michael W. Nall

   50    Director, Chief Executive Officer and President      2013   

Edward Neff(1)

   61    Director      2006   

Ivor Royston, M.D.(2)(3)

   68    Director      2010   

M. Faye Wilson(1)(2)(3)

   75    Director      2009   

Lyle J. Arnold, Ph. D.

   67    Senior Vice-President of Research & Development, Chief Scientific Officer      2011   

Farideh Z. Bischoff, Ph. D.

   48    Vice-President Translational Research and Clinical Development      2007   

William G. Kachioff

   47    Senior Vice-President of Finance and Chief Financial Officer      2011   

 

(1) Audit Committee
(2) Compensation Committee
(3) Nominating and Corporate Governance Committee

Our board of directors is classified into three classes of two or three directors each, with all directors serving for a three-year term and the directors of only one class being elected at each annual meeting of stockholders, so that the terms of the classes of directors are “staggered.” The directors in Class I are Mr. Gerhardt and Mr. Neff. The next election of Class I directors by stockholders will be at our 2014 annual meeting of stockholders, with the elected candidates to then serve until our 2017 annual meeting of stockholders. The directors in Class II are Dr. Chandler, Mr. Huebner and Dr. Royston. The next election of Class II directors by stockholders will be at our 2015 annual meeting of stockholders, with the elected candidates to then serve until our 2018 annual meeting of stockholders. The directors in Class III are Mr. Hale, Mr. Nall and Ms. Wilson. The next election of Class III directors by stockholders will be at our 2016 annual meeting of stockholders, with the elected candidates to then serve until our 2019 annual meeting of stockholders.

Our executive officers are elected by, and serve at the discretion of, our board of directors. There are no family relationships among any of our directors and executive officers, except that Edward Neff is an uncle of Michael W. Nall. The business experience for the past five years (and, in some instances, for prior years) of each of our executive officers and directors is as follows:

David F. Hale

Mr. Hale was appointed as our Executive Chairman in March 2011. He is the Chairman and CEO of Hale BioPharma Ventures LLC, a private company focused on the formation and development of biotechnology, specialty pharma,

 

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diagnostic and medical device companies. He has also been the Chairman of Santarus, Inc., a specialty biopharmaceutical company, since 2004 and a member of Santarus’ board since 2000. He also serves as Chairman of Conatus Pharmaceuticals, Inc. He was previously President and CEO of CancerVax Corporation from October 1999 through its merger in May 2006 with Micromet, Inc., a biotechnology company focused on the development of novel biological products for the treatment of cancer, when he became Chairman of the combined companies. He is a co-founder and served as Chairman of Somaxon Pharmaceuticals, Inc. before its acquisition by Pernix Therapeutics Holdings, Inc., and as Chairman of SkinMedica, Inc., before its acquisition by Allergan, Inc. He also serves as Chairman of Neurelis, Inc., Coloresciences, Inc., CRISI Medical Systems, Inc. and other private companies. Mr. Hale is a serial entrepreneur who has been involved in the founding and/or development of a number of life sciences technology companies. In 1982, after joining Hybritech, Inc., the first monoclonal antibody company, he served as COO, President and then Chief Executive Officer, until Hybritech was acquired by Eli Lilly and Co. in 1986. From 1987 until 1997 he was Chairman, President and CEO of Gensia, Inc., which merged with SICOR to become Gensia Sicor, Inc., which was later acquired by Teva Pharmaceuticals. He was a co-founder and Chairman of Viagene, Inc. from 1987 to 1995, when Viagene was acquired by Chiron, Inc. He was President and CEO of Women First HealthCare, Inc. from late 1997 to June 2000, before joining CancerVax in October 1999. Before joining Hybritech, Mr. Hale was Vice President and General Manager of BBL Microbiology Systems, a diagnostics division of Becton, Dickinson & Co. and from 1971 to 1980, held various marketing and sales management positions with Ortho Pharmaceutical Corporation, a division of Johnson & Johnson, Inc.

We selected Mr. Hale to serve on and lead our board of directors due to his public and private company board experience as well as his extensive experience with and knowledge of health care issues and the operational activities of life sciences companies.

Marsha A. Chandler

Dr. Chandler has been the Executive Vice President/Chief Operating Officer of the Salk Institute for Biological Studies since 2007. She oversees the fiscal and administrative functions of the Institute, providing support to approximately 870 research staff and 230 administrative personnel, and oversees all fund-raising activities. From 1997 to 2007 she served as Senior Vice Chancellor for Academic Affairs at the University of California, San Diego, where she was the chief academic officer responsible for the policies and decisions relating to all academic programs and faculty appointments and performance. She served as Acting Chancellor from 2003-04 and holds an appointment as Professor of Political Science in the Graduate School of International Relations and Pacific Studies at UCSD.

Dr. Chandler is a Fellow of the Royal Society of Canada, the highest academic honor bestowed in that country. She received her Ph.D. from The University of North Carolina at Chapel Hill.

We selected Dr. Chandler to serve on our board of directors due to her experience in organizational management and her stature in the life sciences community. Dr. Chandler also serves as a member of our nominating and corporate governance committee.

Bruce E. Gerhardt

Mr. Gerhardt has been self-employed, practicing as a Certified Public Accountant, since 1986. He is also a tax and business advisor providing tax compliance for small businesses and upper income individuals. He earned his Bachelor of Arts Degree from the University of Southern California in 1973 and is a member of the American Institute of Certified Public Accountants.

We selected Mr. Gerhardt to serve on our board of directors due to his experience and expertise in financial accounting and auditing. Mr. Gerhardt also serves as a member of our audit committee.

Bruce A. Huebner

Mr. Huebner is currently and has been since 2004 a managing director of LynxCom Partners LLC, a healthcare consulting firm with a focus on cancer diagnostics and personalized medicine. Since March 2013 he has been Chairman of Vermillion, Inc., a publicly held molecular diagnostics company. He served as Interim Chief Executive Officer and President of Vermillion from November 2012 to March 2013. From October 2009 to June 2010, Mr. Huebner served as

 

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President and Chief Executive Officer of TrovaGene, Inc., a developer of molecular diagnostics products. From 2005 to 2008, Mr. Huebner served as President of Osmetech Molecular Diagnostics, obtaining FDA clearance for four molecular diagnostic microarray products and introducing them to the marketplace. From 2002 to 2004, Mr. Huebner was President and Chief Operating Officer of Nanogen, Inc., a publicly held nanotechnology/microarray company. From 1996 to 2002, Mr. Huebner was Executive Vice President and Chief Operating Officer of Gen-Probe Incorporated, a leader in the development of nucleic acid tests.

Mr. Huebner received his Bachelor of Science degree in Chemistry from the University of Wisconsin-La Crosse and completed a graduate school senior executive program at Columbia University.

We selected Mr. Huebner to serve on our board of directors due to his strong background in cancer diagnostics sales, marketing, operations and reimbursement. Mr. Huebner also serves as a member of our compensation committee.

Michael W. Nall

Mr. Nall has over 25 years of healthcare sales and marketing experience, most recently serving at Clarient Diagnostic Services, Inc. in positions of increasing responsibility from 2002 through August 2013, with his last position being General Manager, North American Sales and Marketing. While at Clarient, Mr. Nall was also responsible for leading the team assimilating Clarient into GE Healthcare after Clarient was acquired in 2010.

From 1988 until joining Clarient, Mr. Nall served in the diagnostic and medical device industries in various commercial leadership roles for companies including Impath, American Cyanamid, Maquet Surgical, Strato Medical, Horizon Medical Products and Columbia Vital Systems.

Mr. Nall received a Bachelor of Science degree in Business Administration from Central Missouri State University (now known as the University of Central Missouri).

We selected Mr. Nall to serve on our board of directors due to his experience in the cancer diagnostics business, his expertise in the commercialization of products and services such as ours, his background in reimbursement and operations and his status as our chief executive officer and president.

Mr. Nall is a nephew of our director Edward Neff.

Edward Neff

Since 1990, Mr. Neff has been the Chief Executive Officer of Systems, Machines, Automation Components Corporation (also known as SMAC), a manufacturer of moving coil electric actuators.

Mr. Neff has received over 25 United States patents relating to robotics and precise automation. He is a graduate of the University of Michigan.

We selected Mr. Neff to serve on our board of directors due to his experience and expertise in business management and in automated systems. Mr. Neff also serves as a member of our audit committee.

Mr. Neff is an uncle of our Chief Executive Officer, President and director Michael W. Nall.

Ivor Royston, M.D.

Dr. Royston co-founded Forward Ventures and has served as its Managing Partner since 2000. From 1990 to 2000, he served as founding President and CEO of The Sidney Kimmel Cancer Center and from 1978 to 1990, he was a member of the oncology faculty of the University of California, San Diego. In addition to being a co-founder of Hybritech, Inc., in 1986 he co-founded IDEC Corporation, which later merged with Biogen to form BiogenIdec. Dr. Royston has been instrumental in the formation, financing and development of numerous biotechnology companies, including Applied Molecular Evolution (acquired by Eli Lilly), Corixa (acquired by GlaxoSmithKline), Dynavax, LigoCyte (acquired by Takeda), Morphotek (acquired by Eisai), Sequana Therapeutics (acquired by Celera), TargeGen (acquired by Sanofi-Aventis), and Triangle Pharmaceuticals (acquired by Gilead). He is currently a director of MMRGlobal, Inc., a publicly-traded health records management company. Dr. Royston received his B.A. and M.D. degrees from Johns Hopkins University and completed post-doctoral training in internal medicine and medical oncology at Stanford University. In 1997, President Clinton appointed Dr. Royston to a six-year term on the National Cancer Advisory Board.

We selected Dr. Royston to serve on our board of directors due to his extensive experience with emerging life sciences companies. Dr. Royston also serves as chair of our compensation committee and as a member of our nominating and governance committee.

 

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M. Faye Wilson

Ms. Wilson has been a principal of Wilson Boyles & Co., LLC, a business management and strategic planning consulting firm, since 2003. Ms. Wilson is also a member of the board of directors of BioMed Realty Trust, Inc., a real estate investment trust. She served on the board of directors of Farmers Insurance Group of Companies from 1992 through 1998 and the board of directors of The Home Depot, Inc. from 1991 through 2001. Ms. Wilson was also a senior officer of Home Depot from 1998 through 2002. From 1992 until 1998, Ms. Wilson served in several senior management roles at Bank of America Corporation including Chairman of Security Pacific Financial Services and Executive Vice President and Chief Credit Officer for Bank of America’s National Consumer Banking Group. She earned her Master’s Degrees in International Relations and Business Administration from the University of Southern California and an undergraduate degree from Duke University.

We selected Ms. Wilson to serve on our board of directors due to her extensive experience as a director of public companies, her financial acumen and experience, and her expertise in business strategy. Ms. Wilson also serves as chairwoman of our audit committee, as a member of our compensation committee and as a member of our nominating and governance committee.

Lyle J. Arnold, Ph. D.

Dr. Arnold joined us as Senior Vice President and Chief Scientific Officer in 2011. Before then, he consulted for us from May 2010 to April 2011. He is a biotechnology executive, entrepreneur, and developer of innovative technologies covering therapeutics, molecular diagnostics, and genomics. Dr. Arnold also serves as President of Aegea Biotechnologies, Inc., which he founded in 2010 to acquire, develop, and commercialize next generation nucleic acid technologies. Previously he was Vice President, Research at Gen-Probe Incorporated from September 2003 to October 2009. During the time between departing from Gen-Probe and joining us, Dr. Arnold worked as a consultant for various entities through Lyle Arnold Consulting LLC, and started Aegea Biotechnologies in February 2010. He has also held senior scientific and management positions at Molecular Biosystems (co-founder), Genta, Synteni, Incyte Genomics, and Oasis Biosciences (co-founder), where he was President and Chief Scientific Officer from October 2001 to September 2003. In addition, Dr. Arnold was a faculty member of the UCSD School of Medicine and a member of the UCSD Cancer Center. Dr. Arnold is an inventor or co-inventor on 38 issued U.S. patents and more than 140 issued and pending patents worldwide. He is the principal inventor of the chemiluminescent Hybridization Protection Assay (HPA) and associated technologies, core to Gen-Probe assays that have generated more than $5 billion in product revenue. In addition, he has authored more than 50 scientific publications. Dr. Arnold serves on the board of directors of Asuragen, a rapidly emerging biotechnology company in Austin, Texas, as well as on the board of Aegea.

He received a B.S. in Chemistry from the University of California at Los Angeles and a Ph.D. in Chemistry/Biochemistry from the University of California at San Diego.

Farideh Z. Bischoff, Ph. D.

Dr. Bischoff joined us in 2007 as Director of Translational Research and Development and has been Vice President, Translational Research and Clinical Development since 2011. From 1994 to 2007, she was a full-time faculty member in the Department of Obstetrics/Gynecology at Baylor College of Medicine. An expert in clinical cytogenetics and molecular human genetics, she has conducted research and focused on clinical assays relevant to non-invasive (prenatal) genetic testing and more recently cancer screening and surveillance. Dr. Bischoff has been a key investigator in a multi-center NIH/NICHD funded study focused on establishment of protocols and investigations into the clinical utility of circulating rare fetal cells as well as cell-free DNA/RNA for noninvasive prenatal genetic diagnosis. She was also charged with establishment and supervision of the molecular cytogenetic pre-implantation genetic diagnostic (PGD) program at Baylor College of Medicine.

She holds a Ph.D. in Cancer Biology from University of Texas Graduate School for Biomedical Sciences, with postdoctoral training at the MD Anderson Cancer Center and Baylor College of Medicine. Her graduate thesis project

 

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directly contributed to the discovery of germline p53 mutations in Li-Fraumeni cancer patients. Dr. Bischoff has published numerous peer-reviewed papers and book chapters.

William G. Kachioff

Mr. Kachioff, who joined us as Senior Vice President and Chief Financial Officer in August 2011, is experienced in corporate finance, investor relations, corporate governance and manufacturing accounting and systems. He has over twenty years of experience in the life science industry, having most recently served as Vice President and Chief Financial Officer at Althea Technologies, Inc., a pharmaceutical contract manufacturer, from 2009 to 2011. From 2007 to 2009 he was a CFO Partner with Tatum LLC, a national Executive Services firm, where he served a variety of life science industry clients in senior financial management roles. From 2002 to 2005, Mr. Kachioff was Chief Financial Officer at MicroIslet, a publicly traded biotechnology company developing cell transplant therapies for insulin dependent diabetes. From 1999 to 2001, he was Director of Finance at Cutera where he helped prepare the company for the commercial launch of its first product and its initial public offering. Mr. Kachioff has also served in a variety of financial management roles at Coulter Pharmaceutical, Vivus and Abbott Laboratories. He began his professional career as an auditor with Deloitte LLP.

Mr. Kachioff has a B.S. in Management from the University at Buffalo, State University of New York with concentrations in Accounting and Information Systems. He is a member of the American Institute of Certified Public Accountants and the Association of Bioscience Financial Officers.

Director Independence

Upon the completion of this offering, we expect our common stock will be listed on The NASDAQ Capital Market. Under the rules of The NASDAQ Stock Market, independent directors must comprise a majority of a listed company’s board of directors within 12 months after the completion of an initial public offering. In addition, the rules of The NASDAQ Stock Market require that, (i) on the date of the completion of this offering, at least one member of our audit, compensation and nominating and corporate governance committees be independent, (ii) within 90 days after the date of the completion of our initial public offering, a majority of the members of such committees be independent and (iii) within one year after the date of the completion of our initial public offering, all the members of such committees be independent. Audit committee members must also satisfy the independence criteria set forth in Rule 10A-3 under the Exchange Act. Under the rules of The NASDAQ Stock Market, a director will only qualify as an “independent director” if, in the opinion of that company’s board of directors, that person does not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director.

In order to be considered to be independent for purposes of Rule 10A-3, a member of an audit committee of a listed company may not, other than in his or her capacity as a member of the audit committee, the board of directors, or any other board committee: (1) accept, directly or indirectly, any consulting, advisory or other compensatory fee from the listed company or any of its subsidiaries or (2) be an affiliated person of the listed company or any of its subsidiaries.

Our board of directors undertook a review of its composition, the composition of its committees and the independence of each director. Based upon information requested from and provided by each director concerning his background, employment and affiliations, including family relationships, our board of directors has determined that Dr. Chandler, Mr. Gerhardt, Mr. Huebner, Mr. Neff, Dr. Royston and Ms. Wilson, or six of our eight directors, do not have a relationship that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director and that each of these directors is “independent” as that term is defined under the rules of The NASDAQ Stock Market.

Our board of directors also determined that (i) Messrs. Neff and Gerhardt and Ms. Wilson, who compose our audit committee, (ii) Dr. Royston, Mr. Huebner and Ms. Wilson, who compose our compensation committee, and (iii) Dr. Royston, Dr. Chandler and Ms. Wilson, who compose our nominating and corporate governance committee, each satisfy the independence standards for those committees established by the applicable rules and regulations of the SEC and The NASDAQ Stock Market. In making this determination, our board of directors considered the relationships that each non-employee director has with us and all other facts and circumstances our board of directors deemed relevant in determining their independence, including the beneficial ownership of our capital stock by each non-employee director. We intend to comply with all size and independence requirements for committees within the applicable time periods.

 

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EXECUTIVE COMPENSATION

Summary Compensation Table

The following table shows the compensation awarded to or earned in our last two fiscal years by our principal executive officer and our four most highly compensated executive officers who were serving as executive officers as of December 31, 2012. The persons listed in the following table are referred to herein as the “named executive officers.”

 

Name and Principal Position

   Year      Salary
($)(1)
    Option
Awards  ($)(7)
     Other
Compensation
($)(8)
     Total  

David F. Hale

     2012         323,406 (2)      —           —         $ 323,406   

Executive Chairman

     2011         261,094 (2)      27,530         —         $ 288,624   

Michael J. Dunn

     2012         263,844 (3)      —           —         $ 263,844   

SVP, Corporate Development

     2011         216,360 (3)      19,350         —         $ 235,710   

William G. Kachioff

     2012         222,843 (4)      —           —         $ 222,843   

SVP Finance, Chief Financial Officer

     2011         89,343 (4)      15,600         —         $ 104,943   

Lyle J. Arnold, Ph. D.

     2012         210,063 (5)      —           —         $ 210,063   

SVP R&D, Chief Scientific Officer

     2011         142,298 (5)      16,125         —         $ 158,423   

Farideh Z. Bischoff, Ph. D.

     2012         168,091 (6)      —           76,337       $ 244,428   

VP of Translational Research and Clinical Development

     2011         150,032 (6)      3,225         7,080       $ 160,337   

 

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(1) The “Salary” column includes both salary paid and salary amounts deferred under each named executive officer’s amended and restated Salary Reduction and Contingent Payment Agreement, 8% annual interest (compounded monthly) on such deferred salary amounts, and vacation earned but not taken (“accrued vacation”), in each year ended December 31. For information regarding the amended and restated Salary Reduction and Contingent Payment Agreement arrangements, see “Executive Compensation - Narrative Disclosure to Summary Compensation Table - Salary Deferrals.”
(2) Mr. Hale commenced employment on March 10, 2011. 2012 salary amounts include deferred salary of $266,720, interest on deferred salary of $15,049, and accrued vacation of $8,369. 2011 salary amounts include deferred salary of $61,551 and accrued vacation of $17,325.
(3) Mr. Dunn commenced employment on February 15, 2011 and resigned effective on July 31, 2013. 2012 salary amounts include deferred salary of $83,534, interest on accrued salary of $1,628, and accrued vacation of $12,216. 2011 salary amounts include accrued vacation of $14,437.
(4) Mr. Kachioff commenced employment on August 1, 2011. 2012 salary amounts include deferred salary of $94,700, interest on accrued salary of $3,331, and accrued vacation of $4,512. 2011 salary amounts include deferred salary of $6,615 and accrued vacation of $6,605.
(5) Dr. Arnold commenced employment on April 30, 2011. 2012 salary amounts include deferred salary of $64,123, interest on accrued salary of $1,252, and accrued vacation of $8,810. 2011 salary amounts include accrued vacation of $15,375.
(6) 2012 salary amounts include deferred salary of $68,606, interest on accrued salary of $2,420, and accrued vacation of $2,656. 2011 salary amounts include deferred salary of $4,615 and interest on accrued salary of $32.
(7) Represents the aggregate grant date fair value for grants made in 2012 and 2011 computed in accordance with FASB ASC Topic 718. The assumptions we used in valuing the options are described in note 9 to our audited financial statements included in this prospectus.
(8) Includes car and telephone allowances to Dr. Bischoff in each of 2012 and 2011, and a $46,832 commuting expenses reimbursement benefit we provided to Dr. Bischoff in 2012 plus $22,425 of income taxes we paid for Dr. Bischoff in respect of such 2012 benefit.

Narrative Disclosure to Summary Compensation Table

David F. Hale

As of March 10, 2011, we entered into an employment agreement, effective retroactive to January 1, 2011 (“Executive Chairman Agreement”), with David F. Hale in connection with his appointment as our Executive Chairman of the Board of Directors. The Executive Chairman Agreement is effective through December 31, 2013. The Executive Chairman Agreement provides Mr. Hale the following: (i) a monthly fee of $25,000 per month for each month before our board of directors appoints a chief executive officer and for each of the three months following the appointment of the new chief executive officer, with a reduction to $12,500 per month commencing with the fourth month following the appointment of the new chief executive officer (i.e., commencing with December 2013), subject to normal employee payroll deductions and withholdings; and (ii) stock options under our 2007 Equity Incentive Plan to purchase 14,286 shares of common stock, vesting in equal monthly installments over a 4 year period, with full vesting upon a change of control or initial public offering. In addition, vesting would accelerate upon his termination by us or our shareholders without cause, as defined in the 2007 Equity Incentive Plan, provided that he gives us an effective waiver and release of claims. Also, upon an equity financing such as this offering, Mr. Hale will be entitled to receive an additional stock option, on the same terms and conditions except for exercise price, to purchase a number of shares of common stock equal to the excess of (i) 1% of our fully-diluted equity capitalization as of immediately after the financing over (ii) the number of shares subject to the first stock option.

The Executive Chairman Agreement also entitled Mr. Hale to restricted stock units (“RSUs”). Mr. Hale received a time-based RSU award for 428,597 shares of our preferred stock, to fully vest and settle upon a change in control or initial public offering during the period of his continuous service. Mr. Hale would receive a prorated portion of such shares if the change in control or initial public offering occurs within 10 years after January 1, 2011 but after the involuntary termination of his continuous service. The proration would be based upon the number of months he provided continuous service to us divided by 48; but the RSUs would be deemed vested in full upon his involuntary termination without cause, provided that

 

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he gives us an effective waiver and release of claims. Upon the closing of this offering, Mr. Hale would receive 14,286 shares of common stock in settlement of the time-based RSUs.

The Executive Chairman Agreement also entitled Mr. Hale to a performance-based RSU award, which is divided into three equal tranches, each representing shares of our preferred stock equal to 0.5% of our fully-diluted equity capitalization, and each to fully vest and settle upon a change in control or initial public offering occurring within 10 years after January 1, 2011. The tranches were associated with achievement of a specified commercial milestone, a specified funding milestone, and specified leadership milestones. The Executive Chairman Agreement provides that if a change in control or initial public offering occurs during the time of his continuous service but before the performance requirements are achieved, he will be entitled to receive 0.5% of our fully-diluted equity capitalization as of immediately before such event for each of the three tranches. Upon the closing of this offering, Mr. Hale would receive in settlement of the three tranches of the performance-based RSUs a number of shares of common stock equal to 1.5% of our fully-diluted equity capitalization as of immediately before the closing of this offering.

Michael J. Dunn

We entered into an employment agreement as of February 15, 2011 (“SVP Corporate Development Employment Agreement”) with Michael J. Dunn in connection with his appointment as our Senior Vice-President of Corporate Development. The SVP Corporate Development Employment Agreement provided Mr. Dunn the following: (i) a base salary of $250,000 per year, provided that the salary will increase by $25,000 per year upon the finalization of one or more corporate collaborations or other investments that provide at least $15,000,000 in financing to us; (ii) stock options under our 2007 Equity Incentive Plan to purchase 8,333 shares of common stock, with 25% of all shares vesting on the one year anniversary of his employment start date and the remainder vesting in equal monthly installments over the following 3 year period; and (iii) an additional option to purchase 1,666 shares of common stock, vesting in equal monthly installments over a one year period, to be issued upon the completion of a corporate collaboration providing at least $5,000,000 in financing to us.

Mr. Dunn resigned effective on July 31, 2013.

William G. Kachioff

We entered into an employment agreement as of August 1, 2011 (“CFO Employment Agreement”) with William G. Kachioff in connection with his appointment as our Senior Vice-President and Chief Financial Officer. The CFO Employment Agreement provides Mr. Kachioff the following: (i) a base salary of $215,000 per year, provided that the salary will increase to $240,000 per year upon our receipt of aggregate proceeds of $15,000,000 or more from the sales of equity securities, excluding the conversion of outstanding indebtedness; (ii) a one-time bonus of $30,000 upon our receipt of aggregate proceeds of $15,000,000 or more from the sales of equity securities, excluding the conversion of outstanding indebtedness; (iii) stock options under our 2007 Equity Incentive Plan to purchase 8,333 shares of common stock, with 25% of all shares vesting on the one year anniversary of the grant and the remainder vesting in equal monthly installments over the following 3 year period; and (iv) an additional option to purchase 1,666 shares of common stock to be issued upon our receipt of aggregate proceeds of $15,000,000 or more from the sales of equity securities, excluding the conversion of outstanding indebtedness.

Lyle J. Arnold

We entered into an employment agreement as of April 30, 2011 (“CSO Employment Agreement”) with Lyle J. Arnold in connection with his appointment as our Senior Vice-President of Research and Development and Chief Scientific Officer. The CSO Employment Agreement provides Dr. Arnold the following: (i) a base salary of $200,000 per year, provided that the salary will increase to $250,000 per year upon our receipt of aggregate proceeds of $15,000,000 or more from the sales of equity securities, excluding the conversion of outstanding indebtedness; (ii) stock options under our 2007 Equity Incentive Plan to purchase 8,333 shares of common stock, with 25% of all shares vesting on the one year anniversary of the grant and the remainder vesting in equal monthly installments over the following 3 year period; and (iii) an additional option to purchase 1,666 shares of common stock when, based upon a good faith determination by our board of directors, a second generation platform for the capture, detection and enumeration of CTCs has been finalized.

 

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Salary Deferrals

Pursuant to written agreements with 10 officers and senior employees, we deferred payment of portions of such individuals’ salaries in 2012. In exchange we agreed to pay 8% per annum interest (compounded monthly) on the deferred amounts and to award them each, based on their election, either 500 common stock options or 500 restricted stock unit awards. Additional deferrals have been made in 2013 only from the salary of David F. Hale and the salary of one other employee. As of June 30, 2013, the deferred salary amount owing to Mr. Hale was $492,506 (inclusive of interest), the deferred salary amount owing to Dr. Arnold was $67,919 (inclusive of interest), the deferred salary amount owing to Dr. Bischoff was $78,578 (inclusive of interest), the deferred salary amount owing to Mr. Dunn was $88,288 (inclusive of interest), the deferred salary amount owing to Mr. Kachioff was $108,711 (inclusive of interest), and the aggregate deferred salary amount owing to the five other persons was $293,341 (inclusive of interest). One of the uses of the proceeds of this offering is to satisfy these deferred salary amounts of approximately $1 million.

Outstanding Equity Awards

The following table sets forth certain information, on an award-by-award basis, concerning unexercised options to purchase common stock and common stock that has not yet vested for each named executive officer and outstanding as of December 31, 2012. These figures have been adjusted to reflect both our November 2011 1-for-3 reverse common stock split and the 1-for-10 reverse common stock split to be effected immediately before the closing of this offering.

 

            Option Awards      Restricted Stock Units  

Name

   Grant
Date
     Number of
Securities
Underlying
Unexercised
Option (#)
Exercisable
     Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
     Option
Exercise
Price
($)
     Option
Expiration
Date
     Number of
Unvested
Securities
Underlying
(#)
    Market
Price of
Units
that
are
Unvested
($)
 

David F. Hale

     1/3/2011         7,143         7,143         3.30         1/1/2021         —          —     
     1/3/2011         —           —           —           —           14,286        141,437   
     1/3/2011         —           —           —           —           19,136 (1)      189,446   

Michael J. Dunn

     3/25/11         2,256         6,076         3.30         3/25/2021         —          —     
     3/25/11         1,666         —           3.30         3/25/2021         —          —     

William G. Kachioff

     8/1/2011         1,388         2,777         3.30         8/1/2021         —          —     
     8/1/2011         1,388         2,777         3.30         8/1/2021         —          —     

Lyle J. Arnold, Ph. D.

     4/30/2011         3,472         4,861         3.30         4/30/2021         —          —     

Farideh Z. Bischoff, Ph. D.

     8/11/2009         835         —           3.60         8/11/2019         —          —     
     8/11/2009         835         —           3.60         8/11/2019         —          —     
     8/11/2009         835         —           3.60         8/11/2019         —          —     

 

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            Option Awards      Restricted Stock Units  

Name

   Grant
Date
     Number of
Securities
Underlying
Unexercised
Option (#)
Exercisable
     Number of
Securities
Underlying
Unexercised
Options (#)
Unexercisable
     Option
Exercise
Price
($)
     Option
Expiration
Date
     Number of
Unvested
Securities
Underlying
(#)
     Market
Price of
Units
that
are
Unvested
($)
 
     8/11/2009         417         —           3.60         8/11/2019         —           —     
     8/11/2009         417         —           3.60         8/11/2019         —           —     
     3/25/2011         787         879         3.30         3/25/2021         —           —     

 

(1) Estimated.

Potential Payments upon Termination or Change-In-Control

Our employment agreement with Mr. Hale provides that his stock option for 14,286 shares of common stock will fully vest in the event of a change in control (or upon the completion of our initial public offering), and that his time-based RSU award for 428,597 shares of our preferred stock (equivalent to 14,286 shares of common stock) will fully vest and settle upon a change in control (or upon the completion of our initial public offering) during the period of his continuous service; he would receive a prorated portion of such shares if the change in control or initial public offering occurs within 10 years after January 1, 2011 but after the involuntary termination of his continuous service. The proration would be based upon the number of months he provided continuous service to us divided by 48; but the RSUs would be deemed vested in full upon his termination without cause, provided that he gives us an effective waiver and release of claims. The Executive Chairman Agreement also entitled Mr. Hale to a performance-based RSU award, which is divided into three equal tranches, each representing shares of our preferred stock equal to 0.5% of our fully-diluted equity capitalization, and each to settle upon a change in control (or upon the completion of our initial public offering) occurring within 10 years after January 1, 2011. The tranches were associated with achievement of a specified commercial milestone, a specified funding milestone, and specified leadership milestones. The Executive Chairman Agreement provides that if a change in control (or initial public offering) occurs during the time of his continuous service but before the performance requirements are achieved, he will be entitled to receive 0.5% of our fully-diluted equity capitalization as of immediately before such event for each of the three tranches. Because Mr. Hale’s time-based and performance-based RSUs under the Executive Chairman Agreement will both vest and settle upon the closing of this offering, Mr. Hale would receive no additional payments thereunder if a change in control occurs after the closing of this offering.

Our employment agreement with Mr. Dunn provided that if his continuous service was terminated without cause or he resigned with good reason then, provided that he gave us an effective waiver and release of claims, he would be entitled to 6 months’ salary plus up to 6 months of COBRA premiums. However, if he was terminated without cause or he resigned with good reason within 3 months before or 12 months after a change in control, then, provided that he gave us an effective waiver and release of claims, he would be entitled to 12 months’ salary plus up to 12 months of COBRA premiums, plus all his then-outstanding stock options would fully vest. Effective on July 31, 2013, Mr. Dunn resigned, and there was no right to any such severance payments.

Our employment agreement with Mr. Kachioff provides that if his continuous service is terminated without cause or he resigns with good reason then, provided that he gives us an effective waiver and release of claims, he will be entitled to 6 months’ salary plus up to 6 months of COBRA premiums. However, if he is terminated without cause or he resigns with good reason within 3 months before or 12 months after a change in control, then, provided that he gives us an effective waiver and release of claims, he will be entitled to 12 months’ salary plus up to 12 months of COBRA premiums. Additionally, all of his then-outstanding stock options will fully vest.

 

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Our employment agreement with Dr. Arnold provides that if his continuous service is terminated without cause or he resigns with good reason then, provided that he gives us an effective waiver and release of claims, he will be entitled to 6 months’ salary plus up to 6 months of COBRA premiums. However, if he is terminated without cause or he resigns with good reason within 3 months before or 12 months after a change in control, then, provided that he gives us an effective waiver and release of claims, he will be entitled to 12 months’ salary plus up to 12 months of COBRA premiums. Additionally, all of his then-outstanding stock options will fully vest.

The common stock RSUs granted to five of our non-employee directors under the 2007 Equity Incentive Plan provide for acceleration of vesting in the event of a change in control or the director’s involuntary removal from the board of directors by our shareholders without cause.

A total of 18,330 stock options granted to five of our non-employee directors under the 2007 Equity Incentive Plan were amended in February 2012 to provide for acceleration of vesting in the event of the director’s involuntary removal from the board of directors by our shareholders without cause, provided that the director gives us an effective waiver and release of claims.

The 390,000 preferred stock RSUs (equivalent to 13,000 shares of common stock) granted to Dr. Royston vest only upon a change in control or the effectiveness of an underwriting agreement for an initial public offering within 10 years. If Dr. Royston is still serving on the board at that time, all of the preferred stock RSUs would vest. If Dr. Royston was not serving on the board at that time, his entitlement would be equal to the full award multiplied by a fraction (not to exceed 1), the numerator of which is the number of months he served on the board and the denominator of which is 48. This RSU award was amended in February 2012 to provide that in the event of his involuntary removal from the board of directors by our shareholders without cause before the change in control or the effectiveness of an underwriting agreement for an initial public offering, then (provided that the director gives us an effective waiver and release of claims) all the preferred stock RSUs would vest upon the change in control or the effectiveness of an underwriting agreement for an initial public offering.

The vesting of all stock options and RSUs awarded under our 2013 Equity Incentive Plan will accelerate fully in the event that the optionee’s continuous service is terminated without cause, or the optionee resigns for good reason, within 10 days before or 12 months after a change in control. In addition, the vesting of all stock options and RSUs awarded in July 2013 to Mr. Hale, Mr. Kachioff, Dr. Arnold and Dr. Bischoff under our 2013 Equity Incentive Plan will, if the optionee’s continuous service persists through the first anniversary of a change in control, accelerate fully upon such first anniversary.

Director Compensation

In December 2010, our board of directors approved a resolution that each year on January 1, each non-employee director (with the exception of Mrs. Reiss and Mr. Neff) shall be automatically granted an annual RSU award under the 2007 Equity Incentive Plan covering a number of shares of common stock equal to 0.25% of our fully diluted outstanding capital stock as of the December 31 immediately preceding the applicable grant date of the RSUs. Such RSU awards were granted on January 1, 2011 and 2012, and vested in equal monthly installments over 12 months from the date of the grant. Additionally, in January 2012, each person who was serving as a non-employee director was granted a “true up grant” in addition to the annual RSU award covering a number of shares of common stock equal to 0.25% of our fully diluted outstanding capital stock as of December 31, 2011. These “true up grants” vested 100% on the date of the grant. In January 2012, five RSU awards, for a total of 29,300 shares of common stock, were granted in accordance with this resolution.

The RSU awards due to be granted on January 1, 2013 were not in fact granted. Instead, on July 31, 2013, RSU awards for 12,230 shares of common stock were granted to each of Mr. Gerhardt, Mr. Neff and Dr. Royston and a RSU award for 20,000 shares of common stock was granted to Ms. Wilson. These awards vest in equal monthly installments over five months beginning August 1, 2013. The shares underlying the 2013 awards, if vested, would be distributed no later than August 24, 2014.

During 2012, the non-employee directors received compensation for their service as follows (we have listed the value of the RSU awards in the “Restricted Stock Awards ($)” column):

 

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Name

   Fees Earned or
Paid in Cash ($)(1)
     Option
Awards  ($)(2)
     Restricted
Stock
Awards
($)(3)
     Total
($)