10-K 1 htgm-10k_20161231.htm 10-K htgm-10k_20161231.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

For the fiscal year ended December 31, 2016

OR

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

Commission File Number 001-37369

 

HTG Molecular Diagnostics, Inc.

(Exact name of Registrant as specified in its Charter)

 

 

Delaware

 

86-0912294

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3430 E. Global Loop

Tucson, AZ

 

85706

(Address of principal executive offices)

 

(Zip Code)

Registrant’s telephone number, including area code: (877) 289-2615

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.001 per share

 

The NASDAQ Global Market

 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES      NO  

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.    YES      NO  

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

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    YES      NO  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 

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 definition 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 small reporting company)

  

Small reporting company

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES      NO  

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The NASDAQ Global Market on June 30, 2016, was $8,218,698.

The number of shares of Registrant’s Common Stock outstanding as of March 17, 2017 was 8,052,451.

 

 

 

 

 

 


 

Table of Contents

 

 

 

Page

PART I

 

 

Item 1.

Business

2

Item 1A.

Risk Factors

37

Item 1B.

Unresolved Staff Comments

66

Item 2.

Properties

66

Item 3.

Legal Proceedings

67

Item 4.

Mine Safety Disclosures

67

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

68

Item 6.

Selected Financial Data

69

Item 7.

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

70

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

80

Item 8.

Financial Statements and Supplementary Data

80

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

116

Item 9A.

Controls and Procedures

116

Item 9B.

Other Information

116

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

117

Item 11.

Executive Compensation

125

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

138

Item 13.

Certain Relationships and Related Transactions, and Director Independence

140

Item 14.

Principal Accounting Fees and Services

144

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

145

Item 16.

Form 10-K Summary

145

 

 

 

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PART I

Unless the context requires otherwise, references to “HTG,” “HTG Molecular Diagnostics,” “we,” “us” and “our” refer to HTG Molecular Diagnostics, Inc.

Forward-Looking Statements

This Annual Report on Form 10-K, including the sections entitled “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may contain forward-looking statements. We may, in some cases, use words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” or the negative of those terms, and similar expressions that convey uncertainty of future events or outcomes, to identify these forward-looking statements. Any statements contained herein that are not statements of historical facts may be deemed to be forward-looking statements. Forward-looking statements in this Annual Report include, but are not limited to, statements about:

 

our ability to successfully commercialize our products and services, including our HTG EdgeSeq assays and corresponding automation systems;

 

our ability to generate sufficient revenue or raise additional capital to meet our working capital needs;

 

our ability to secure regulatory clearance or approval, domestically and internationally, for the clinical use of our products;

 

our ability to develop new technologies to expand our product offerings, including direct-target sequencing for detection of mutations in genomic DNA and/or expressed RNA (such as single-point mutations and gene rearrangements, like gene fusions and insertions), and methods to detect mutation load and microsatellite instability;

 

the implementation of our business model and strategic plans for our business;

 

the regulatory regime for our products, domestically and internationally;

 

our strategic relationships, including with holders of intellectual property relevant to our technologies, manufacturers of next-generation sequencing, or NGS, instruments and consumables, critical component suppliers, distributors of our products, and third parties who conduct our clinical studies;

 

our intellectual property position;

 

our expected use of proceeds from our initial public offering;

 

our ability to comply with the restrictions of our debt facility and meet our debt obligations;

 

our expectations regarding the market size and growth potential for our life sciences and diagnostic businesses;

 

our expectations regarding trends in the demand for sample processing by our biopharmaceutical customers;

 

any estimates regarding expenses, future revenues, capital requirements, and stock performance; and

 

our ability to sustain and manage growth, including our ability to develop new products and enter new markets.

These forward-looking statements reflect our management’s beliefs and views with respect to future events and are based on estimates and assumptions as of the filing date of this Annual Report and are subject to risks and uncertainties. We discuss many of these risks in greater detail under “Risk Factors.” Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

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Item 1. Business.

Overview

We are a commercial stage company that develops and markets products and services based on proprietary technology that facilitates the routine use of targeted molecular profiling. Molecular profiling is the collection of information about multiple molecular targets, such as DNA and RNA, also called biomarkers, in a biological sample. Molecular profiling information has many important applications, from basic research to molecular diagnostics in personalized medicine. Our technology can be used throughout that range of applications, which is just one of its many benefits. Our focus is on clinical applications. Our primary customer segments include biopharmaceutical companies, academic research centers and molecular testing laboratories.

Historically, molecular profiling has faced several technical challenges in clinical applications. These include (i) limited “multiplexing,” which means only a few biomarkers could be tested in a single sample, (ii) the need for vast amounts of sample to test more than a few biomarkers, which often required several different technologies conducted in different locations, (iii) complex sample preparation, and (iv) manual and/or time consuming workflows. Even where it was possible to test tens, hundreds or thousands of biomarkers, such as with fixed arrays, data analysis could be quite complicated and time consuming.

Our proprietary technology has several key differentiators, including (i) multiplexing from tens to thousands of biomarkers in a single sample, (ii) very low sample input requirements, (iii) simple, extraction-free sample preparation, which is effective with a wide variety of samples, (iv) automated workflow with sample-to-result turnaround times rivaling any current competitor, and (v) simplified data output. In addition, our HTG EdgeSeq assay technology, launched in 2014, generates a molecular profiling library for detection using NGS. Among other things, NGS provides improved sensitivity and dynamic range for our HTG EdgeSeq assays. We believe these advantages position us to outperform most other now-available molecular profiling technologies, especially in certain sample types, such as formalin-fixed, paraffin-embedded tissue, or FFPE. While we continue to advance our technology, we are particularly focused on gaining market recognition and expanding our product offerings.

Our current sources of revenue include services provided by our VERI/O laboratory (discussed below) and sales of our automation systems and integrated NGS-based HTG EdgeSeq assays. Our current assay product offerings include the following:

 

HTG EdgeSeq Oncology Biomarker Panel,

 

HTG EdgeSeq Immuno-Oncology Assay,

 

HTG EdgeSeq Lymphoma Panel,

 

HTG EdgeSeq microRNA Whole-Transcriptome Assay, and

 

HTG EdgeSeq DLBCL Cell of Origin Assay.

Our assays are currently sold for research use only, except in Europe where our diffuse large B-cell lymphoma, or DLBCL, assay is CE-marked and available for diagnostic use. In March 2017, we obtained CE-marking of our HTG EdgeSeq ALKPlus Assay in Europe, and we continue work on our pre-market approval, or PMA, submission for this assay in the United States. In 2017, we also have a focused development pipeline of new profiling products, which includes planned panels for translational research, drug development, and molecular diagnostics with initial focus in immuno-oncology and next generation pathology. We also expect to complete feasibility testing on several new technological developments, including our direct-target sequencing “version 2” chemistry, or V2 chemistry.

Our HTG EdgeSeq assays are automated on either our HTG Edge or HTG EdgeSeq platform, which may also be referred to as an “instrument” or “processor” and which, together with the assay, is a fully integrated system. Our HTG Edge platform can run both our original, plate-based assays and our NGS-based HTG EdgeSeq assays. We continue to support a small number of customers interested in utilizing our plate-based assays (such as our HTG Edge DMPK Core CYP Assay or otherwise on a custom manufacturing basis); however, in 2016, based on market trends and customer feedback, we shifted our product focus to our NGS‑based HTG EdgeSeq system.

Customers can also obtain the advantages of our proprietary technology by engaging our VERI/O laboratory for pre-clinical and clinical research-related services, including drug development and translational research. Our VERI/O lab processes samples for molecular profiling data or, if aligned with our clinical diagnostic product strategy, designs custom research or investigational profiling assays. In 2017, we also expect to deploy our V2 chemistry in the VERI/O lab for detection of DNA mutations.

We believe the value propositions of our products and services are gaining significant recognition. In 2016, we entered into agreements with Bristol-Myers Squibb, or BMS, and Merck KGaA, which are just two examples of the 36 individual project programs with biopharmaceutical companies employing our proprietary technology in their clinical research and drug development programs as of December 31, 2016.  

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As we navigate product-related regulatory requirements to launch additional molecular diagnostic products, initially in Europe and then in the United States, we expect our research products and services will continue to drive market recognition and technology adoption. Further, we expect that strategically positioning our proprietary technology, products and services in drug or other clinical development programs will drive a future, ongoing portfolio of molecular diagnostic products, including companion diagnostic products.

We have incurred significant losses since our inception, and we have never been profitable. We incurred net losses of $26.0 million and $21.4 million for the years ended December 31, 2016 and 2015, respectively, and we had an accumulated deficit of approximately $115.6 million as of December 31, 2016. As of December 31, 2016, we had available cash and cash equivalents totaling approximately $7.5 million and investments in short-term corporate and government debt securities totaling $4.3 million, and had current liabilities of approximately $10.0 million plus an additional $14.0 million in long-term liabilities primarily attributable to our growth term loan and our obligation to NuvoGen Research LLC, or NuvoGen.  

Our Strategy

Our objective is to establish the HTG solutions as the standard in molecular profiling, and to make their benefits accessible to all molecular labs from research to the clinic. The key components of our strategy are:

 

Focus on immuno-oncology based molecular profiling. We plan to develop novel RNA-based gene classifiers to help biopharmaceutical companies and leading translational medicine researchers better understand and predict durable response to immune checkpoint inhibitor drug candidates, such as anti-PD-L1 therapeutics, in mono- and combination therapies. We also plan to develop novel DNA profiling tests that can provide information about mutation load and microsatellite instability, which are genetics factors believed to be associated with response to immune checkpoint inhibitor therapies.

 

Increase and strengthen companion diagnostics collaborations with biopharmaceutical companies. We believe collaborations with biopharmaceutical companies with late-stage drug development programs will lead to us generating companion diagnostic consumables revenue. As of December 31, 2016, we had 36 active development programs across 16 leading biopharmaceutical companies which are incorporating companion diagnostics in their drug development programs. We plan to expand upon our first companion diagnostic partnership (Merck KGaA for DLBCL cell of origin determination) with additional companion diagnostic collaborations. We have entered into an agreement with QIAGEN Manchester Limited, a subsidiary of QIAGEN, N.V., or QIAGEN, to expand our commercial and technical capabilities in this market. We intend to continue to leverage our VERI/O laboratory services business to enable nimble response to emerging biopharmaceutical molecular profiling requirements.

 

Increase our market adoption by leveraging the advantages of our technology, including low sample input and high sensitivity. We plan to promote global adoption of our proprietary technology in molecular labs, biopharmaceutical companies and major translational research centers by demonstrating the key differentiating aspects of our chemistry and platforms, such as small sample utilization, multiplexing and high sensitivity. These advantages result in cost, time and ease of use benefits for our customers. To facilitate adoption, we announced and branded our VERI/O service laboratory, in 2016, to support customers who desire additional laboratory capacity, assay design services, and/or to access our service-only content offerings and, in addition, we continue to offer our HTG EdgeSeq system and reagents to customers who want to bring our technology in-house.

 

Establish our systems workflow as the best solution for clinical sequencing. We intend to continue to establish our technology as the best sample and library preparation method for clinical applications with next generation sequencers. We believe our differentiated HTG EdgeSeq chemistry will accelerate adoption by leveraging the large and growing installed base of next generation sequencers. We are engaged with industry and corporate partners including Illumina, Life Technologies Corporation and QIAGEN, to position our HTG EdgeSeq products as the benchmark for workflow in targeted sequencing applications.

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Develop new molecular diagnostic panels with high medical utility. The HTG platforms were developed with features that we believe will enable local molecular labs to routinely test targeted RNA expression, including expressed gene mutations, such as ALK gene rearrangements using our HTG EdgeSeq ALKPlus Assay, all from extremely small samples, such as a single five micron section of FFPE tissue. We plan to develop future molecular diagnostic assays in conformance with existing reimbursement codes to facilitate our clinical customers’ billings. We also plan to work in the major European medical centers to develop and validate certain solid tumor classifiers and lower cost alternatives for breast and prostate cancer testing.

 

Expand the addressable market of HTG technology through new applications. We have demonstrated technical feasibility for several new applications that are intended to allow us to measure DNA mutations directly and in expressed RNA, and improve the already-high sensitivity of our HTG EdgeSeq assays. These new applications are expected to allow us to, among other things, develop future “multi-parameter” panels that detect both RNA and DNA targets in a single assay, for use in translational research, companion diagnostics and molecular diagnostics. We believe these applications and panels can be developed efficiently with reasonable capital investment.

Our Market

Development of Molecular Profiling

Molecular profiling is the analysis of biomarkers, including DNA and RNA and protein, in biological samples, such as tissue, cells, blood and other biofluids, to identify gene expression patterns or genomic changes. New molecular approaches are making it possible to perform these characterizations in unprecedented ways, resulting in a shift from the traditional approach of looking at one target at a time to the simultaneous analysis of potentially tens, hundreds or thousands of targets.

Among what we believe are the most promising applications of molecular profiling is the targeted sequencing of RNA and DNA from patient samples to identify gene expression patterns or molecular markers of disease that can aid in diagnosis, gauge patient prognosis or predict response to an available therapy. These applications have launched a fundamental shift towards personalized medicine where an individual patient’s molecular profile is used to guide treatment.

We estimate that the global molecular profiling market is approximately $27.0 billion today. Based on published industry reports, cancer profiling makes up the largest segment of this market at an estimated $17.8 billion, the substantial majority of which we believe currently consists of research-use-only products, and is expected to grow to $35.0 billion by 2018. Our initial diagnostic products target the approximate $4.0 billion pathology related diagnostic markets where we can transition existing testing methods to NGS-based workflows. The companion diagnostic market is currently estimated at $2.5 billion and growing approximately 18% annually. We believe that the acceleration of investment into immuno therapy drugs will also be a catalyst for future companion diagnostics for combination therapies where gene expression classification is expected to be important.  

For decades, the treatment of disease was dominated by one-size-fits-all drug regimens. Over the last 10 years, numerous molecular markers and profiling techniques have transitioned from research tools to inclusion in clinical guidelines for patient care. Oncology drug developers have also seen the benefits of molecular markers and today there are many drugs in clinical development with a companion biomarker strategy.

Among the vanguard of these personalized treatments were hormone therapies for breast cancer patients whose tumors expressed the estrogen receptor protein. This was followed using trastuzumab for treating patients with HER2-positive breast cancers. This paradigm shift led to significantly improved patient outcomes when compared to the non-specific, chemotherapeutic approaches used in the past.  

The evolution of molecular profiling has also taken shape over the last decade in non-small cell lung cancer, or NSCLC. NSCLC patients were first profiled for EGFR gene mutations to select patients most likely to respond to the drug erlotinib. Next came testing for ALK gene rearrangements as an indicator of response to the drug crizotinib. Now, additional mutations and rearrangements such as ROS1, RET, HER2, KRAS and MET, have been integrated into the NCCN guidelines for the treatment of lung cancer and are used to guide patient treatments.

Similar trends are unfolding in other diseases such as thyroid cancer, colon cancer, and melanoma. These trends are fueling rapid growth of new molecular profiling offerings, technologies and industry business models to support the demand. The fastest growing segment of the estimated $10.6 billion molecular diagnostics market, a subset of the estimated $27.0 billion global molecular profiling market, is clinical testing in oncology. As oncologists rapidly integrate this new level of molecular profiling information into patient management strategies, a growing number of highly specialized central laboratories now offer tests that address specific clinical questions. The trend towards highly multiplexed profiling is not limited to oncology; other examples of expanding demand include prenatal, neonatal, inherited disease, and organ transplant and rejection profiling.

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Molecular profiling continues to move into clinical applications, including molecular profiling to develop clinical biomarker strategies, patient stratification for clinical trials, and companion diagnostics. The primary goal is to develop an understanding, at the molecular level, about why a drug does or does not work in a patient population. Variability in patients’ gene expression patterns is believed to at least partially explain why the 25% response rate for oncology therapeutics is among the lowest for all disease states.

While the primary objective of these drug-development efforts is to improve response rates, third-party payor pressures to lower patient treatment costs also plays a significant role. As a result, most biopharmaceutical companies develop biomarker strategies to increase the rate of patient response to new drugs in development. Typically, studies will focus on a variety of biological profiling markers that include RNA or protein expression levels, and/or presence or absence of DNA mutations (such as gene fusions and rearrangements), which can be detected in genomic DNA or expressed RNA or protein. Currently, it is estimated that there are over 2,000 clinical trials underway in oncology, and that the clear majority of drug developers believe personalized and targeted therapy development is important to the future success of drug development.

When a molecular biomarker panel is used for selection of patients in a Phase 3 clinical trial to demonstrate safety and efficacy of a new drug, the drug and biomarker test are often submitted to the applicable regulatory agency for approval together. In the United States, upon Food and Drug Administration, or FDA, approval of the biomarker test, or companion diagnostic, the patient must be tested with the companion diagnostic prior to treatment with the drug. Companion diagnostic tests have a clear clinical utility which generally supports favorable reimbursement decisions. We believe there are over 900 active oncology drug development programs, most of which have molecular biomarker strategies, creating a significant opportunity for molecular diagnostic companies with the right molecular profiling solutions.

Complexities and Challenges of Molecular Profiling Today

Currently, molecular profiling typically is conducted in the clinical setting using a variety of profiling techniques and instrumentation platforms across multiple laboratory departments, and, in many situations, sent to distant labs. These techniques include immunohistochemistry, or IHC, fluorescent in situ hybridization, or FISH, polymerase chain reaction, or PCR, gene expression arrays, or GEA, and NGS. This distributed profiling approach has accelerated the use of molecular profiling and increased the need to make the process more accessible and routine. However, molecular profiling is also highly specialized because current technologies are complex, require multiple capital-intensive workflows, and are not economically scalable to the case volume of the local laboratory. The fragmentation of methods, sample logistics and information flow has created significant challenges for labs, physicians and patients as discussed below.

Insufficient Sample Availability

The proliferation of new molecular profiles and technologies has led to the need for more biopsy material to conduct tests of interest. However, the trend is toward less invasive procedures that produce smaller biopsies and thus, in many situations there simply is not enough collected sample to meet all the profiling requirements. For example, historically, the standard method of collecting tumor samples for testing in oncology is via a surgical procedure where the tumor is resected or biopsied and then stabilized, or fixed, in a formaldehyde-based fixative known as formalin. Between 24 to 72 hours after the tissue is removed from the patient, it is permanently stabilized in a hard block of paraffin where it can be stored at room temperature for decades. This preservation technique was developed over 100 years ago, well in advance of the discovery of nucleic acids such as DNA and RNA. While techniques to recover nucleic acids from these FFPE tissue samples have been developed, formalin fixation presents several technical challenges in analyzing DNA and RNA sequences. Because of the convenience of this preservation method, though, FFPE samples are the starting material for almost all tumor-profiling testing in oncology today.

Most commonly, in the past and continuing today, very thin slices of tissue from FFPE blocks, typically five microns in thickness, are affixed to glass slides for testing. Then, a histological stain called an H&E (for the combination of hematoxylin and eosin) is used to differentially mark cellular structures, making it simple for a pathologist to examine the patterns of the normal and diseased tissue under a microscope. IHC stains are also often performed on FFPE tissue slides to aid diagnosis, prognosis or help guide therapy selection, with each IHC stain consuming two slides, one for the stain, and the other for a negative control. Historically, five to ten slides in total were consumed in the complete diagnostic workup for each tumor. With the advent of new molecular techniques there are additional demands for tissue, and most molecular tests on the market today require much more than a single slide. In many clinical situations, there simply is not enough collected tissue to meet all the profiling requirements. The growing number of specialized tumor-profiling tests, and their appetite for FFPE tissue or other sample material, is in direct conflict with the trend towards smaller, less-invasive testing approaches.

Slow Turnaround Times

In many cases, turnaround times for comprehensive profiling of a patient’s sample(s) are several weeks due to the logistical time to route samples to various laboratory departments and to distant specialized labs. Several technologies for sample characterization

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have been used and introduced over the years to determine the status of various molecular characteristics for a sample. These characteristics include RNA and protein expression levels, and/or the presence or absence of DNA mutations, such as single-point mutations and gene fusions and rearrangements, which mutations can be detected in genomic DNA or expressed RNA and protein. A single tumor specimen from a cancer patient is often profiled for multiple molecular characteristics where each characteristic is measured using a different platform. These platforms are utilized in separate laboratory departments or institutions with different technicians and clinicians, requiring that the sample and data be split into multiple workflows. This also requires even more sample consumption.

The time it takes to deliver the final report to a treating physician so that informed treatment decisions may be made is dependent on the turnaround time of the slowest test. A single laboratory with well-choreographed routing of tissues and information may be able to complete sample profiling within a week, but if part of the sample needs to be sent for additional profiling at a specialty lab, the total turnaround time may be lengthened by one or two weeks due to shipping, accessioning by the receiving laboratory and integration of the testing results into the final report.

Implications of Workflow Inefficiencies on Data Quality and Integration

In addition to the challenges of splitting a single sample into multiple testing workflows, the individual workflow for molecular profiling of biological samples, including FFPE tissues, is complicated. Many of the steps from sample to result require manual intervention by a molecular technician. While these technicians are trained to standard operating procedures and proficiency tested, the levels of proficiency and precision vary among technicians. Variability introduced by technicians performing manual steps can translate to variability of results, with a test sample frequently at risk of experiencing losses of fidelity through the series of separation and transformation steps.

Further, the increase in number of technologies for sample characterization and fragmentation of the testing workflows can also create challenges in putting all the results together in a timely, complete profiling report. This level of data integration is critical for the treating physicians to assure they have the complete molecular assessment prior to consultation with the patient. Without a complete molecular assessment, there is limited ability to discuss the diagnosis, prognosis and treatment options. Overall, we believe the critical relationship between the local pathologist and treating physician has been fractured as many tests results are now sent directly to the treating physician from these specialized and centralized Clinical Laboratory Improvement Amendments, or CLIA, laboratories. We believe the pathologist is critical to aggregating the diagnostic, prognostic and predictive information in a single patient molecular profile that can be utilized by the treating physician for therapeutic decisions.

Case Study of the Current Limitations in Molecular Profiling: Immuno-Oncology

A rapidly developing area of oncology drug development is the broad grouping of approaches referred to as immuno-oncology therapies. These immuno-oncology therapeutics include checkpoint inhibitors such as Keytruda (pembrolizumab) for melanoma and NSCLC, cancer vaccines such as chimeric antigen receptors in development by various companies and immunomodulatory therapies such as interferon-alpha. Increasingly, these immuno-therapies are being coupled with more traditional oncology drugs such as tyrosine kinase inhibitors and chemotherapeutics to create synergistic treatment options that attack multiple aspects of the tumor and potentially increase patient response.

While single-biomarker IHC tests have been approved as companion or complimentary diagnostics for anti-PD-1 checkpoint-inhibiting therapies, a proliferation of checkpoint inhibitors targeting additional ligands and receptors for CTLA4, OX40, LAG3, TIM‑3 and others, coupled with combination approaches, is challenging the one-biomarker / one-drug diagnostic paradigm that previously advanced IHC-based companion diagnostics (e.g. HER2, ALK, c-KIT, etc). Understanding the complex biological framework of the tumor microenvironment is becoming increasingly important in interpreting the host immune response to tumors and developing the best single or combination therapy approach.  

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The need for multiplexed gene expression assessment is illustrated in the graphic below where two histologically similar DLBCL tumors elicit very different host immune responses. Both cases have similar tumor composition and large populations of tumor infiltrating lymphocytes (see left-most panel). In case 1, however, the immune system is responding primarily with natural killer lymphocytes, as indicated by the biomarker expression shown in the right-most panel; whereas in case 2, the immune system expresses biomarkers of CD8 cytotoxic lymphocytes (center panel). Based on this information and other clinical parameters, very different immunotherapeutic strategies may be recommended to combat the tumor. We believe that current molecular profiling techniques, like IHC, FISH or RT-qPCR, are ill-suited for comprehensive assessment of the tumor microenvironment at least because of the amount of information (e.g. number of biomarkers) relevant to the clinical decision making that needs to be collected from limited amounts of sample in a time- and cost-efficient way. 

 

Case Study of the Current Limitations in Molecular Profiling: NSCLC

The complexities and potential inefficiencies present in current molecular profiling techniques can be seen in NSCLC. While an increasing number of clinical parameters are being assessed using multiple testing methodologies, the size of the tumor specimen has dramatically decreased, with approximately 70% of lung cancer patients receiving their diagnosis from a small biopsy or cytological specimen. Personalized therapy and entry into clinical trials for NSCLC are heavily dependent on accurate histological classification which is typically performed by IHC. Tumor samples are also routinely tested for various gene mutations and gene rearrangements, with each of these tests performed on a different platform with a disparate workflow.

It is common for each of these platforms to be in separate laboratory departments and/or locations with different technicians and clinicians, requiring that the already small sample be split into multiple workflows. The results from the individual testing workflows are typically aggregated into a single report, signed off by the pathologist and transmitted to the oncologist. As outlined in the diagram below, the multiple steps involved in the process may substantially slow turnaround times and result in an incomplete molecular profile not suitable to inform clinical decision making.

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Example of Typical NSCLC Testing Workflow

 

Our Solution

We have developed and sell assays, automation platforms and services based on a proprietary technology that provides precise, efficient molecular profiling of samples for clinical and research purposes. Our proprietary products and services are designed to work with many different biological sample types, can generate robust results from very small samples, and obviate the need for many of the sample-preparation steps associated with traditional molecular profiling techniques. Our platforms and assays enable the simultaneous detection and quantitation of tens, hundreds or thousands of molecular targets and are capable, now or in the future, of profiling multiple parameters such as RNA expression levels, RNA-expressed gene fusions and insertions and DNA mutations in a single testing workflow that can use NGS detection for quantitative measurement.

We manufacture the consumables utilized with our platforms specifically for our platforms and these consumables cannot be obtained from other sources. At the core of our solution is our proprietary chemistry called quantitative nuclease protection, or qNPA. Our qNPA-based chemistries provide an extremely efficient method for analyzing DNA and RNA as it eliminates the need for DNA or RNA extraction or reverse transcription. We designed and developed our HTG automation platforms to optimize the capabilities of our chemistries, provide fast turnaround time and enable ease of use to molecular labs. Our chemistries and automation platforms are highly adaptable, so when molecular profiling needs change or emerge, we expect to be able to efficiently add new applications to address these needs.

The HTG systems provide data in a simple easy to use format. The entire workflow for both systems from sample preparation to a molecular profiling report can be accomplished in 24-36 hours.

We believe most customers in our target markets would prefer to maintain control of their samples and perform the profiling internally but are challenged by limitations in available technologies. We believe we are well positioned to democratize molecular profiling with the following key benefits:

 

Optimize sample utilization. The HTG systems can analyze as many as 2,500 genes from extremely small sample volumes such as a single five micron section of tissue or 15 microliters of plasma or serum. Our technology allows customers to do more with less, which meets the needs of clinical or pre-clinical laboratories where today there is often not enough patient sample to do all the testing available or desired. We believe providing customers the ability to work with extremely small sample will be a significant driver of adoption of our technology and systems.

 

Compatibility with multiple sample types. Our HTG systems allow customers to profile and unlock molecular information from a wide variety of biological samples such as FFPE tissue, cells, blood serum and plasma. We have successfully demonstrated the ability to profile these and other sample types, and believe we ultimately can profile most clinically relevant sample types, including cell-free circulating nucleic acids from tumors, a rapidly developing area of investigation which is referred to as a liquid biopsy. We believe that the capabilities of our system will allow us to efficiently expand applications, regardless of sample type.

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Flexible and adaptable chemistry allows for use in multiple applications. We believe our proprietary chemistry provides the ability to measure a variety of molecular targets in many necessary applications, including RNA expression levels, expressed RNA gene rearrangements (such as gene fusions and insertions), and DNA point mutations, and offers the ability to quantify these applications on a variety of NGS platforms. This flexibility provides customers the ability to optimize their use of our technologies based on their specific throughput, workflow and application needs. Our proprietary chemistry is comparatively simple, with fewer steps than competing technologies. For example, compared to RT-qPCR, our chemistry does not require extraction or cDNA synthesis. Compared to traditional RNA sequencing, our chemistry does not require extraction, cDNA synthesis, shearing, rRNA depletion, ligation, adenylation, or size selection. We believe that the elimination of these steps helps prevent biases associated with these steps, sample degradation and increased opportunities for technician error.

 

Robust data. Molecular profiling produces large amounts of information that is used, among other things, to make important decisions, such as identifying potential drug targets or selecting a patient for a therapeutic treatment. This information is valuable only to the extent it accurately represents the true biology of the test sample and the same answer can be produced under many different conditions. Our chemistries are highly specific and sensitive, meaning they can detect the right target even when very little is present in the sample. Our system produces consistent results on a replicate-to-replicate, day-to-day and instrument-to-instrument basis.

 

Automation provides superior workflow and ease of use. Our technologies are designed with fewer workflow steps in part due to the elimination of the need for complex sample-preparation processes such as extraction, cDNA synthesis, labeling, selection, depletion and shearing. This enables customers to limit hands-on time and the need for specialized skills, resulting in turnaround times of approximately 24-36 hours. Additionally, our HTG EdgeSeq application further integrates sample preparation for targeted sequencing and greatly simplifies the data bioinformatics, so customers looking to leverage their NGS instrument can seamlessly add this capability to their current workflows.

 

Simplified bioinformatics. Our software provides data in a simple and easy to use format through a simple graphical user interface, or GUI, that is flexible enough for researchers yet structured enough for clinical laboratories. The HTG EdgeSeq parser software, which processes the data from the NGS platform, is modular so that new applications can be downloaded without any changes to hardware. We believe the simplicity of our bioinformatics solution will help drive the adoption of our platform.

Current Commercial Panels Offered on the HTG Platforms

We currently market proprietary molecular profiling panels targeting late stage drug development programs with potential breakthrough therapies, such as immuno-oncology. We market these panels to biopharmaceutical companies, with which we collaborate in biomarker development programs. We believe these programs could facilitate our commercialization of companion diagnostic tests. In addition, our panels are used in pre-clinical and clinical research areas, which, we also believe, will facilitate our commercialization of diagnostic tests, including tumor classifiers and prognostic tests. Our currently marketed panels are:

 

HTG EdgeSeq Immuno-Oncology Assay. One of the most promising areas of cancer therapy is immunotherapy or immuno-oncology, where new classes of oncology drugs are thought to enable or boost the host immune response towards tumors. Multiple drugs targeting the genes CTLA4, PD-1 and PD-L1 are on market with additional candidates moving into late-stage trials. Profiling samples for the genes targeted by these therapies may be predictive of drug response and aid in the stratification of patients into responsive and non-responsive groups. The HTG EdgeSeq Immuno-Oncology Assay measures the expression of 549 of these immuno-oncology-associated genes.

 

HTG EdgeSeq DLBCL Cell of Origin Assay. DLBCL tumors are frequently classified into either the activated B-cell like, or ABC, or germinal center B-cell like, or GCB, sub-types by measuring the molecular profile of the tumor. These two subtypes display different clinical pathologies, as patients with the GCB subtype of DLBCL tend to respond differently than those of the ABC sub-type. With many of the large number of new DLBCL-targeting drugs appearing to have greater efficacy in one of the sub-types, a need for a reliable, FFPE-based cell of origin classification assay has emerged. The HTG EdgeSeq DLBCL Cell of Origin Assay is being utilized in numerous late-stage drug programs to stratify these patients.

 

HTG EdgeSeq Oncology Biomarker Panel. This RNA expression panel measures the expression of up to 2,560 genes implicated in cancer for profiling tumor tissues, analyzing cancer pathways and identifying new biomarkers across both solid tumors and hematolymphoid neoplasms. We worked with key opinion leaders to identify the genes in this panel, which we believe is a comprehensive list of genes targeting known signaling pathways and receptor gene families implicated in cancer. Representative genes in this panel include EGFR, HER2, HER3, HER4, PD-1 and FGFR. When paired with our HTG EdgeSeq microRNA Whole-Transcriptome Assay (below), we provide customers with a comprehensive solution for profiling their large sample archives for novel expression signatures.

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HTG EdgeSeq Lymphoma Panel. Measures the expression of 92 genes frequently assessed in lymphomas, including 22 common non-Hodgkins B-cell lymphoma markers from a single 5 micron thick FFPE section. This product is designed to enable detailed molecular profiles of lymphomas using a single FFPE slide.  

 

HTG EdgeSeq microRNA Whole-Transcriptome Assay. Human microRNAs are short non-coding strands of RNA that are believed to be used by the cell for gene regulation. The HTG EdgeSeq microRNA Whole-Transcriptome Assay enables the simultaneous profiling of 2,083 microRNAs, allowing new, potentially clinically relevant miRNA profiles to be discovered. Our ability to efficiently profile small FFPE samples is a significant differentiator in the rapidly growing microRNA market.

 

HTG Edge DMPK Core CYP Assay. Biopharmaceutical companies often perform DMPK profiling studies as part of the drug development process to adhere to regulatory guidance. A set of genes known as the cytochrome P450 family is known to predict both the toxicity and stability of drugs in the human body. The HTG Edge DMPK Core CYP Assay enables DMPK scientists to measure six cytochrome P450 genes recommended for in vitro pharmacokinetic studies. The DMPK area is a high-volume profiling market segment and creates synergies with down-stream clinical drug development programs.

We utilize several alternative arrangements to sell our systems. Our platforms can be purchased directly by our customers, who also then purchase HTG EdgeSeq assays and other consumables from us on an as-needed basis. In some instances, we provide our instruments free of charge on a limited basis to facilitate customer evaluation. We also may choose to install instruments for our customers at no cost, in exchange for an agreement to purchase assays and other consumables from us at a stated price over the term of the agreement, or allow customers to rent our instrument for a monthly fee. As of December 31, 2016, we had an installed base of 47 HTG Edge and HTG EdgeSeq instruments (consisting of 27 systems sold, six covered under reagent rental agreements, one rental, nine evaluation units and four systems with key opinion leaders). 

Product and Technology Pipeline Plan

Our objective is to establish the HTG EdgeSeq system as a standard in molecular profiling, making this capability broadly accessible. We are leveraging our flexible and adaptable platform to develop comprehensive molecular profiling panels across an increasing set of molecular applications. We believe it is important to include applications that cover a broad set of genomic variation as well as expression-based clinical biomarkers to continually increase the value of the HTG EdgeSeq system and provide a more complete profiling solution for our customers. The diagram below depicts our planned expansion of systems, applications and profiling panels which are being adding in a phased approach.

 

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Opportunities for Comprehensive Molecular Profiling in Diagnostics

We are planning to develop a portfolio of molecular diagnostic products using our proprietary technology to provide a single, efficient testing system for sample profiling that integrates seamlessly into a customer’s NGS testing workflow.

We are initially focused on areas where the diagnostic testing paradigm has significant inefficiencies. For example, many leading medical institutions are shifting from a single-drug / single-test approach to a broader tumor profiling strategy for their oncology practices. Rather than testing for single mutational analyses, such as KRAS mutations in colorectal cancer, these institutions use their NGS platforms to assess the mutational status of 50 or more genes. In addition, the information a physician needs to make clinical decisions often comes from tests conducted using various testing modalities such as IHC, FISH and NGS. These complexities lead to a growing and unmet demand in clinical diagnostics for more comprehensive molecular profiles that can include RNA expression, RNA fusions and rearrangements, DNA mutations and protein expression.

We are developing solutions to address the detection and measurement of gene rearrangements such as gene fusions and insertions. A fusion gene is a hybrid gene formed from two previously separate genes. A well-established example is the EML4-ALK fusion gene found in a subset of malignant lung cancers. Our research team previously demonstrated feasibility to simultaneously detect and measure key gene fusions in lung cancer such as ALK, ROS1, RET and NTRK1 from multiple small sample types including FFPE, cell lines and purified RNA. An insertion is the addition of one or more nucleotides into a genomic sequence; a small percentage of NSCLC exhibit HER2 exon 20 insertions.

We are currently developing our HTG ALKPlus Assay, or ALKPlus Assay, as our first clinical diagnostic test for the U.S. market. Our ALKPlus Assay is a comprehensive panel for lung gene rearrangements that will detect certain fusions in the following genes: ALK, ROS1, RET and NTRK1 as well as certain insertions in HER2. This test panel is in clinical study phase and three of the four PMA modules have been submitted to the FDA. We completed the CE marking of this assay in Europe in March 2017, and expect to obtain FDA pre-market approval for the ALKPlus Assay by late 2017 or early 2018. The intended use for the ALKPlus Assay, if approved by the FDA, will be as a companion diagnostic for crizotinib therapy for ALK positive NSCLC cases. Information on the ROS1, RET, NTRK1 and HER2 gene rearrangements included in the ALKPlus Assay panel will be provided with RUO status. After obtaining the appropriate exemption(s), we believe the ROS1, RET, NTRK1 and HER2 gene rearrangements detected with the ALKPlus Assay could also be used for investigational use only, or IUO, for certain late-stage drug development trials, and, as appropriate, receive FDA approval in the future.

When we look at the current state of a NSCLC patient assessment, the HTG EdgeSeq ALKPlus Assay fulfills one critical part of the current diagnosis process. Other critical factors clinicians need to understand NSCLC prior to treatment are the tumor sub-type (adenocarcinoma, or ADC, squamous cell carcinoma, or SCC, neuroendocrine) and its EGFR and KRAS mutational status. A well-known U.S. cancer center recently published a peer-reviewed article showing that our technology can be used to determine whether a tumor is an ADC or SCC. In addition, we are currently developing enhancements to our chemistry, our V2 chemistry, which we believe will enable direct-sequencing of EGFR and KRAS mutations in NSCLC and other disease states. Taken together, these enhancements could, in the future, provide a single testing workflow, which we refer to as the HTG total lung solution, whereby information about the NSCLC subtype and status of clinically recognized biomarkers can be obtained in a single “multiparameter” test.

Ultimately, we believe that HTG technology can bring multiparameter testing to a wide variety of solid tumor sample types. We will need to develop, refine and implement new panel protocols and make changes or adjustments to our chemistry and software to optimize these planned applications and panels for use with our HTG EdgeSeq system. This will require substantial effort from our research scientists and the use of various laboratory equipment, supplies and materials, which combined represent the most significant costs that we expect to incur in connection with the development of these applications and profiling panels.  

The HTG EdgeSeq system can augment or, in some cases, replace IHC testing

IHC tests currently are integral to the diagnostic workup for most tumor types, providing qualitative protein expression data within the morphological context of the tissue tested. While there are over 400 different biomarkers tested by IHC in clinical practice today, we believe it is rare to test more than ten. This is due in part to tissue availability, especially for minimally invasive core needle biopsies, and limitations on the number of tests reimbursed per case. We are in the concept stage for an HTG EdgeSeq next generation pathology product, which is intended to enable the assessment of the RNA analogues for a clear majority of clinical IHC biomarkers in a single NGS-based test. We believe this single-test concept will provide pathologists a standard by which to measure all tumors, augmenting or in some cases replacing their IHC testing with a quantitative assessment of the tumor biology.

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Serving the decentralized markets with Project JANUS

In addition to continued menu expansion for clinical diagnostic products we have begun the development of our next generation instrument targeting the lower throughput clinical market segment. We refer to this development program as Project JANUS. We believe the lower throughput clinical market segment will potentially increase our addressable market for instrument sales from hundreds to thousands of labs. The molecular testing market is served by a mix of centralized reference laboratories, comprehensive cancer centers, and decentralized regional hospital laboratories. Volumes of particular case types and downstream testing needs for solid tumors are somewhat unpredictable for these providers. We believe Project JANUS is well suited for managing low, medium, and surge testing volumes; thus, assisting our customers with this unpredictable aspect of their businesses. We anticipate testing panels for Project JANUS to include mutations, fusions, expression classifiers and a molecular surrogate for IHC. Our approach is to serve centralized markets with the HTG EdgeSeq system and expand to the decentralized market with Project JANUS, as shown schematically in the following figure. We believe our current HTG EdgeSeq system has the throughput capabilities that match the needs of the centralized market. Project JANUS is our planned approach to expand our addressable market to the lower sample throughput labs and further decentralize the market. Due to various research and development priorities, Project JANUS development efforts were temporarily put on hold during the third quarter of 2016. We intend to resume development efforts as soon as reasonably feasible and as our V2 chemistry matures.

Our Technology

 

HTG Chemistries

The qNPA chemistry used in our current HTG EdgeSeq assays reliably measures tens to thousands of messenger RNA, or mRNA, and microRNA gene expression levels from very small amounts of difficult to handle samples without the need for conducting RNA extraction, cDNA synthesis, RNA amplification or RNA-labeling steps. Two primary elements of our chemistry process are DNA to RNA hybridization and S1 nuclease digestion. Both elements have been widely researched for decades and are well understood. The method is described in more detail below.

HTG EdgeSeq Chemistry

Our HTG EdgeSeq chemistry is shown schematically in the following figure. Specifically, DNA nuclease protection probes, or DNA protection probes, which include a target-specific region flanked by universal wing sequences are hybridized to targeted RNAs. Target RNA can be both soluble and cross-linked in the biological matrix. Universal DNA wingmen probes are hybridized to the wings to prevent S1 nuclease digestion. S1 nuclease is added to remove single-stranded nucleic acids, including unhybridized DNA

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protection probes and RNA. Following S1 nuclease treatment, the only remaining DNA protection probes in the reaction are those hybridized to targeted RNA and wingmen probes to form a hybridized complex. This produces an approximately 1:1 ratio of DNA protection probes to the RNA targeted in the sample. Alkaline hydrolysis of the hybridized complexes releases the DNA protection probes from such complexes. The released DNA protection probes are ready for quantitation. DNA protection probes are labeled with sequencing adaptors and tags in a thermocycler. The labeled DNA protection probes are concentrated, pooled, and ready for sequencing using standard NGS protocols. Data from the NGS instrument is processed and reported by the parser software provided with the HTG EdgeSeq system.

 

HTG EdgeSeq V2 Chemistry

Like our current HTG EdgeSeq chemistry described above, our next generation V2 chemistry is based upon nuclease protection probes, which are used to protect regions of DNA and/or RNA for direct sequencing of the target. We expect to provide further details about the V2 chemistry in due course. We plan to make our V2 chemistry first available in our VERI/O laboratory, in the first half of 2017, for services such as detection of selected DNA mutations.

Key Advantages of HTG Chemistries

 

Multiplexing tens, hundreds or thousands of targets. Measuring multiple genes in a single reaction can be challenging with competitive technologies due to the complex interactions of reaction components. While we are currently marketing a panel with our HTG EdgeSeq chemistry that can profile up to 2,560 genes in a sample, we believe we can develop applications using our chemistry for multiplexing more than 2,560 genes if there is a customer need. The high level of gene multiplexing allows for significantly lower amounts of tissue to be used per sample than in competitive low-plex profiling technologies.

 

No RNA extraction. Competitive technologies for assessing RNA generally require RNA that is isolated and purified from other components found in the sample. These time-consuming steps may lead to some target loss and bias the test outcome. In FFPE tissues, for example, it has been reported that a fraction of the RNA is lost in the purification process because it cannot be separated from insoluble tissue components and the fixation and embedding process or long storage times for FFPE tissue may damage the RNA and break it into smaller, more difficult to analyze fragments. This makes molecular profiling of small FFPE tissues particularly challenging and can result in testing failures and loss of precious samples due to insufficient RNA recovery. These biases introduced by RNA extraction cannot be overcome and may be magnified throughout the subsequent analysis. Our proprietary chemistry does not require RNA extraction for FFPE samples or most other sample types (we recommend extracting RNA from fresh-frozen tissue samples to prevent processing variability), improves utilization of precious samples, improving workflow and reducing costs by eliminating a step known to bias the data.

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No cDNA synthesis. Many competitive technologies, most prominently qRT-PCR and traditional RNA sequencing, require conversion of RNA into DNA for analysis. This process, called reverse transcription, requires an enzyme to move along the extracted RNA to create a DNA copy of the molecule. When damaged and fragmented RNA is used, these small RNA strands become increasingly difficult to convert into DNA in an accurate and reproducible manner. Our proprietary chemistry does not require conversion of the RNA to DNA by reverse transcription, removing a technical difficulty experienced with competitive technologies.

 

Short protection probes. Many samples contain RNA degraded by various combinations of heat, age, poor processing, and fixation. In these samples, the RNA is damaged and fragmented into smaller strands. Utilizing short protection probes of 50 bases or less, our proprietary chemistry is more efficient than competitive technologies that require longer strands of RNA for quantitation.

 

Simplicity. Our proprietary chemistry is simple, with fewer steps than competing technologies. Compared to RT-qPCR, our chemistry does not require extraction or cDNA synthesis. Compared to traditional RNA sequencing, our chemistry does not require extraction, cDNA synthesis, shearing, rRNA depletion, ligation, adenylation, or size selection. We believe that the accumulation of these steps required by other technologies results in amplification of biases, sample degradation and increased opportunities for technician error.

HTG Chemistry and Instrument Platforms

Our assays and instruments were developed and are manufactured under ISO 13485:2003 guidelines using our proprietary HTG EdgeSeq chemistry to simplify multiplexed nucleic acid testing in research and clinical laboratories. The entire workflow from sample preparation to a molecular profiling report can be accomplished in approximately 36 hours for 96 samples. With the speed, flexibility, sensitivity, and accuracy of our HTG platforms, combined with the system’s ability to work effectively with small sample volumes, researchers can profile tens, hundreds or thousands of different genes per sample.

 

The HTG Edge and HTG EdgeSeq (shown above) platforms consist of a processor, a host computer and integrated software. The processor is a fully automated instrument that prepares biological samples for quantitation using proprietary, electronically barcoded, single-use consumables. The processor has barcode scanner units to process the two-dimensional barcodes printed on the consumables loaded into the instrument. The barcoded consumables are single-use in order to reduce operator errors and provide chain of custody traceability for the samples. The robotic systems within the instrument are engineered for reliable performance and low maintenance. The walking path of the robot is programmed to minimize any chance of contamination of the reagents or samples. One host computer supports up to five processors allowing laboratories to easily expand their capacity by adding processors.

HTG EdgeSeq applications combine either the HTG Edge processor or HTG EdgeSeq processor with an NGS platform to enable the quantitative analysis of tens, hundreds or thousands of targeted RNAs in a single panel. The sample is prepared for quantitation on the processor, then labeled with molecular sequencing adaptors and tags. The labeled samples are concentrated, pooled, and sequenced on an NGS platform using standard protocols. Data from the NGS instrument are processed and reported by the parser software included with the system. HTG EdgeSeq assays currently are available to process sample batches ranging from eight to 96.

HTG Edge and HTG EdgeSeq Platform Workflow

Our HTG platforms deliver complex molecular profiling information in a simple four step workflow. A technician spends relatively little time preparing samples which are easily loaded into the applicable processor. Once the sample is loaded, the processor

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performs our proprietary chemistry protocol with no technician intervention, which is commonly referred to as walk away automation. Once the sample is processed, a technician prepares the sample for quantitation on an existing NGS instrument. This flexibility in quantifying molecular information provides customers the ability to optimize their use of the HTG Edge or HTG EdgeSeq platform based on their specific throughput, workflow and application requirements. In comparison to traditional RNA sequencing (sometimes referred to as RNA Seq), there are many fewer steps required for molecular profiling using HTG EdgeSeq applications as shown in the diagrams below.

HTG Platform Performance

Our HTG systems have performance characteristics that enable our customers to reproducibly, accurately and quantitatively profile from tens to thousands of genes in a single reaction using very small samples. This section provides details and examples of these performance characteristics.

Equivalent quantitative expression results from large as well as very small samples

HTG EdgeSeq assays and panels are analytically validated with sample inputs ranging from as much as 25 mm2 to, in a few cases, 1.5 mm2 tumor surface area from a single 5 µm section, enabling comprehensive molecular profiling on a large surgical resection or very small needle core biopsy. Needle core biopsies are often the only tissue available for profiling of certain tumor types. A representation of the difference in the amount of tissue available in a surgical resection versus a core needle biopsy is shown graphically below (left panel). In an internal study using our HTG EdgeSeq resections versus core needle biopsies from the same non-small cell lung cancers (right panel), Pearson correlations (log2 transformed counts) greater than 0.96 were observed. These results indicate that our assay provides the same result for the two sample sizes tested.

 

 

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We believe obtaining molecular profiles from very small samples is of critical importance to our customers. We have demonstrated reproducible, quantitative results from a fraction of the more than 100 ng of input RNA typically required for competitive technologies. In the study shown below, the HTG EdgeSeq Oncology Biomarker Panel was used to measure mRNA expression levels in a dilution series from 12.5 ng to 1.56 ng of Universal Human RNA. In the figure titled Input Titration Correlations below, correlations between each dilution were measured by Pearson’s r and are displayed in each comparison field. A Pearson correlation between two perfectly identical molecular profiles will produce an r-value of 1.0. The r-values obtained in the study shown below, of greater than 0.99, indicate nearly identical molecular profiles were obtained throughout the dilution series. In the figure titled Assay Linearity below, the raw number of sequencing reads for each of the samples in the dilution series are shown, with the statistical measure of how close the data are to the fitted regression line, R-squared, of 0.98481. These plots demonstrate the capability of the HTG EdgeSeq applications on the HTG Edge or HTG EdgeSeq platform to deliver equivalent molecular profiles over a range of sample inputs.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Leveraging the dynamic range and sensitivity of NGS

The end product of the HTG EdgeSeq assay is a library of DNA probes that, once sequenced, are compared to a reference database consisting of the sequences of the probes used in the assay. NGS platforms sequence each nucleotide of each DNA probe in the library to produce highly specific information about each such probe. Each nucleotide sequenced is stored as a single read. With the capacity of a single sequencing run numbering in the millions of reads, NGS platforms are highly sensitive, capable of detecting low abundance or rare sequences, while having a wide dynamic range, accurately counting the relative number of abundant sequences. In the development and validation of gene expression assays, we believe it is important that the applicable assay reliably measure differential gene expression for both high and low abundance genes. As an example of how the HTG EdgeSeq system leverages the sensitivity of NGS, the graphic below shows the relative expression of the low-abundance immunotherapy targeted genes PD-1 and PD-L1 across a wide range of sample inputs using the HTG EdgeSeq DLBCL Cell of Origin Assay.

 

High fidelity between processing conditions

One of the greatest challenges faced in molecular profiling of formalin fixed samples is the poor fidelity routinely seen when comparing the results across various processing conditions. One example is the lack of fidelity seen between formalin fixed samples, such as FFPE, to non-fixed tissue. It has been repeatedly demonstrated that the fixation process can lead to different molecular profiles in otherwise identical samples. We believe researchers often obtain sub-optimal molecular profiling results solely due to the formalin fixation process. We further believe that our chemistry overcomes the losses in fidelity between non-fixed and FFPE tissues, enabling users to obtain an accurate assessment of tumor biology from FFPE tissues.  

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To demonstrate fidelity between non-fixed and FFPE tissues that may be achieved using the HTG EdgeSeq system, a resection from a breast cancer tumor was prospectively collected and split, with half of the specimen immediately frozen and the other formalin fixed and paraffin embedded. RNA from the non-fixed, fresh frozen specimen was extracted and added to the HTG lysis buffer (we recommend extracting the RNA from fresh tissue samples to prevent processing variability). The matched FFPE tissue was directly lysed in the HTG lysis buffer without extraction. Both specimens were then profiled using the HTG EdgeSeq Immuno-Oncology Assay. The scatterplot below shows the correlation between the non-fixed, fresh frozen tissue and the FFPE tissue, with a Pearson correlation coefficient of r = 0.95, indicating that our proprietary chemistry produces the same result regardless of whether or not a sample is fresh or fixed. We believe our system enables researchers and clinicians to access their large collections of archived FFPE tissues to deliver reproducible, biologically relevant molecular profiles.

 

 

Compatibility with multiple sample types

We believe our proprietary chemistry is robust across many biological sample types. Below are technical replicates of heart FFPE, plasma and whole blood preserved in PAXgene profiled using the HTG EdgeSeq microRNA Whole-Transcriptome Assay. As shown by the high correlations, our customers can expect the same result from a sample run after run.  

 

 

Detection of gene fusions

In feasibility studies, HTG EdgeSeq chemistry has demonstrated the ability to accurately detect gene rearrangements in patient-derived FFPE tissues. The example below demonstrates detection in a patient sample with a characterized gene fusion involving the KIF5B and RETS genes. Using multiple DNA protection probes, the HTG EdgeSeq system can detect gene rearrangements such as fusions. We are developing an assay that allows gene fusions to be detected in two ways. First is the direct measurement and detection of the unique RNA sequence created at the gene fusion site. This is indicated by the strong signal obtained from the KIF5B-RET v1 probe in the following graph. The second approach involves calculating the ratio of signals obtained from probes targeting both the 5’ and 3’ end of the RET gene. Samples which do not contain a RET gene fusion will have similar RET 5’ and RET 3’ expression. In the

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sample above, however, which contains a RET gene fusion as indicated by the fusion-junction specific prove, we see significantly higher signal from the RET 3’ probe implying the two parts of the RET gene are no longer connected, indicating a gene rearrangement has occurred.

 

A cell line with a known ALK gene fusion and normal (or wild-type) ROS1 gene was tested using the same 5’ and 3’ probe ratio methodology described for the RET fusion above. As expected with a fused ALK gene, the expression of the 3’ portion of the transcript is much higher than the 5’ portion, indicating a fusion event has occurred. An example of a known non-fusion gene, ROS1, is also shown in the example where the 5’ and 3’ ends of the ROS1 are expressed at a 1:1 ratio, indicating this gene has not undergone a fusion event.

 

 

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Discriminating between closely related sequences

The specificity of our proprietary chemistry is demonstrated in the data chart below. Closely related synthetic miRNA pools supplied by Association of Biomolecular Resource Facilities were split between pools. All possible probes were used to profile individual pools. As shown in the following graphs, from 3-11% of NPP probes bound to off-target sequences with a 1-base difference (right graph) while only 0.1-0.3% of NPP probes bound to off-target sequences with a 2-base difference (left graph). In both examples, the on-target hybridization signal is at least 8X greater than off-target hybridization. Data was generated using the Illumina MiSeq v2 1x50 reagent kit. We believe that our proprietary chemistry is highly specific and will enable our customers to discriminate between closely related sequences.

 

Repeatability

An important consideration in adoption of a molecular profiling platform is the degree to which the same molecular profile can be obtained from a sample tested on multiple replicates and multiple occasions. Obtaining highly similar profiles indicates that the panel is stable, and that the data generated is reliable and repeatable. The XY scatterplots below show the correlation between the same sample on technical replicates using the HTG EdgeSeq Immuno-Oncology Assay. Extremely similar results were obtained, as demonstrated by the Pearson correlation coefficient r-values of 0.96 and 0.97 for fresh frozen and FFPE samples, respectively. We believe the HTG EdgeSeq system enables our customers to produce stable and repeatable molecular profiles. As demonstrated by the measurement of 549 mRNAs in the sample, HTG EdgeSeq chemistry has the ability to reliably detect large numbers of genes in a complex background.

 

 

 

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Reproducibility

Another important consideration in adoption of a molecular profiling platform is the degree to which the same molecular profile can be obtained from a single sample tested multiple times over on the same and different instruments. Obtaining highly similar profiles indicates that the chemistry and instrument platform is stable, and that the data generated is reliable and reproducible. The XY scatterplots below show the correlation between the same sample profiles on three separate instruments across three days using the HTG EdgeSeq Oncology Biomarker Panel. The scale of the vertical and horizontal axes represent log 2 transformed, filtered probe counts. Extremely similar results were obtained, as demonstrated by the Pearson r-values above 0.96 for all comparisons. We believe the HTG EdgeSeq platform and HTG EdgeSeq chemistry enables our customers to produce stable and reproducible molecular profiles.

 

Research and Development

We have committed, and expect to commit, significant resources to developing new technologies and products, improving product performance and reliability and reducing costs. We have assembled an experienced research and development team with the scientific, engineering, software and process talent that we believe is required to successfully grow our business. As of December 31, 2016, our research and development team consisted of 21 employees across the disciplines of research and development scientist, platform development and bioinformatics.

As discussed in more detail above, in addition to an ongoing focus on the expansion of our profiling applications and test panel menu, in 2016 we began the development of the next generation of our HTG EdgeSeq chemistry, or V2 chemistry, which will allow targeted, direct sequencing of RNA and DNA. Applications of the V2 chemistry are likely to include mutation detection, expressed mutation detection, expression measurements and co-detection of RNA and DNA from FFPE tissue.  

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We have also begun the development of our next generation Project JANUS instrument program. External development efforts for Project JANUS with Invetech PTY, Ltd. were temporarily put on hold in mid-2016, but are expected to resume in the near future as our V2 DNA chemistry matures.

We incurred research and development expenses of $7.9 million and $4.6 million for the years ended December 31, 2016 and 2015, respectively.

Sales and Marketing

We distribute our instruments and consumables via direct sales in the United States and Europe and also through distributors in parts of Europe and other countries. As of December 31, 2016, our U.S. sales and marketing organization consisted of 33 employees including 11 in direct sales or sales management, 15 in sales support and seven in marketing. In addition to our direct sales team in the United States, as of December 31, 2016, we had three direct sales and support employees in Europe and distribution agreements in several additional countries. This sales model provides us with direct sales coverage in the United Kingdom, France, Germany, Switzerland, Belgium and the Nordic countries, and distributors in Spain, Portugal, Italy and Israel.  

Our sales and marketing efforts are targeted at biopharmaceutical companies, clinical research centers and clinical diagnostic labs focused on sample profiling for translational research, biomarker/companion assay development and lab-developed diagnostic testing. We intend to promote adoption of our HTG EdgeSeq system, sample profiling panels and future molecular diagnostic assays, upon marketing clearance or approval by FDA by expanding our U.S. sales force, building a greater direct sales presence in Europe, expanding international distribution, and continuing to collaborate with key opinion leaders to validate our platform and influence utilization of our products.

The top two customers accounted for 29% and 12% of our revenue for the year ended December 31, 2016, compared with 38% and 7% for the year ended December 31, 2015. We derived 0% and 8% of our total revenue from grants and contracts primarily from one organization during the years ended December 31, 2016 and 2015, respectively.

Manufacturing and Suppliers

We primarily perform manufacturing and final acceptance testing in house. External resources are leveraged for their specific expertise in either producing components for our HTG Edge and HTG EdgeSeq instruments and raw materials for our consumables in accordance with our designs, or based on their catalog products which are utilized as is within our designs. We manufacture HTG Edge and HTG EdgeSeq instruments and reagent kits at our Tucson, Arizona facility, which has been certified to ISO 13485:2003 standards. We completed capital improvements in 2016, which created over 6,500 square feet of dedicated manufacturing and operations space. We believe that our existing manufacturing capacity is sufficient to meet our needs at least for the next several years.

Instruments

We assemble our HTG Edge and HTG EdgeSeq instruments at our Tucson, Arizona facility. We have qualified an alternative third-party manufacturer for our instruments and we believe additional instrument manufacturing alternatives would be available if necessary. Instrument component vendors are qualified and reviewed regularly to ensure that manufacturing standards are met and maintained. We award contracts for estimated annual quantities of components and, considering the replenishment lead times of our vendors, take delivery of batches covering approximately one month of demand at a time.

Consumables

We assemble our HTG Edge and HTG EdgeSeq consumables at our Tucson, Arizona facility. Raw material vendors are selected using precise standards, and are reviewed regularly for compliance with our specific quality requirements. We purchase raw material stock in quantities that often exceed projected annual demand. We complete batches of finished goods approximating quarterly demand and supervise inventory on a minimum/maximum basis to ensure that we are replenishing our finished goods and raw material ahead of demand.

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Competition

We have categorized known competition into:

 

Other molecular platform offerings such as PCR-based technologies, microarrays and next generation sequencers from companies such as Agilent Technologies, Inc., ArcherDx, Inc., BioRad Laboratories, Exiqon A/S, Fluidigm Corporation, Genomic Health, Roche Diagnostics, a division of the Roche Group of companies, QIAGEN, Illumina, Inc., Abbott Molecular, Luminex Corporation, Affymetrix, Inc., NanoString Technologies, Inc. and Thermo Fisher Scientific, Inc.

 

Centralized CLIA labs offering molecular profiling and gene expression tests as laboratory-developed tests, or LDTs, such as Foundation Medicine, Inc., Trovagene, Inc., Guardant Health, Inc. and Genomic Health, Inc.

 

NGS target enrichment technologies from companies such as Agilent Technologies, Inc.

 

Decentralized CLIA labs developing LDTs locally such as major cancer centers

We believe that the principal competitive factors in all of our target markets include:

 

cost of capital equipment;

 

cost of consumables and supplies;

 

reputation among customers;

 

innovation in product offerings;

 

flexibility and ease-of-use;

 

accuracy and reproducibility of results; and

 

compatibility with existing laboratory processes, tools and methods.

We believe that additional competitive factors specific to the diagnostics market include:

 

breadth of clinical decisions that can be influenced by information generated by tests;

 

volume, quality, and strength of clinical and analytical validation data;

 

availability of coverage and adequate reimbursement for testing services; and

 

economic benefit accrued to customers based on testing services enabled by product

We believe the automation afforded by our HTG EdgeSeq system coupled with fast turnaround time, high multiplexing capability, lysis only/no extraction protocol and low sample requirement gives us numerous competitive advantages in our target markets, as discussed in more detail elsewhere in this Item 1.

While we believe that we compete favorably based on the factors described above, many of our competitors are more highly capitalized and/or have been in existence for a longer period, and enjoy several competitive advantages over us, including:

 

Greater name and brand recognition, financial and human resources;

 

Broader product lines;

 

Larger sales forces and more established distributor networks;

 

Substantial intellectual property portfolios;

 

Larger and more established customer bases and relationships; and

 

Better established, larger scale and lower cost manufacturing capabilities.

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Intellectual Property

Our success depends in part on our ability to develop and maintain intellectual property rights relating to key aspects of the technology employed in our HTG Edge and HTG EdgeSeq platforms and assays, maintain any strategic licenses to use intellectual property owned by third parties, preserve the confidentiality of our trade secrets and operate without infringing the valid and enforceable patents and other proprietary rights of third parties. We rely upon certain patents, registered and common law trademarks, trade secrets, know-how, invention and patent assignment agreements and continuing technological innovation to develop and maintain our competitive position. We intend to aggressively protect, defend and extend the intellectual property rights in our technology.

Patents and Patent Applications

As of December 31, 2016, our patent portfolio included 13 patent families that, collectively, consisted of nine issued U.S. patents, 37 granted foreign patents (variously in Australia, Canada, China, Japan, France, Germany, Italy, Spain, and United Kingdom), and 28 patent applications pending in the United States and foreign jurisdictions. This portfolio is directed to our nuclease-protection-based technologies as well as to lung cancer and melanoma biomarker panels and a DLBCL cell-of-origin classifier discovered using our nuclease-protection-based technology, which will help us maintain an exclusive position in key areas of our business, including targeted nuclease-protection based sequencing, and, if we should so elect, may provide opportunities for out-licensing melanoma, DLBCL, or lung-cancer-related content. There were two pending applications and 10 granted patents, including one U.S. patent, directed to our novel HTG EdgeSeq methods in the portfolio as of December 31, 2016. The HTG EdgeSeq method patents will expire in April 2032. The portfolio also included two pending applications directed to our V2 HTG EdgeSeq methods as of December 31, 2016. Worldwide, as of December 31, 2016, we had 21 patents in the two patent families directed to our HTG Edge plate-based methods; these patents will begin to expire at the end of December 2017 with the last ones expiring in June 2022.

Agreements with Third Parties

Asset Purchase Agreement with NuvoGen Research, LLC

We entered an asset purchase agreement dated January 9, 2001, as amended in November 2003, September 2004, November 2012 and February 2014, with NuvoGen to acquire certain intellectual property from NuvoGen. The acquired technology generally relates to our array-based nuclease protection panels. Pursuant to the terms of the agreement, in exchange for the acquired technology, we initially paid NuvoGen 5,587 shares of our common stock, fixed payments of $740,000 over the first two years of the agreement and agreed to pay NuvoGen 6% our yearly revenue, which would be applied to any fixed payments, until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15,000,000. Pursuant to the latest amendment to the agreement, through 2017, we are only required to pay a yearly fixed fee, in quarterly installments, to NuvoGen of $800,000, and may defer any accrued revenue-based payments. Beginning in 2018, we are obligated to pay the greater of $400,000 or 6% of sales, plus amounts, if any, deferred in the 2017 period by which 6% of revenue exceeds the applicable fixed fee plus 5% interest on such deferred amounts until the obligation is repaid in full. We paid our fixed fees for 2015 and the first quarter of 2016 in advance, and resumed making quarterly payments in April 2016. No revenue-based payments were deferred in 2016.

In a transaction related to the foregoing acquisition, NuvoGen also received a non-exclusive, royalty free license under the acquired technology pursuant to an agreement dated September 15, 2004. The license is limited to NuvoGen’s own internal service-oriented efforts and activities to accelerate the development of targeted drugs and other pharmaceutical compounds and agents as part of NuvoGen’s grant funded or other basic research and development of drugs intended for the treatment of cancer. Pursuant to the agreement, if NuvoGen produces revenue through the sale of cancer drugs developed through use of the license for entities other than for-profit and other commercial drug-research and development service ventures, NuvoGen will pay us a royalty in the mid-single digit range percentage of such revenue for the quarter. This agreement may be terminated by either party in case of a breach by the other party, and we may terminate the agreement by giving written notice if NuvoGen files for bankruptcy or performs other similar actions.

License Agreement with Merck

In connection with the investment by Merck Capital Ventures LLC in the Company, we granted to Merck Sharpe & Dohme, or Merck, pursuant to an agreement dated February 15, 2011, a non-exclusive, worldwide, royalty-free, non-sublicenseable (except to affiliates of Merck) license to certain of our qNPA patent rights solely for Merck’s internal research and development purposes. We may terminate the agreement upon a breach of any material provision of the agreement by Merck, if Merck has not cured such breach within 60 days after receiving written notice from us.

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Loan and Security Agreement with Oxford Finance, LLC and Silicon Valley Bank

On August 22, 2014, we entered a Loan and Security Agreement, or the Loan Agreement, with Oxford Finance LLC, or Oxford, as collateral agent, or in such capacity, Agent, and a lender and Silicon Valley Bank, as a lender, or SVB, and together with Oxford, the Lenders, providing for up to two separate term loans in an aggregate principal amount of $16.0 million.

We borrowed the initial term loan in the principal amount of $11.0 million, or Term Loan A, on August 22, 2014. Term Loan A bears interest at a fixed rate of 8.50% per annum. On or prior to June 30, 2015, the Loan Agreement allowed us to borrow one additional term loan, or Term Loan B, for up to $5.0 million, subject to the satisfaction of certain borrowing conditions. We received the Term Loan A proceeds, net of a $320,000 original issue discount, with a requirement to pay a final payment of 3.75% of the total amount borrowed.

In August 2015, the Company and its lenders amended the Loan Agreement to extend the availability of Term Loan B until March 31, 2016. Pursuant to the August 2015 amendment to the Loan Agreement, we made monthly interest-only payments until April 1, 2016. Following the interest-only payment period, equal monthly payments consisting of principal and interest amortized over the remaining term of the loan through the September 1, 2018 maturity date are due. The amendment also increased the final fee payment percentage to 4.75%. In February 2016, the Company notified its lenders, pursuant to the requirements of the amendment to the Loan Agreement, of its intention to draw the remaining $5.0 million available under Term Loan B. This additional principal will be repaid evenly over the course of 30 months beginning April 1, 2016 and bears interest at a fixed rate of 8.75%. The final fee premium relating to Term Loan B of $237,500 is being amortized to interest expense, using the effective interest method, over the term of Term Loan B.

We may prepay all, but not less than all, of the loaned amount plus accrued and unpaid interest thereon through the prepayment date with 15 days’ notice to Oxford. In accordance with the August 2015 amendment, we will be obligated to pay a prepayment fee equal to (i) 2% of the principal amount repaid if the loan is prepaid after the first anniversary but on or prior to the second anniversary of the August 2015 amendment and (ii) 1% of the principal amount repaid if the loan is repaid after the second anniversary of the August 2015 amendment and prior to maturity. We are not entitled to reborrow any amounts of principal once such principal has been repaid. The agreement was again amended in June 2016 to modify the definitions of permitted indebtedness and permitted liens to provide for an increased maximum amount of permitted indebtedness, authorize a new category of permitted indebtedness and authorize a new category of permitted liens.

While any amounts are outstanding under the credit facility, we are subject to several affirmative and restrictive covenants, including covenants regarding delivery of financial statements, maintenance of inventory, payment of taxes, maintenance of insurance, dispositions of property, business combinations or acquisitions, incurrence of additional indebtedness and transactions with affiliates, among other customary covenants. We are also restricted from paying cash dividends or making other distributions or payments on our capital stock except for repurchases of stock pursuant to employee stock purchase plans, employee restricted stock agreements, stockholder rights plans, director or consultant stock option plans, or similar plans, provided such repurchases do not exceed $100,000 in the aggregate per fiscal year.

We granted the Agent a security interest in our personal property to secure our obligations under the loan agreement. The security interest does not extend to patents, trademarks and other intellectual property rights (except for rights to payment related to the sale, licensing or disposition of such intellectual property rights) or certain other specified property. If we default under our term loan, our lenders could foreclose on our assets, including substantially all of our cash, which is held in accounts with our lenders.

Upon the occurrence of certain events, including but not limited to the failure by us to satisfy our payment obligations under the loan agreement, the breach of certain of our other covenants under the loan agreement, and the occurrence of a material adverse change, the Agent will have the right, among other remedies, to declare all principal and interest immediately due and payable, and will have the right to receive the final payment fee and, if the payment of principal and interest is due prior to maturity, a prepayment fee. The Agent also will have the right, among other remedies, to foreclose upon and/or sell or otherwise liquidate our personal property upon the occurrence of certain events.

In connection with Term Loan A, we granted each of the Lenders warrants to purchase 1,256,281 shares of the Company’s Series E Preferred Stock at an exercise price of $0.2189 per share. The warrants are exercisable until August 22, 2024 and were automatically converted to warrants for common stock upon completion of our initial public offering, or IPO, in May 2015. In connection with the funding of Term Loan B, in March 2016, we issued Oxford a common stock warrant exercisable for 45,307 shares of common stock at an exercise price of $2.759 per share, and the warrant previously issued to SVB automatically became exercisable for an additional 5,317 shares of common stock at an exercise price of $23.51 per share in accordance with the Loan Agreement.

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Development and Component Supply Agreement with Illumina, Inc.

In October 2014, we entered a development and component supply agreement with Illumina, Inc., or Illumina, for the development and worldwide commercialization by us of up to two complete diagnostic gene expression profiling tests for use with Illumina’s diagnostic instruments, using components supplied by Illumina. We refer to these diagnostic gene expression profiling tests as in vitro diagnostic, or IVD, test kits or assays. The IVD test kits may be used in two discrete testing fields chosen by us, one or both of which may relate to oncology for breast, lung, lymphoma or melanoma tumors, and up to one of which may relate to transplant, chronic obstructive pulmonary disease, or immunology/autoimmunity. We provided notice to Illumina of our first testing selection during the quarter ended March 31, 2015. We are in discussions with Illumina regarding, among other things, a potential extension of the original October 2016 deadline to select a second field.

In the fourth quarter of 2015, we and Illumina agreed to a development plan for the development and regulatory approval of the selected IVD test kit, following which we paid Illumina a $100,000 fee. Illumina has agreed to provide development and regulatory support as part of the plan, which relates to our HTG EdgeSeq ALKPlus Assay, now in development. We are also required to pay Illumina up to $1.0 million in the aggregate upon achievement of specified regulatory milestones relating to the IVD test kits. In addition, we have agreed to pay Illumina a single digit percentage royalty on net sales of any IVD test kits that we commercialize pursuant to the agreement. Ongoing research and development costs for these programs have been expensed as incurred.

Pursuant to the agreement, we have agreed to obtain our requirements for certain components to be used in the development and/or commercialization of IVD test kits from Illumina. We and Illumina have also agreed to negotiate in good faith to enter into a supplemental supply agreement for the continued purchase and supply of the foregoing components.

Absent earlier termination, the agreement will expire in October 2019 or on the date which the last to expire development plan under the agreement is completed, whichever is earlier. We may terminate the agreement at any time upon 90 days’ written notice and may terminate any development plan under the agreement upon 30 days’ prior written notice. Illumina may terminate the agreement upon 30 days’ prior written notice if we undergo certain changes of control or immediately if we fail to select a testing field for an IVD test kit within 24 months following the date of the agreement. Either party may terminate the agreement upon the other party’s material breach of the agreement that remains uncured for 30 days, or upon the other party’s bankruptcy.

Authorization, Supply and Regulatory Authorization Agreement with Life Technologies Corporation

In March 2016, we entered an Authorization, Supply and Regulation Authorization Agreement with Life Technologies Corporation, or LTC, a wholly owned subsidiary of Thermo Fisher Scientific, Inc., for the development and worldwide commercialization by us of up to five RNA-based NGS panels, or HTG Assays, for use with LTC’s sequencing instruments and components supplied to end‑users by LTC.

Pursuant to the agreement, we have agreed to obtain our requirements for certain components to be used in the development of HTG Assays from LTC. In March 2016, we purchased approximately $250,000 of LTC products and equipment in accordance with this agreement. LTC has agreed to provide support in our efforts to obtain regulatory approval of the HTG Assays. We are required to pay LTC a milestone payment in the mid-six figure dollar range upon certain regulatory achievements for each HTG Assay. In addition, we have agreed to pay LTC a single digit percentage royalty on net sales of HTG Assays that we commercialize pursuant to the agreement. No milestone or royalty payments have been accrued or made pursuant to this agreement as of December 31, 2016.

Absent early termination, the initial term of the agreement will expire in March 2021 and thereafter will automatically renew for additional two year periods for as long as we continue to develop or sell HTG Assays, provided that neither party provides written notice of its election to terminate the agreement at least 60 days prior to expiration of the then-current term. Either party may terminate the agreement (a) upon the other party’s material breach that remains uncured for 30 days, (b) upon the other party’s bankruptcy or (c) upon written notice in the event the party providing notice reasonably determines that continued performance under the agreement may violate any regulatory law, or any other applicable law or regulation or FDA guidance.

Bristol-Myers Squibb Agreement

In May 2016, we entered into a Collaboration Agreement with Bristol-Myers Squibb, or BMS, for the development, in collaboration with BMS, of two custom assays based on our HTG EdgeSeq technology. Following development of each custom assay, at BMS’s request, we may also perform sample processing services using such custom assay(s) and/or supply the custom assay(s) to BMS or its third-party subcontractors. Additional custom assay development related to immuno-oncology research may be undertaken pursuant to the agreement in accordance with a mutually acceptable work plan, which is incorporated by written amendment. 

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BMS paid an initial non-refundable, non-creditable program set-up fee, and has agreed to pay an annual non-refundable, non-creditable project management fee in quarterly installments, as well as a fee for each custom assay developed. Each such fee was or is in the low six-figure range. At BMS’s request, we will supply custom assay kits and perform sample processing services.

The agreement will expire on May 11, 2019 or, if a project is then ongoing, the date of delivery of the final report for such project. Either party may terminate the agreement upon the other party’s material breach or default in the performance of a material obligation under the agreement or if certain warranties or representations are untrue in any material respect, either a Default, and such Default remains uncured for 60 days or such longer period if the Default cannot be cured within 60 days. BMS may terminate a project upon 90 days’ prior written notice.

Merck KGaA Agreement

In October 2016, we entered a Master CDx Agreement, or master agreement, with Merck KGaA, Darmstadt, Germany, or Merck KGaA to serve as the basis for one or more project agreements to develop, seek regulatory approval for, and commercialize companion diagnostics for Merck KGaA drug candidates and corresponding therapeutics. Concurrently, we entered into a first project agreement under the master agreement concerning our sequencing-based DLBCL cell of origin assay, or DLBCL Assay and Merck KGaA’s investigational drug, M7583, or Project.

The Project has three stages aligned with timelines and outcomes of M7583 development. During stages 1 and 2, we will perform specified DLBCL Assay development activities. In stage 3, we will obtain applicable regulatory approvals on the DLBCL Assay and make it commercially available in the United States and certain other jurisdictions.

Stages 2 and 3 each have an up-front payment, and all stages of the Project have milestone-based payments. We are eligible to receive up to a total of $9,900,000 over a period of approximately nine years in fixed or determinable contract consideration comprising up-front and milestone payments. In addition, during stages 1 and 2 of the Project, we will sell DLBCL Assay kits and/or perform sample processing services upon request of, and as instructed by, Merck KGaA.

Merck KGaA may terminate the Project by providing 90 days’ prior written notice, at which point Merck KGaA will reimburse us for costs incurred during the termination period, of an amount not to exceed non-cancellable, non-reimbursable expenses, and we will reimburse Merck KGaA for any costs that have been prepaid without being incurred prior to termination. Further, either party may also terminate the agreement upon the other party’s material breach that remains uncured for 45 days or upon the other party’s bankruptcy.

QIAGEN Agreement

In November 2016, we entered a Master Assay Development, Commercialization and Manufacturing Agreement, or Governing Agreement, with QIAGEN Manchester Limited, or QML, a wholly owned subsidiary of QIAGEN N.V. The Governing Agreement creates a framework for the companies to combine their technological and commercial strengths to offer biopharmaceutical companies a complete NGS-based solution for the development, manufacture and commercialization of companion diagnostic assays. Under the Governing Agreement, the parties will jointly seek companion diagnostic programs with biopharmaceutical companies, QML will contract with interested biopharmaceutical companies for specified projects, each a Project, and the companies will enter into a statement of work under the Governing Agreement, which sets forth the rights and obligations of each party with respect to each Project.

The parties’ relationship under the Governing Agreement is exclusive in the oncology field. Such exclusivity in the oncology field may be lost and become non-exclusive if certain performance targets are not met. Projects may be undertaken in non-oncology fields at each party’s discretion on a non-exclusive basis.  

The companies will share net profits under each statement of work, based on whether development of particular assays under a statement of work are primarily based on each company’s intellectual property. Each statement of work will provide additional financial terms for the corresponding Project, which terms will depend on the respective development and/or commercialization activities of the parties.

The Governing Agreement will continue for a five-year term. However, either party may terminate the agreement upon (i) the other party’s uncured material breach, bankruptcy or insolvency, (ii) specified events affecting all statements of work, or (iii) a change of control by either party. In the event a party terminates the Governing Agreement for its own change of control, a $2.0 million termination payment will be payable to the non-terminating party.

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Pursuant to a stock purchase agreement, entered concurrent with the Governing Agreement, QIAGEN North American Holdings, Inc., or QNAH, another wholly owned subsidiary of QIAGEN N.V., purchased 833,333 shares of our common stock on November 17, 2016 at $2.40 per share, for a total purchase price of $2.0 million. QNAH agreed to purchase up to an additional $2.0 million of our common stock (subject to any applicable limitations under the rules of the NASDAQ Stock Market) upon the sale by the Company of at least $12.0 million of common or preferred stock in a financing transaction that occurs prior to May 16, 2017, or such other mutually agreeable date, or a Qualified Financing. The price per share payable by QNAH in a second tranche purchase will be equal to the price per share at which shares are sold in a Qualified Financing.

Trade Secrets

We also rely on trade secrets, including unpatented know-how, technology and other proprietary information to maintain our competitive position. We seek to protect these trade secrets, in part, by entering into nondisclosure and confidentiality agreements with parties who have access to them, such as our employees, corporate collaborators, outside scientific collaborators, contract manufacturers, consultants, advisors and other third parties. We also enter into invention or patent assignment agreements with our employees and consultants that obligate them to assign to us any inventions developed in the course of their work for us. We cannot provide any assurance, however, that we have entered into such agreements with all relevant parties, or that these parties will abide by the terms of these agreements. Despite measures taken to protect our intellectual property, unauthorized parties might copy or commercially exploit aspects of our technology or obtain and use information that we regard as proprietary.

For additional information relating to the risks associated with our intellectual property position see “Risk Factors – Risks Related to our Intellectual Property.”

Third-Party Coverage and Reimbursement

Clinical laboratories will acquire our instrumentation through a capital purchase, capital lease or reagent purchasing agreement. These laboratories will offer their customers a menu of testing services using our IVD test kits or their LDTs, which they may develop using components they purchase from us, or a combination of both. Our customers will generate revenue for these testing services by collecting payments from third-party payors, including public and private payors, as well as patient co-payments.

United States

In the United States, our customers will utilize the existing reimbursement framework for testing services: Tier 1 and Tier 2 Molecular Pathology Procedures

Prior to January 1, 2013, molecular pathology procedures were reimbursed using the 83890-83912 code series, commonly known as “stacking codes”, which were based on the various technical steps performed to produce a test result. The American Medical Association, or AMA, created the Tier 1 codes (81200-81383) and Tier 2 codes (81400-81408) to specifically identify the test being performed and as a replacement to stacking codes. The stacking codes were deleted from the clinical laboratory fee schedule used by the Centers for Medicare and Medicaid Services, or CMS, for payment determination in 2013. Single analyte tests for mutations and gene rearrangements are described by these Tier 1 and Tier 2 codes; specific examples include 81235 for epidermal growth factor receptor, or EGFR, mutation analysis and 81401 for EML4/ALK rearrangement analysis. Single analyte tests not specifically called out in Tier 1 or Tier 2 codes can be submitted for reimbursement consideration using the miscellaneous code 81479.

Genomic Sequencing Procedures.

The AMA created codes for Genomic Sequencing Procedures, or GSPs, and other Molecular Multianalyte Assays as part of its calendar year 2015 update to the clinical laboratory fee schedule. AMA has since modified the GSP codes to clarify the definition to include DNA and RNA. Our customers may use these codes to seek reimbursement for diagnostic multi-analyte test offerings, such as:

 

Gene expression classifiers for hematolymphoid neoplasms, such as the determination of activated B-cell like, or ABC, or germinal center B-cell like, or GCB, subtypes of diffuse large B-cell lymphomas

 

Gene rearrangements in solid tumors and hematolymphoid neoplasms

 

Mutations in solid tumors and hematolymphoid neoplasms

Payments for Tier 1 and Tier 2 Molecular Pathology Procedures and GSPs may be sought from both public and private payors. Claims for Medicare coverage are processed by private Medicare Administrative Contractors, or MACs, such as Novitas and Cahaba, and coverage for specific test codes are specified in Local Coverage Determinations, or LCDs, issued by individual MACs or National Coverage Determinations, or NCDs, which apply to all MACs. Private payors issue their own coverage determinations that are largely

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reflective of the CMS LCDs and NCDs. HTG closely monitors trends in coverage through interactions with customers, industry associations such as the College of American Pathologists, or CAP, and the Association for Molecular Pathology, or AMP, and industry consultants; these trends are key considerations in our product development plans.

Our customers may use our products, subject to regulatory limitations, to offer testing services that provide an analysis of 5‑50 genes as well as 51 or more genes. In October 2014, CMS released its preliminary determinations regarding the method for determining 2015 payment rates for new codes under the clinical laboratory fee schedule. CMS recommended that payment rates for GSPs be determined through a process known as gapfill rather than by crosswalking to allow CMS and its contractors to gather information about the manner in which the tests are performed and the resources necessary to provide them, so that ultimately CMS can set an appropriate payment rate for these tests. In the gapfill process, the local MACs determine the appropriate fee schedule amounts in the first year, and CMS calculates a national payment rate based on the median of these local fee schedule amounts in the second year. On September 27, 2015, gapfill pricing for CPTs 81445 and 81450 for the assessment of 5-50 genes in solid and liquid tumors, respectively, were set at $597 and $648, respectively, and remains the same as of December 31, 2016. CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors has not yet been priced. 

We believe that establishment of the aforementioned reimbursement codes specific to genomic sequencing procedures such as our clinical diagnostic tests currently in development is an important factor in expanding access to our products. In addition, coverage and reimbursement of our clinical diagnostic tests by government and private payors is essential to our commercial success. Accordingly, our strategy includes efforts to encourage third-party payors to establish coverage, coding and payment that will facilitate access to our tests as we seek FDA approval for these tests and expand our commercialization efforts in the United States. Our success in these efforts depends in part on the extent to which governmental authorities, private health insurers and other third-party payors provide coverage for and establish adequate reimbursement levels for tests using our technology. Failure by our customers who use our tests to obtain sufficient coverage and reimbursement from healthcare payors or adverse changes in government and private third-party payors’ policies would have a material adverse effect on our business, financial condition, results of operations and future growth prospects.

In addition to uncertainties surrounding coverage policies, there are periodic changes to reimbursement. Third-party payors regularly update reimbursement amounts and from time to time revise the methodologies used to determine reimbursement amounts. This includes annual updates to payments made under the Clinical Laboratory Fee Schedule, or CLFS, with amounts assigned to the procedure billing codes used to report the specific laboratory services. The CLFS sets the maximum amount payable under Medicare for each billing code. Payment under the CLFS has been limited from year-to-year by Congressional action such as imposition of national limitation amounts and freezes on the otherwise applicable annual consumer price index updates. In February 2012, the Middle-Class Tax Relief and Job Creation Act of 2012 was signed into law which, in part, reduced the potential future cost-based increases to the CLFS by 2%. The payment amounts under the CLFS are important not only for Medicare reimbursement, but also because although there is no uniform policy of coverage and reimbursement amongst third-party payors, other third-party payors are often guided by the Medicare CLFS in establishing reimbursement rates. For example, state Medicaid programs are prohibited from paying more than the Medicare fee schedule limit for clinical laboratory services furnished to Medicaid recipients. Because of the anticipated reduction in the CLFS payment amounts, certain third party payors may also reduce reimbursement amounts.

Beginning January 1, 2016, there will also be major changes to the payment formula under the CLFS. Under the Protecting Access to Medicare Act of 2014, which was signed to law in April 2014, clinical laboratories must report laboratory test payment data for each Medicare-covered clinical diagnostic lab test that it furnishes during a time period to be defined by future regulations. The reported data must include the payment rate (reflecting all discounts, rebates, coupons and other price concessions) and the volume of each test that was paid by each private payor (including health insurance issuers, group health plans, Medicare Advantage plans and Medicaid managed care organizations). Beginning in 2017, the Medicare payment rate for each clinical diagnostic lab test will be equal to the weighted median amount for the test from the most recent data collection period. The payment rate will apply to laboratory tests furnished by a hospital laboratory if the test is separately paid under the hospital outpatient prospective payment system.

Outside the United States

Our target markets outside of the United States are Europe and Asia/Pacific. Our diagnostic product menu plans for Europe and Asia/Pacific consist primarily of NGS‑based test kits that will satisfy existing or emerging testing demand, and we expect to be competing based on testing efficiency, quality and price.

In Europe, coverage for molecular diagnostic testing is varied. Countries with statutory health insurance (e.g., Germany, France, The Netherlands) tend to be more progressive in technology adoption with favorable reimbursement for molecular diagnostic testing. In countries such as the United Kingdom with tax-based insurance, adoption and reimbursement for molecular diagnostic testing is not uniform and is influenced by local budgets.

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In Asia/Pacific, our commercial strategy is to opportunistically partner with distributors in countries with sufficient demand for our products to justify the investment by both parties.

Our diagnostic product menu plans for Europe and Asia/Pacific consist primarily of NGS-based test kits that will satisfy existing or emerging testing demand, and we will be competing based on testing efficiency, quality and price. We plan to seek partners knowledgeable in local molecular diagnostic testing reimbursement practices and, working co‑operatively with such partners, prepare, to the extent feasible, favorable reimbursement treatment for our diagnostic products in the applicable Asia/Pacific markets. Preferably, such favorable reimbursement decisions will coincide with or precede the launch of each applicable diagnostic product.

Failure by our ex-U.S. customers to obtain sufficient coverage and reimbursement for our diagnostic products from healthcare payors or adverse changes in government and private payors’ policies would have a material adverse effect on our ex-U.S. growth prospects and our overall business, financial condition, and results of operations.

Government Regulation – Medical Device Regulations

United States

Our products and operations are subject to extensive and rigorous regulation by the FDA and other federal, state, local and foreign authorities. Currently we are limited to marketing our products for research use only, which means that we cannot make any diagnostic or clinical claims. However, we intend to seek regulatory clearances or approvals in the United States and other jurisdictions to market certain assays for diagnostic purposes. The clinical diagnostics under development by HTG are classified as “medical devices” under the United States Food, Drug and Cosmetic Act, or FDCA. The FDA regulates, among other things, the research, development, testing, manufacturing, approval, labeling, storage, recordkeeping, advertising, promotion and marketing, distribution, post approval monitoring and reporting and import and export of medical devices in the United States to assure the safety and effectiveness of such products for their intended use.

Unless an exemption applies, each new or significantly modified medical device we seek to commercially distribute in the United States will require either a premarket notification to the FDA requesting permission for commercial distribution under Section 510(k) of the FDCA, also referred to as a 510(k) clearance, or approval from the FDA of a PMA application. Both the 510(k) clearance and PMA submission can be expensive, and lengthy, and require payment of significant user fees, unless an exemption is available.

Device Classification

Under the FDCA, medical devices are classified into one of three classes – Class I, Class II or Class III – depending on the degree of risk associated with each medical device and the extent of control needed to provide reasonable assurances with respect to safety and effectiveness.

Class I devices are those for which safety and effectiveness can be reasonably assured by adherence to a set of regulations, referred to as General Controls, which require compliance with the applicable portions of the FDA’s Quality System Regulation, or QSR, facility registration and product listing, reporting of adverse events and malfunctions, and appropriate, truthful and non-misleading labeling and promotional materials. Some Class I devices, also called Class I reserved devices, also require premarket clearance by the FDA through the 510(k) premarket notification process described below. Most Class I products are exempt from the premarket notification requirements.

Class II devices are those that are subject to the General Controls, as well as Special Controls, which can include performance standards, guidelines and post market surveillance. Most Class II devices are subject to premarket review and clearance by the FDA. Premarket review and clearance by the FDA for Class II devices is accomplished through the 510(k) premarket notification process. Under the 510(k) process, the manufacturer must submit to the FDA a premarket notification, demonstrating that the device is “substantially equivalent,” as defined in the statute, to either:

 

a device that was legally marketed prior to May 28, 1976, the date upon which the Medical Device Amendments of 1976 were enacted, or

 

another commercially available, similar device that was cleared through the 510(k) process.

To be “substantially equivalent,” the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data are sometimes required to support substantial equivalence.

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After a 510(k) notice is submitted, the FDA determines whether to accept it for substantive review. If it lacks necessary information for substantive review, the FDA will refuse to accept the 510(k) notification. If it is accepted for filing, the FDA begins a substantive review. By statute, the FDA is required to complete its review of a 510(k) notification within 90 days of receiving the 510(k) notification. As a practical matter, clearance often takes longer, and clearance is never assured. Although many 510(k) premarket notifications are cleared without clinical data, the FDA may require further information, including clinical data, to make a determination regarding substantial equivalence, which may significantly prolong the review process. If the FDA agrees that the device is substantially equivalent, it will grant clearance to commercially market the device.

After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, could require a PMA application. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination regarding whether a new premarket submission is required for the modification of an existing device, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or approval of a PMA application is obtained. If the FDA requires us to seek 510(k) clearance or approval of a PMA application for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. In addition, in these circumstances, we may be subject to significant regulatory fines or penalties for failure to submit the requisite PMA application(s). In addition, the FDA is currently evaluating the 510(k) process and may make substantial changes to industry requirements.

The PMA Process

If the FDA determines that the device is not “substantially equivalent” to a predicate device, or if the device is classified into Class III, the device sponsor must then fulfill the much more rigorous premarketing requirements of the PMA process, or seek reclassification of the device through the de novo process. A manufacturer can also submit a petition for direct de novo review if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk.

Class III devices include devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to those deemed not substantially equivalent following the 510(k) process. The safety and effectiveness of Class III devices cannot be reasonably assured solely by the General Controls and Special Controls described above. Therefore, these devices are subject to the PMA application process, which is generally costlier and time consuming than the 510(k) process. Through the PMA application process, the applicant must submit data and information demonstrating reasonable assurance of the safety and effectiveness of the device for its intended use to the FDA’s satisfaction. Accordingly, a PMA application typically includes, but is not limited to, extensive technical information regarding device design and development, pre-clinical and clinical study data, manufacturing information, labeling and financial disclosure information for the clinical investigators in device studies. The PMA application must provide valid scientific evidence that demonstrates to the FDA’s satisfaction reasonable assurance of the safety and effectiveness of the device for its intended use.

In the United States, absent certain limited exceptions, human clinical studies intended to support medical device clearance or approval require an Investigational Device Exemption, or IDE, application. Some types of studies deemed to present “non-significant risk” are deemed to have an approved IDE once certain requirements are addressed and Institutional Review Board approval is obtained. If the device presents a “significant risk” to human health, as defined by the FDA, the sponsor must submit an IDE application to the FDA and obtain IDE approval prior to commencing the human clinical studies. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of subjects. Generally, clinical studies for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate institutional review boards at the clinical study sites. There can be no assurance that submission of an IDE will result in the ability to commence clinical studies, and although the FDA’s approval of an IDE allows clinical testing to go forward for a specified number of subjects, it does not bind the FDA to accept the results of the trial as sufficient to prove the product’s safety and efficacy, even if the trial meets its intended success criteria.

Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If the PMA application is determined to be sufficiently complete, the FDA will accept the application for filing and begin the review. The FDA, by statute and by regulation, has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant’s response to deficiencies communicated by the FDA. The FDA considers a PMA or PMA supplement to have been voluntarily withdrawn if an applicant fails to respond to an FDA request for information (e.g. major deficiency letter) within a total of 360 days. Before approving or denying a

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PMA, an FDA advisory panel may be convened to review the PMA and provide the FDA with the committee’s recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. This advisory panel may also involve a public meeting if FDA determines public input is required. Prior to approval of a PMA, the FDA may conduct a bioresearch monitoring inspection of the clinical study data and clinical study sites, and a QSR inspection of the manufacturing facility and processes. Overall, the FDA review of a PMA application generally takes between one and three years, but may take significantly longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:

 

the device may not be shown safe or effective to the FDA’s satisfaction;

 

the data from pre-clinical studies and clinical studies may be insufficient to support approval;

 

the manufacturing process or facilities may not meet applicable requirements; and

 

changes in FDA approval policies or adoption of new regulations may require additional data.

If the FDA evaluation of a PMA is favorable, the FDA will issue either an approval letter, or an approvable letter, which usually contains several conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA letter authorizing commercial marketing of the device, subject to the conditions of approval and the limitations established in the approval letter. If the FDA’s evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional analytical studies or clinical studies are necessary, in which case approval of the PMA submission may be delayed for several months or years while the analytical studies and/or trials are conducted and data are submitted in an amendment to the PMA. The PMA process can be expensive, uncertain and lengthy and a number of devices for which FDA approval has been sought by other companies have never been approved by the FDA for marketing.

New PMA applications or PMA supplements may be required for modification to the manufacturing process, labeling, device specifications, materials or design of a device that has been approved through the PMA process. PMA supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the approved PMA application and may or may not require as extensive technical or clinical data or the convening of an advisory panel, depending on the nature of the proposed change.

In approving a PMA application, the FDA may also require some form of post market studies or post market surveillance, whereby the applicant follows certain patient groups for several years and makes periodic reports to the FDA on the clinical status of those patients when necessary to protect the public health or to provide additional safety and effectiveness data for the device. FDA may also require post market surveillance for certain devices cleared under a 510(k) notification, such as implants or life-supporting or life-sustaining devices used outside a device user facility. The FDA may also approve a PMA application with other post-approval conditions intended to ensure the safety and effectiveness of the device, such as, among other things, restrictions on labeling, promotion, sale, distribution and use.

Post-Approval Requirements

After the FDA permits a device to enter commercial distribution, numerous regulatory requirements apply. These include, but are not limited to:

 

the registration and listing regulation, which requires manufacturers to register all manufacturing facilities and list all medical devices placed into commercial distribution;

 

the QSR, which requires manufacturers, including third party manufacturers, to follow elaborate design, testing, production, control, supplier/contractor selection, complaint handling, documentation and other quality assurance procedures during the manufacturing process;

 

labeling regulations and unique device identification requirements;

 

advertising and promotion requirements;

 

restrictions on sale, distribution or use of a device;

 

PMA annual reporting requirements;

 

the FDA’s general prohibition against promoting products for unapproved or “off-label” uses;

 

the Medical Device Reporting, or MDR, regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to reoccur;

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medical device correction and removal reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may present a risk to health;

 

recall requirements, including a mandatory recall if there is a reasonable probability that the device would cause serious adverse health consequences or death;

 

an order of repair, replacement or refund;

 

device tracking requirements; and

 

post approval study and post market surveillance requirements.

Our facilities, records and manufacturing processes are subject to periodic unscheduled inspections by the FDA. Failure to comply with the applicable United States medical device regulatory requirements could result in, among other things, warning letters, untitled letters, fines, injunctions, consent decrees, civil penalties, unanticipated expenditures, repairs, replacements, refunds, recalls or seizures of products, operating restrictions, total or partial suspension of production, the FDA’s refusal to issue certificates to foreign governments needed to export products for sale in other countries, the FDA’s refusal to grant future premarket clearances or approvals, withdrawals or suspensions of current product clearances or approvals and criminal prosecution.

Research Use Only

A research use only, or RUO, product is one that is not intended for clinical diagnostic use and must be labeled “For Research Use Only. Not for use in diagnostic procedures.” Products that are intended for research use only and are properly labeled as RUO are exempt from compliance with the FDA requirements discussed above, including the approval or clearance and QSR requirements. A product labeled RUO but intended to be used diagnostically may be viewed by the FDA as adulterated and misbranded under the FDC Act and is subject to FDA enforcement activities. The FDA may consider the totality of the circumstances surrounding distribution and use of an RUO product, including how the product is marketed, when determining its intended use.

European Union

The European Union, or EU, has also adopted requirements that affect our products. These requirements include establishing standards that address creating a certified quality system as well as several directives that address specific product areas. The most significant of these directives is the In Vitro Diagnostic Medical Device Directive, or IVDD, which includes:

 

Essential Requirements. The IVDD specifies “essential requirements” that all medical devices must meet. The requirements are similar to those adopted by the FDA relating to quality systems and product labeling.

 

Conformity Assessment. Unlike United States regulations, which require virtually all devices to undergo some level of premarket review by the FDA, the IVDD currently allows manufacturers to bring many devices to market using a process in which the manufacturer certifies that the device conforms to the essential requirements for that device. A small number of products must go through a more formal pre-market review process. Devices that comply with the requirements of a relevant directive will be entitled to bear the CE conformity marking, indicating that the device conforms to the essential requirements of the applicable directives and, accordingly, can be marketed throughout the EU and European Economic Area.

 

Vigilance. The IVDD also specifies requirements for post market reporting similar to those adopted by the FDA.

Other International

Several other countries, including Australia, Canada, China and Japan, have adopted or are in the process of adopting standards for medical devices sold in those countries. Many of these standards are loosely patterned after those adopted by the European Union, but with elements unique to each country. Although there is a trend towards harmonization of quality system standards, regulations in each country may vary substantially, which can affect timelines of introduction. We routinely monitor these developments and address compliance with the various country requirements as new standards are adopted.

Government Regulation – Fraud and Abuse and Other Healthcare Regulation

We may be subject to various federal and state healthcare laws, including, but not limited to, anti-kickback laws. Penalties for violations of these healthcare laws include, but are not limited to, criminal, civil and/or administrative penalties, damages, fines, disgorgement, individual imprisonment, possible exclusion from Medicare, Medicaid and other federal healthcare programs,

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additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws and the curtailment or restructuring of operations.

Federal Anti-Kickback Statute

The Federal Anti-Kickback Statute prohibits persons or entities from knowingly and willfully soliciting, offering, receiving or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, or for the purchasing, leasing, ordering, or arranging for or recommending, any good, facility, service or item for which payment may be made in whole or in part under federal healthcare programs, such as the Medicare and Medicaid programs. The Federal Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. The term “remuneration” expressly includes kickbacks, bribes, or rebates and has been broadly interpreted to include anything of value, including for example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payments, ownership interests and providing anything at less than its fair market value.

There are several statutory exceptions and regulatory safe harbors protecting certain business arrangements from prosecution under the Federal Anti-Kickback Statute. These statutory exceptions and safe harbors set forth provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they may not be prosecuted under the Federal Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within one or more applicable statutory exceptions or safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy all requirements of an applicable safe harbor may result in increased scrutiny by government enforcement authorities and will be evaluated on a case-by-case basis based on a cumulative review of all of its facts and circumstances. Additionally, the intent standard under the Federal Anti-Kickback Statute was amended under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, collectively, the ACA, to a stricter standard such that a person or entity no longer needs to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Further, the intent to induce referrals need only be “one purpose” of the remuneration for violations of the Federal Anti-Kickback Statute. The ACA provides that the government may assert that a claim including items or services resulting from a violation of the Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal civil False Claims Act which is discussed below.

Federal Civil False Claims Act

The federal civil False Claims Act prohibits, among other things, persons or entities from knowingly presenting or causing to be presented a false or fraudulent claim to, or the knowing use of false statements to obtain payment from or approval by the Federal Government. Suits filed under the federal civil False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government. These individuals, sometimes known as “relators” or, more commonly, as “whistleblowers”, may share in any amounts paid by the entity to the government in fines or settlement. The number of filings of qui tam actions has increased significantly in recent years, causing more healthcare companies to have to defend a case brought under the federal civil False Claim Act. If an entity is determined to have violated the federal civil False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties for each separate false claim. Many comparable state laws are broader in scope and apply to all payors, and therefore, are not limited to only those claims submitted to the Federal Government.

Federal Physician Self-Referral Prohibition

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

Federal Civil Monetary Penalties Statute

The Federal Civil Monetary Penalties Statute, among other things, imposes fines against any person or entity who is determined to have presented, or caused to be presented, claims to a federal healthcare program that the person knows, or should know, is for an item or service that was not provided as claimed or is false or fraudulent.

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Health Insurance Portability and Accountability Act of 1996

The Federal Health Insurance Portability and Accountability Act, or HIPAA, created several additional federal crimes, including healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private third-party payors. 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 healthcare benefits, items or services.

In addition, HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and their implementing regulations established uniform standards for certain covered entities, which are certain healthcare providers, health plans and healthcare clearinghouses, as well as their business associates that perform services for them that involve the creation, use, maintenance or disclosure of, individually identifiable health information, governing the conduct of specified electronic healthcare transactions and protecting the security and privacy of protected health information. Among other things, HITECH also created four new tiers of civil monetary penalties and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions.

The Federal Physician Payments Sunshine Act

The Federal Physician Payments Sunshine Act requires certain manufacturers of drugs, devices, biologics and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program, with certain exceptions, to report annually to CMS, information related to “payments or other transfers of value” provided to physicians (defined to include doctors, dentists, optometrists, podiatrists and chiropractors) and teaching hospitals, and applicable manufacturers and group purchasing organizations to report annually to CMS ownership and investment interests held by physicians, as defined above, and their immediate family members. Failure to submit timely, accurately and completely the required information for all payments, transfers of value and ownership or investment interests may result in civil monetary penalties of up to an aggregate of $150,000 per year and up to an aggregate of $1.0 million per year for “knowing failures.”

State Law Equivalents

Many states have also adopted laws similar to each of the above federal laws, such as anti-kickback and false claims laws, which may be broader in scope and apply to items or services reimbursed by any third-party payor, including commercial insurers, as well as laws that restrict our marketing activities with health care professionals and entities, and require us to track and report payments and other transfers of value, including consulting fees, provided to healthcare professionals and entities. Some states mandate implementation of compliance programs to ensure compliance with these laws. We also are subject to foreign fraud and abuse laws, which vary by country. We may be subject to certain state and foreign laws governing the privacy and security of health information in some circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

Healthcare Reform

In March 2010, President Obama enacted the ACA, which is substantially changing healthcare financing and delivery by both governmental and private insurers, and is significantly impacting the medical device industry. The ACA’s provisions of importance to our business include, but are not limited to, a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, which became effective January 1, 2013. However, the Consolidated Appropriations Act of 2016, signed into law in December 2015, includes a two-year moratorium on the medical device excise tax that applies between January 1, 2016 and December 31, 2017. Absent further legislative action, the tax will be automatically reinstated for medical device sales beginning January 1, 2018.

Since its enactment in 2010, there have been judicial and Congressional challenges to certain aspects of the ACA. In January 2017, President Trump signed an Executive Order directing federal agencies with authorities and responsibilities under the ACA to waive, defer, grant exemptions from, or delay the implementation of any provision of the ACA that would impose a fiscal or regulatory burden on states, individuals, healthcare providers, health insurers, or manufacturers of pharmaceuticals or medical devices. In January 2017, Congress also voted to adopt a budget resolution for fiscal year 2017, or the Budget Resolution, that authorizes the implementation of legislation that would repeal portions of the ACA. Following the passage of the Budget Resolution, in March 2017, the U.S. House of Representatives introduced legislation known as the American Health Care Act, which, if enacted, would amend or repeal significant portions of the ACA. Among other changes, the American Health Care Act would repeal the annual fee on certain brand prescription drugs and biologics imposed on manufacturers and importers, eliminate the 2.3% excise tax on medical devices, eliminate penalties on individuals and employers that fail to maintain or provide minimum essential coverage, and create refundable tax credits to assist individuals in buying health insurance. The American Health Care Act would also make significant changes to

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Medicaid by, among other things, making Medicaid expansion optional for states, repealing the requirement that state Medicaid plans provide the same essential health benefits that are required by plans available on the exchanges, modifying federal funding, including implementing a per capita cap on federal payments to states, and changing certain eligibility requirements.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. 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 reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following passage of the Bipartisan Budget Act of 2015, will stay in effect through 2025 unless Congressional action is taken. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

The full impact of the ACA, its possible repeal, and any legislation passed to replace the ACE, as well as other laws and reform measures that may be proposed and adopted in the future, remains uncertain, but may continue the downward pressure on medical device pricing, especially under the Medicare program, and may also increase our regulatory burdens and operating costs, which could have a material adverse effect on our business operations.

The Foreign Corrupt Practices Act

The Foreign Corrupt Practices Act, or FCPA, prohibits any U.S. individual or business from paying, offering, or authorizing payment or offering of anything of value, directly or indirectly, to any foreign official, political party or candidate for the purpose of influencing any act or decision of the foreign entity to assist the individual or business in obtaining or retaining business. The FCPA also obligates companies whose securities are listed in the United States to comply with accounting provisions requiring the company to maintain books and records that accurately and fairly reflect all transactions of the corporation, including international subsidiaries, and to devise and maintain an adequate system of internal accounting controls for international operations.

Employees

As of December 31, 2016, we had 82 full-time and 3 part-time employees, of which 10 are employed in administration, 13 in manufacturing and operations, 21 in research and development, five in regulatory and quality affairs, and 36 in sales and marketing. We had three employees in Europe as of December 31, 2016, all others were in the United States. We believe that our success will depend, in part, on our ability to attract and retain qualified personnel. We have never experienced a work stoppage due to labor difficulties and believe that our relations with our employees are good. None of our U.S. employees are represented by labor unions. Collective bargaining is established by law in France and Germany. We and our European employees, who reside in France and Germany, have agreed to the terms of the applicable collective bargaining agreements.

Our ability to retain current talent and recruit new people into our Company is another critical factor in our performance. We have initiated multiple programs to promote our organizational culture and to identify the best possible new talent as the organization grows and new positions are made available. In 2016, we launched our five company value statements: embrace the mission, engage, build community, expect healthy tension and assume positive intent. We also adopted a cultural index tool which assesses new hire candidates for cultural fit and to encourage teamwork among existing employees.

Corporate Information

We were originally incorporated in Arizona in October 1997 as “High Throughput Genomics, Inc.” In December 2000, we reincorporated in Delaware as “HTG, Inc.” and in March 2011 we changed our name to “HTG Molecular Diagnostics, Inc.” Our principal executive offices are located at 3430 E. Global Loop, Tucson, AZ 85706, and our telephone number is (877) 289-2615. Our corporate website address is www.htgmolecular.com. Information contained on or accessible through our website is not a part of this report, and the inclusion of our website address in this report is an inactive textual reference only.

This report contains references to our trademarks, including VERI/O, HTG Edge and HTG EdgeSeq, and to trademarks belonging to other entities. Solely for convenience, trademarks and trade names referred to in this report, including logos, artwork and other visual displays, may appear without the ® or TM symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights or the rights of the applicable licensor to these trademarks and trade names. We do not intend our use or display of other companies’ trade names or trademarks to imply a relationship with, or endorsement or sponsorship of us by, any other companies.

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We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of our IPO in May 2015, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeded $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period. We refer to the Jumpstart Our Business Startups Act of 2012 in this Annual Report on Form 10-K as the “JOBS Act,” and references to “emerging growth company” have the meaning associated with it in the JOBS Act.

Item 1A. Risk Factors.

An investment in shares of our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information in this report, and in our other public filings, before deciding to purchase, hold or sell shares of our common stock. The occurrence of any of the following risks could have a material adverse effect on our business, financial condition, results of operations and future growth prospects or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time. In these circumstances, the market price of our common stock could decline, and you may lose all or part of your investment. You should consider all of the risk factors described when evaluating our business.  

Risks Related to our Business and Strategy

We have incurred losses since our inception and expect to incur losses for the foreseeable future. We cannot be certain that we will achieve or sustain profitability.

We have incurred losses since our inception and expect to incur losses in the future. We incurred net losses of $26.0 million and $21.4 million for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, we had an accumulated deficit of $115.6 million. We expect that our losses will continue for the foreseeable future as we will be required to invest significant additional funds to support product development, including development of our next generation instrument platforms, development of our new HTG EdgeSeq panels, including our initial IVD assay, and the commercialization of our HTG EdgeSeq system and proprietary consumables. We also expect that our selling, general and administrative expenses will continue to increase due to the additional costs associated with market development activities, expanding our staff to sell and support our products, and the increased administrative costs associated with being a public company. Our ability to achieve or, if achieved, sustain profitability is based on numerous factors, many of which are beyond our control, including the market acceptance of our products, competitive product development and our market penetration and margins. We may never be able to generate sufficient revenue to achieve or, if achieved, sustain profitability.

We might not be able to continue as a going concern absent our ability to raise additional equity or debt capital. Even if capital is available, it might be available only on unfavorable terms.

This Annual Report on Form 10-K for the year ended December 31, 2016, includes disclosures regarding management’s assessment of its ability to continue as a going concern and a report from our independent auditors that includes an explanatory paragraph regarding going concern, as our current liquidity position and recurring losses from operations since inception and negative cash flows from operating activities raise substantial doubt about our ability to continue as a going concern. We have had recurring operating losses and negative cash flows from operations since inception, and we have an accumulated deficit of approximately $115.6 million as of December 31, 2016. As of December 31, 2016, we had cash, cash equivalents and investments in short term available-for-sale securities of approximately $11.8 million, and had current liabilities of approximately $10.0 million plus an additional $14.0 million in long-term liabilities primarily attributable to our growth term loan and NuvoGen obligation. We believe that our existing cash resources will be sufficient to fund our planned operations and expenditures until mid-way through the second quarter of 2017. However, we cannot provide assurances that our plans will not change or that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate.

 

To date, to fund our operations and develop and commercialize our products, we have relied primarily on equity and debt financings and revenue generated from the sale of our HTG Edge and HTG EdgeSeq systems, the sale of our proprietary consumables and related services. We will need to raise additional capital to fund our continued operations until our revenue reaches a level sufficient to provide for self-sustaining cash flows, if ever. There can be no assurance that additional capital will be available to us when needed or on acceptable terms, or that our revenue will reach a level sufficient to provide for self-sustaining cash flows. If we are unable to raise additional capital in the future when required or in sufficient amounts or on terms acceptable to us, we may have to delay, scale back or discontinue one or more product development programs, curtail our commercialization activities, significantly reduce expenses, sell assets (potentially at a discount to their fair value or carrying value), enter into relationships with third parties to develop or commercialize products or technologies that we otherwise would have sought to develop or commercialize independently, cease operations altogether, pursue an acquisition of our company at a price that may result in up to a total loss on investment for our stockholders, file for bankruptcy or seek other protection from creditors, or liquidate all of our assets. In addition, if we default under

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our term loan agreement, our lenders could foreclose on our assets, including substantially all of our cash which is held in accounts with our lenders.

Even if capital is available, it might be available only on unfavorable terms. Any additional equity or convertible debt financing into which we enter could be dilutive to our existing stockholders. Any future debt financing into which we enter may impose covenants upon us that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us.

If we obtain additional financing to fund our business activities in the future and there remains doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding on commercially reasonable terms or at all. If we are unable to continue as a going concern, holders of our common stock or other securities may lose the entire value of their investment.

Payments under the instruments governing our indebtedness may reduce our working capital. In addition, a default under our term loan agreement could cause a material adverse effect on our financial position.

In August 2014, we entered into a $16.0 million term loan agreement with Oxford Finance LLC and Silicon Valley Bank, who we collectively refer to as the lenders. Under the terms of the term loan agreement, the lenders initially provided us with a term loan of $11.0 million. In March 2016, we borrowed the remaining $5.0 million pursuant to the term loan agreement. The loan is secured by a lien covering substantially all of our assets, excluding patents, trademarks and other intellectual property rights (except for rights to payment related to the sale, licensing or disposition of such intellectual property rights) and certain other specified property. The interest-only payment period expired in April 2016, and we are currently required to make monthly principal and interest payments through September 2018. Payments under the term loan agreement could result in a significant reduction of our working capital, which in turn could significantly impact our need to raise additional capital in order to continue as a going concern. As of December 31, 2016, we had $11.8 million outstanding under the term loan agreement, of which amount $6.4 million is scheduled to become due and payable over the 12 months following such date, compared to cash, cash equivalents and investments in short term available‑for‑sale securities of approximately $11.8 million. If we default under our term loan agreement, our lenders could foreclose on our assets, including substantially all of our cash, which is held in accounts with our lenders.    

Pursuant to the terms of an asset purchase agreement with NuvoGen Research, LLC, or NuvoGen, pursuant to which we acquired certain intellectual property, we agreed to pay NuvoGen the greater of $400,000 or 6% of our yearly revenue until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15.0 million. For fiscal years 2013 to 2017, NuvoGen agreed to accept annual fixed fees in the range of $425,000 to $800,000, paid in quarterly installments, and to defer the balance of any revenue-based payments. To date, we have paid NuvoGen approximately $6.3 million. We paid annual fixed fees of $575,000 and $725,000 for 2015 and 2016, respectively. As of December 31, 2016, we have not deferred any revenue-based payments. For 2017, our annual fixed fee payable to NuvoGen is $800,000, payable in quarterly installments. Beginning in 2018, we are again obligated to pay the greater of $400,000 or 6% of our annual revenue plus amounts, if any, deferred in the 2017 period by which 6% of revenue exceeds the $800,000 fixed fee plus 5% interest on any such deferred amounts until the obligation is repaid in full. Payments to NuvoGen could result in a significant reduction in our working capital.

Our term loan agreement requires us, and any debt arrangements we may enter into in the future may require us, to comply with various covenants that limit our ability to, among other things:

 

dispose of assets;

 

complete mergers or acquisitions;

 

incur indebtedness;

 

encumber assets;

 

pay dividends or make other distributions to holders of our capital stock;

 

make specified investments;

 

change certain key management personnel; and

 

engage in transactions with our affiliates.  

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These restrictions could inhibit our ability to pursue our business strategies. If we default under our obligations under the term loan agreement, the lenders could proceed against the collateral granted to them to secure our indebtedness or declare all obligation under the term loan agreement to be due and payable. In certain circumstances, procedures by the lenders could result in a loss by us of all of our equipment and inventory, which are included in the collateral granted to the lenders. If any indebtedness under the term loan agreement were to be accelerated, there can be no assurance that our assets would be sufficient to repay in full that indebtedness. In addition, upon any distribution of assets pursuant to any liquidation, insolvency, dissolution, reorganization or similar proceeding, the holders of secured indebtedness will be entitled to receive payment in full from the proceeds of the collateral securing our secured indebtedness before the holders of other indebtedness or our common stock will be entitled to receive any distribution with respect thereto.

We may incur additional indebtedness in the future. The debt instruments governing such indebtedness may contain provisions that are as, or more, restrictive than the provisions governing our existing indebtedness under the term loan agreement. If we are unable to repay, refinance or restructure our indebtedness when payment is due, the lenders could proceed against the collateral granted to them to secure such indebtedness or force us into bankruptcy or liquidation.

Our HTG EdgeSeq product portfolio requires the use of NGS instrumentation and reagents and could be adversely affected by actions of third party NGS product manufacturers over whom we have no control.

A key element of our strategy is to establish our HTG EdgeSeq system as the best sample and library preparation method for clinical applications of next generation sequencers. We depend at least in part on the availability of NGS instrumentation and reagents, and the ability of our HTG EdgeSeq products to operate seamlessly with NGS instrumentation. Any significant interruption or delay in the ability of our HTG EdgeSeq products to operate on or with NGS instrumentation could reduce demand for our products and result in a loss of customers.

Our reputation, and our ability to continue to establish or develop our technology for clinical applications of next generation sequencers, are dependent upon the availability of NGS instrumentation and the reliable performance of our products with NGS instrumentation. We are not able to control the providers of NGS instrumentation, which increases our vulnerability to interoperability problems with the products that they provide. For example, providers of NGS instruments may discontinue existing products, or introduce new NGS instrumentation products with little or no notice to us. This may cause some of our products not to be operable with one or more NGS instruments or may adversely affect regulatory approvals of our future IVD HTG EdgeSeq products, potentially for extended periods of time. Any interruption in the ability of our products to operate on NGS instruments could harm our reputation or decrease market acceptance of our products, and our business, financial condition and operating results may be materially and adversely affected. We also could experience additional expense in developing new products or changes to existing products to meet developments in NGS instrumentation, and our business, financial condition and operating results may be materially and adversely affected.

Current medical device regulation in the United States and other jurisdictions requires manufacturers of IVD molecular profiling tests that use NGS detection, referred to as NGS IVD tests, to include in regulatory submissions, technical information about the NGS products that are required for performance of, but are not supplied with, the NGS IVD test. These regulatory agencies also require that the NGS instrumentation have “locked” software for the detection of the NGS IVD test results. Thus, to obtain regulatory approval for NGS IVD tests, manufacturers like us, currently must have arrangements with NGS product manufacturers to gain access to technical information and NGS instrument software. We currently have agreements with two NGS product manufacturers that grant us rights to develop, manufacture and sell up to six future HTG EdgeSeq NGS IVD tests in specified fields, subject to, among other things, the NGS product manufacturers’ rights to terminate such agreements and discontinue products or implement product design changes that could adversely affect our HTG EdgeSeq NGS IVD tests. There can be no assurance that our agreements with these NGS product manufacturers, or any future NGS product manufacturers that we contract with, will not be terminated earlier than we currently expect, that an NGS product manufacturer will perform its contractual duties to us, or that we will otherwise receive the benefits we anticipate receiving under those agreements. In addition, if regulatory agencies do not change their requirements for NGS IVD test approval or clearance and the NGS instrument manufacturers close their systems to third party NGS IVD test development (in general or with specific NGS IVD test manufacturers) and we are not able to maintain or enforce our agreements with such manufacturers, we may not be able to meet our commercial goals and our business, financial condition and operating results may be materially and adversely affected.

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The development of future products is dependent on new methods and/or technologies that we may not be successful in developing.

We are planning to expand our product offerings in the fields of detecting RNA fusions and other gene rearrangements and DNA mutations, such as expressed DNA mutations. We believe we have successfully demonstrated proof of concept that our technology is able to detect these fusions and expressed DNA mutations, but to date our work in this area has only been on a very small scale or may not have the specificity required for certain applications. We cannot guarantee that we will be able to successfully develop these applications on a commercial scale. If we are unsuccessful at developing additional applications involving RNA fusions or DNA mutations, we may be limited in the breadth of additional products we can offer in the future, which could impact our future revenues and profits.

We have initiated development of a new version of our HTG EdgeSeq system that will target the lower-volume throughput lab market. This development program, which we refer to as Project JANUS, is expected to increase our addressable market by enabling efficient molecular profiling of smaller quantity batches of samples. This program involves the development of new chemistry that is not currently compatible with our existing HTG Edge or HTG EdgeSeq platforms. We have temporarily suspended the development of this program in favor of other high value projects that we expect to provide greater short term benefits, and if we are unable to resume or successfully develop this new version of our HTG EdgeSeq system and on the timeframe we anticipate, our addressable market could be limited, which could harm our business, results of operations and financial condition.    

We may not be able to develop new products or enhance the capabilities of our systems to keep pace with rapidly changing technology and customer requirements, which could have a material adverse effect on our business and operating results.

Our success depends on our ability to develop new products and applications for our technology in existing and new markets, while improving the performance and cost-effectiveness of our systems. New technologies, techniques or products could emerge that might offer better combinations of price and performance than our current or future products and systems. Existing or future markets for our products, including gene expression analysis, liquid-based specimen analysis (e.g., plasma, blood and urine) and single-cell analysis, as well as potential markets for our diagnostic product candidates, are characterized by rapid technological change and innovation. It is critical to our success that we anticipate changes in technology and customer requirements and successfully introduce new, enhanced and competitive technologies to meet our customers’ and prospective customers’ needs on a timely and cost-effective basis. At the same time, however, we must carefully manage the introduction of new products. If customers believe that such products will offer enhanced features or be sold for a more attractive price, they may delay purchases until such products are available. We may also have excess or obsolete inventory of older products as we transition to new products and our experience in managing product transitions is very limited. If we do not successfully innovate and introduce new technology into our product lines or effectively manage the transitions to new product offerings, our revenues and results of operations will be adversely impacted.

Competitors may respond more quickly and effectively than we do to new or changing opportunities, technologies, standards or customer requirements. We anticipate that we will face increased competition in the future as existing companies and competitors develop new or improved products and as new companies enter the market with new technologies.

If we do not successfully manage the development and launch of new products, our financial results could be adversely affected.

We face risks associated with launching new products and with undertaking to comply with regulatory requirements for certain of our products. If we encounter development or manufacturing challenges or discover errors during our product development cycle, the product launch date(s) may be delayed. The expenses or losses associated with unsuccessful product development or launch activities or lack of market acceptance of our new products could adversely affect our business or financial condition.

If we do not achieve, sustain or successfully manage our anticipated growth, our business and growth prospects will be harmed.

Our current personnel, systems and facilities may not be adequate to support our business plan and future growth. Our need to effectively manage our operations, growth and various projects requires that we, among other things:

 

continue to improve our operational, financial, management and regulatory compliance controls and reporting systems and procedures;

 

attract and retain sufficient numbers of talented employees;

 

manage our commercialization activities effectively and in a cost-effective manner;

 

manage our relationship with third parties related to the commercialization of our products; and

 

manage our development efforts effectively while carrying out our contractual obligations to contractors and other third parties.

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Moreover, growth will place significant strains on our management and our operational and financial systems and processes. For example, expanded market penetration of our HTG EdgeSeq system and related proprietary panels, and future development and approval of diagnostic products, are key elements of our growth strategy that will require us to hire and retain additional sales and marketing, regulatory, manufacturing and quality assurance personnel. If we do not successfully forecast the timing and cost of the development of new panels and diagnostic products, the regulatory clearance or approval for product marketing of any future diagnostic products or the demand and commercialization costs of such products, or manage our anticipated expenses accordingly, our operating results will be harmed.

Our future success is dependent upon our ability to expand our customer base and introduce new applications.

Our current customer base is primarily composed of biopharmaceutical companies, academic institutions and molecular labs that perform analyses using our HTG Edge or HTG EdgeSeq systems and consumables for research use only, which means that they may not be used for clinical diagnostic purposes. In July 2016, we obtained CE marking in Europe for our HTG EdgeSeq system and HTG EdgeSeq DLBCL Cell of Origin Assay, which means that these products may be used for diagnostic purposes in Europe. Our success will depend, in part, upon our ability to increase our market penetration among our customer base and to expand our market by developing and marketing new clinical diagnostic tests and research-use-only applications, and to introduce diagnostic products into clinical laboratories in the United States and other jurisdictions after obtaining the requisite regulatory clearances or approvals. We may not be able to successfully complete development of or commercialize any of our planned future tests and applications. To achieve these goals, we will need to conduct substantial research and development, conduct clinical validation studies, expend significant funds, expand and scale-up our research and development and manufacturing processes and facilities, expand and train our sales force; and seek and obtain regulatory clearance or approvals of our new tests and applications, as required by applicable regulations. Additionally, we must demonstrate to laboratory directors, physicians and third-party payors that our current and any future diagnostic products are effective in obtaining clinically relevant information that can inform treatment decisions, and that our HTG EdgeSeq systems and related panels can enable an equivalent or superior approach than other available technology. Furthermore, we expect that a combination of increasing the installed base of our HTG EdgeSeq systems and entering into additional service and custom assay development agreements with biopharmaceutical customers will drive increased demand for our relatively high margin panels. If we are not able to successfully increase our installed base and biopharmaceutical customer relationships, then sales of our panels, sample processing services to be performed by our VERI/O laboratory and our margins for these revenue items may not meet expectations. Attracting new customers and introducing new panels requires substantial time and expense. Any failure to expand our existing customer base, or launch new panels or diagnostic products, would adversely affect our ability to improve our operating results.

Our financial results may vary significantly from quarter to quarter or may fall below the expectations of investors or securities analysts, each of which may adversely affect our stock price.

Investors should consider our business and prospects considering the risks and difficulties we expect to encounter in the new, uncertain and rapidly evolving markets in which we compete. Because these markets are new and evolving, predicting their future growth and size is difficult. We expect that our visibility into future sales of our products, including volumes, prices and product mix between instruments, consumables and services, will continue to be limited and could result in unexpected fluctuations in our quarterly and annual operating results.

Numerous other factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual operating results. For example, two customers accounted for 29% and 12% of our revenue for the year ended December 31, 2016 and two customers accounted for 38% and 7% for the year ended December 31, 2015. If orders from our top customers are reduced or discontinued, our revenue in future periods may materially decrease. Fluctuations in our operating results may make financial planning and forecasting difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. Factors that may contribute to fluctuations in our operating results include many of the risks described under the caption “Risk Factors – Risks Related to Our Business and Strategy” of this report. In addition, one or more of such factors may cause our revenue or operating expenses in one period to be disproportionately higher or lower relative to the others. Our products involve a significant capital commitment from our customers or may depend on customer studies that have variable or indefinite timelines, and accordingly involve a lengthy sales cycle. We may expend significant effort in attempting to make a particular sale, which may be deferred by the customer or never occur. Accordingly, comparing our operating results on a period-to-period basis may not be meaningful, and investors should not rely on our past results as an indication of our future performance. If such fluctuations occur or if our operating results deviate from our expectations or the expectations of investors or securities analysts, our stock price may be adversely affected.

Our sales cycle is lengthy and variable, which makes it difficult for us to forecast revenue and other operating results.

Our sales process involves numerous interactions with multiple individuals within any given organization, and often includes in-depth analysis by potential customers of our products (where in some instances we will provide a demonstration unit for their use and

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evaluation), performance of proof-of-principle studies, preparation of extensive documentation and a lengthy review process. As a result of these factors, the capital investment required in purchasing our instruments and the budget cycles of our customers, the time from initial contact with a customer to our receipt of a purchase order can vary significantly and be up to 12 months or longer. Given the length and uncertainty of our sales cycle, we have in the past experienced, and likely will in the future experience, fluctuations in our instrument sales or service revenues on a period-to-period basis. In addition, any failure to meet customer expectations could result in customers choosing to retain their existing systems or service providers or to purchase systems or services other than ours.

If the utility of our HTG EdgeSeq system, proprietary profiling panels, services and solutions in development is not supported by studies published in peer-reviewed medical publications, the rate of adoption of our current and future products and the rate of reimbursement of our future products by third-party payors may be negatively affected.

We anticipate that we will need to maintain a continuing presence in peer-reviewed publications to promote adoption of our products by biopharmaceutical companies, academic institutions and molecular labs and to promote favorable coverage and reimbursement decisions. We believe that peer-reviewed journal articles that provide evidence of the utility of our current and future products or the technology underlying the HTG EdgeSeq system, consumables and services are important to our commercial success. It is critical to the success of our sales efforts that we educate a sufficient number of clinicians and administrators about our HTG EdgeSeq system, our current panels and services and our future solutions, and demonstrate the research and clinical benefits of these solutions. Our customers may not adopt our current and future solutions, and third-party payors may not cover or adequately reimburse our future products, unless they determine, based on published peer-reviewed journal articles and the experience of other researchers and clinicians, that our products provide accurate, reliable, useful and cost-effective information. Peer-reviewed publications regarding our products and solutions may be limited by many factors, including delays in the completion of, poor design of, or lack of compelling data from studies that would be the subject of the article. If our current and future solutions or the technology underlying our HTG EdgeSeq platform, our current panels and services or our future solutions do not receive sufficient favorable exposure in peer-reviewed publications, the rate of research and clinician adoption and positive coverage and reimbursement decisions could be negatively affected.

We provide our HTG Edge and HTG EdgeSeq systems and profiling panels free of charge or through other arrangements to customers or key opinion leaders through evaluation agreements or reagent rental programs, and these programs may not be successful in generating recurring revenue from sales of our systems and proprietary panels.

We sell our HTG Edge and HTG EdgeSeq systems and profiling panels under different arrangements to expand our installed base and facilitate the adoption of our platform.

In some instances, we provide equipment free of charge under evaluation agreements for a limited period of time to permit the user to evaluate the system for their purposes in anticipation of a decision to purchase the system. We retain title to the equipment under such arrangements unless a decision to purchase is made, and in most cases, require evaluation customers to purchase a minimum quantity of consumables during the evaluation period.

When we place a system under a reagent rental agreement, we install equipment in the customer’s facility without a fee and the customer agrees to purchase consumable products at a stated priced over the term of the agreement. While some of these agreements did not historically contain a minimum purchase requirement, we have included a minimum purchase requirement in all reagent rental agreements in 2015 and 2016, and will continue to do so in the future. We retain title to the equipment and such title is transferred to the customer at no additional charge at the end of the initial arrangement. The cost of the instrument under the agreement is expected to be recovered in the fees charged for consumables, to the extent sold, over the term of the agreement.

Other arrangements might include a collaboration agreement whereby an academic or a commercial collaborator agrees to provide samples free of charge in exchange for the use of a HTG Edge and/or HTG EdgeSeq system at no cost in furtherance of a research or clinical project.

Any of the foregoing arrangements could result in lost revenues and profit and potentially harm our long-term goal of achieving profitable operations. In addition, despite the fact we require customers who receive systems we continue to own to carry insurance sufficient to protect us against any equipment losses, we cannot guarantee that they will maintain such coverage, which may expose us to a loss of the value of the equipment in the event of any loss or damage.

There are instances where we provide our systems to key opinion leaders free of charge, to gather data and publish the results of their research to assist our marketing efforts. We have no control over some of the work being performed by these key opinion leaders, or whether the results will be satisfactory. It is possible that the key opinion leader may generate data that is unsatisfactory and could potentially harm our marketing efforts. In addition, customers may from time to time create negative publicity about their experience with our systems, which could harm our reputation and negatively affect market perception and adoption of our platform.

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Placing our HTG Edge and HTG EdgeSeq systems under evaluation agreements, under reagent rental agreements or with our key opinion leaders without receiving payment for the instruments could require substantial additional working capital to provide additional units for sale to our customers.

A significant amount of our inventory consists of instruments held by prospective customers who are evaluating our products and may not be converted to revenue on the timeframe that we anticipate or at all.

As of December 31, 2016, approximately $186,000 of our inventory consisted of HTG EdgeSeq instruments held by customers who are evaluating and testing our HTG EdgeSeq products. If these prospective customers do not adopt our products within the time periods that we estimate, or at all, then we will not be able to convert the inventory held by these customers into revenues. If we are unable to sell this inventory to other customers or if it becomes obsolete as we introduce and expand the customer base for our HTG EdgeSeq system, we may be required to write off a significant portion of this inventory.

Our strategy of developing companion diagnostic products may require large investments in working capital and may not generate any revenues.

A key component of our strategy is the development of companion diagnostic products designed to determine the appropriate patient population for administration of a particular therapeutic to more successfully treat a variety of illnesses. Successfully developing a companion diagnostic product depends both on regulatory approval for administration of the therapeutic, as well as regulatory approval of the diagnostic product. Even if we are successful in developing products that would be useful as companion diagnostic products, and potentially receive regulatory approval for such products, the biopharmaceutical companies that develop the corresponding therapeutics may ultimately be unsuccessful in obtaining regulatory approval for any such therapeutic, or, even if successful, select a competing technology to use in their regulatory submission instead of ours. The development of companion diagnostic products requires a significant investment of working capital which may not result in any future income. This could require us to raise additional funds which could dilute our current investors, or could impact our ability to continue our operations in the future.

Our current business depends on levels of research and development spending by academic and governmental research institutions and biopharmaceutical companies, a reduction in which could limit demand for our products and adversely affect our business and operating results.

Our revenue is currently derived from sales of our HTG Edge and HTG EdgeSeq systems, proprietary panels, and the development of custom assays and sample processing for biopharmaceutical companies, academic institutions and molecular labs worldwide for research applications. The demand for our products and services will depend in part upon the research and development budgets of these customers, which are impacted by factors beyond our control, such as:

 

changes in government programs that provide funding to research institutions and companies;

 

macroeconomic conditions and the political climate;

 

changes in the regulatory environment;

 

differences in budgetary cycles;

 

market-driven pressures to consolidate operations and reduce costs; and

 

market acceptance of relatively new technologies, such as ours.

We believe that any uncertainty regarding the availability of research funding may adversely affect our operating results and may adversely affect sales to customers or potential customers that rely on government funding. In addition, academic, governmental and other research institutions that fund research and development activities may be subject to stringent budgetary constraints that could result in spending reductions, reduced allocations or budget cutbacks, which could jeopardize the ability of these customers to purchase our products. Our operating results may fluctuate substantially due to reductions and delays in research and development expenditures by these customers. Any decrease in our customers’ budgets or expenditures, or in the size, scope or frequency of capital or operating expenditures, could materially and adversely affect our business, operating results and financial condition.

We have limited experience in marketing and selling our products, and if we are unable to successfully commercialize our products, our business may be adversely affected.

We have limited experience marketing and selling our products. Our HTG Edge system was introduced for sale in the life sciences research market in the third quarter of 2013. Our HTG EdgeSeq chemistry was introduced for sale in the life sciences research market in the third quarter of 2014. Our dedicated HTG EdgeSeq system was introduced for sale in the life sciences research

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market in the fourth quarter of 2015. Our VERI/O service laboratory was announced in June 2016. We currently market our products through our own sales force in the United States and Europe, and have distributors in parts of Europe, the Middle East and Asia. In the future, we intend to expand our sales and support team in the United States, continue to build a direct sales and support team in Europe and establish additional distributor and/or third party contract sales team relationships in other parts of the world. However, we may not be able to market and sell our products effectively. Our sales of life science research products and potential future diagnostic products will depend in large part on our ability to successfully increase the scope of our marketing efforts and establish and maintain a sales force commensurate with our then applicable markets. Because we have limited experience in marketing and selling our products in the life science research market and in marketing and selling our products in the diagnostic market, our ability to forecast demand, the infrastructure required to support such demand and the sales cycle to customers is unproven. If we do not build an efficient and effective sales force and distributor relationships targeting these markets, our business and operating results will be adversely affected.

If we do not obtain regulatory clearance or approval to market our products for diagnostic purposes, we will be limited to marketing our products for research use only. In addition, if regulatory limitations are placed on our diagnostic products our business and growth will be harmed.

In many jurisdictions, including the United States, we are currently limited to marketing all or some of our HTG Edge and HTG EdgeSeq systems and proprietary profiling panels for research use only, which means that we cannot make any diagnostic or clinical claims for those products in those jurisdictions. We have sought and intend to continue to seek regulatory clearances or approvals in the United States and other jurisdictions to market certain panels for diagnostic purposes; however, we may not be successful in doing so.

The FDA regulates diagnostic kits sold and distributed through interstate commerce in the United States as medical devices. Unless an exemption applies, generally, before a new medical device may be sold or distributed in the United States, or may be marketed for a new use in the United States, the medical device must receive either FDA clearance of a 510(k) pre-market notification or pre-market approval. Thus, before we can market or distribute our profiling panels, including our mRNA and miRNA panels, as IVD kits for use by clinical testing laboratories in the United States, we must first obtain pre-market clearance or pre-market approval from the FDA. Even if or when we apply for clearance or approval from the FDA for any of our products, the process can be lengthy and unpredictable. We are working collaboratively with multiple biopharmaceutical companies to clinically validate our HTG EdgeSeq DLBCL Cell of Origin Assay, which we believe can classify DLBCL as either ABC or GCB subtype and detect the expression of additional drug-linked gene targets such as PD-1, PD-L1 and CD19. We expect to submit the DLBCL assay for U.S. regulatory clearances or approvals at some future time if and when our work with the biopharmaceutical companies reaches an appropriate stage. We initiated a modular submission process to obtain FDA approval of our HTG EdgeSeq ALKPlus Assay to detect certain gene fusions in lung cancer. Pending the outcome of clinical studies, we expect to complete the FDA submission for the HTG EdgeSeq ALKPlus Assay in 2017. We cannot provide any assurances that our clinical studies or collaborations with biopharmaceutical companies will have the desired outcomes or that we will meet the regulatory clearance or approval timelines for either product. Further, even if we complete the requisite clinical validations and submit an application, we may not receive FDA clearance or approval for the commercial use of our tests on a timely basis, or at all. If we are unable to obtain regulatory clearance or approval, or if clinical diagnostic laboratories do not accept our cleared or approved tests, our ability to grow our business could be compromised.

Similarly, foreign countries have either implemented or are in the process of implementing increased regulatory controls that require that we submit applications for review and approval by foreign regulatory bodies. We obtained the right to CE mark the HTG EdgeSeq DLBCL Cell of Origin Assay and the HTG EdgeSeq ALKPlus Assay for sale as an IVD in Europe, in July 2016 and March 2017, respectively. Once we do apply for the HTG EdgeSeq ALKPlus Assay or any other product, we may not receive ex-U.S. approval for the commercial use of our tests on a timely basis, or at all. If we are unable to achieve appropriate ex-U.S. approvals, or if clinical diagnostic laboratories outside the United States do not accept our tests, our ability to grow our business outside of the United States could be compromised.

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Clinical studies of any product candidate that we intend to market as an IVD kit may not be successful. If we are unable to successfully complete non-clinical and clinical studies of our product candidates or experience significant delays in doing so, our business will be materially harmed.

Our clinical diagnostic business prospects in the United States and other applicable jurisdictions will depend on our ability to successfully complete clinical studies for product candidates that we intend to market as IVD kits. A failure of one or more clinical studies can occur at any stage of testing. The outcome of non-clinical studies may not be predictive of the success of clinical studies, and interim results, if any, of a clinical study do not necessarily predict final results. Moreover, non-clinical and clinical data are often susceptible to varying interpretations and analyses, and many companies that have believed their product candidates performed satisfactorily in non-clinical and clinical studies have nonetheless failed to obtain pre-marketing clearance or approval for their products. Completion of clinical studies, announcement of results of the studies and our ability to obtain regulatory approvals could be delayed for a variety of reasons, including:

 

unsatisfactory results of any clinical study, including failure to meet study objectives;

 

the failure of our principal third-party investigators to perform our clinical studies on our anticipated schedules;

 

imposition of a clinical hold following an inspection of our clinical study operations or trial sites by the FDA or other regulatory authorities;  

 

our inability to adhere to clinical study requirements directly or with third parties, such as contract research organizations;

 

different interpretations of our non-clinical and clinical data, which could initially lead to inconclusive results; and

 

delays in obtaining suitable patient samples for use in a trial;

Our development costs will increase if we have material delays in any clinical study or if we need to perform more or larger clinical studies than planned. If the delays are significant, or if any of our products do not prove to be equivalent to a predicate device or safe or effective, as applicable, or do not receive required regulatory approvals, our financial results and the commercial prospects for our product candidates will be harmed. Furthermore, our inability to complete our clinical studies in a timely manner could jeopardize our ability to obtain regulatory approval.

If our HTG EdgeSeq systems and proprietary profiling panels fail to achieve and sustain sufficient market acceptance, or we are not able to continue to expand our service relationships with biopharmaceutical customers, we will not generate expected revenue, and our prospects may be harmed.

We are currently focused on selling our HTG EdgeSeq systems and profiling panels within the life sciences research market. We plan to develop panels for many different disease states including companion diagnostics to determine the proper course of treatment for those diseases. We may experience reluctance, or refusal, on the part of physicians to order, and third-party payors to cover and provide adequate reimbursement for, our panels if the results of our research and clinical studies, and our sales and marketing activities relating to communication of these results, do not convey to physicians, third-party payors and patients that the HTG EdgeSeq systems and related profiling panels provide equivalent or better diagnostic information than other available technologies and methodologies. We believe our panels represent an emerging methodology in diagnosing disease states, and we may have to overcome resistance among physicians to adopting it for the marketing of our products to be successful. Even if we are able to obtain regulatory approval from the FDA, the use of our panels may not become the standard diagnostic tool for those diseases on which we plan to focus our efforts. A portion of our strategy is to develop diagnostic tools in conjunction with biopharmaceutical companies to help assess the proper course of treatment for specific diseases, and to perform sample processing and analysis services for biopharmaceutical customers through our VERI/O laboratory. Even if we are successful in developing those diagnostic tools and receive regulatory approval, we still may not be successful in marketing those diagnostic tests. Furthermore, our biopharmaceutical partners may choose alternative diagnostic tests to market with their products instead of ours which could limit our diagnostic test sales and revenues.

As part of our current business model, we intend to seek to enter into strategic collaborations and licensing arrangements with third parties to develop diagnostic tests.

We have relied, and expect to continue to rely, on strategic collaborations and licensing agreements with third parties to develop or in-license technologies based on which we develop profiling panels. We have entered into agreements with third parties to facilitate or enable our development of assays, and ultimately diagnostic tests, to aid in the diagnosis of immuno-oncology, breast-related disorders, melanoma and other diseases. We intend to enter into additional similar agreements with life sciences companies, biopharmaceutical companies and other researchers for future diagnostic products. However, we cannot guarantee that we will enter into any additional agreements. In particular, our life sciences research or biopharmaceutical customers are not obligated to collaborate with us or license technology to us, and they may choose to develop diagnostic products themselves or collaborate with our competitors. Establishing collaborations and licensing arrangements is difficult and time-consuming. Discussions may not lead to

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collaborations or licenses on favorable terms, or at all. Potential collaborators or licensors may elect not to work with us based upon their assessment of our financial, regulatory or intellectual property position. To the extent that we enter new collaboration or licensing agreements, they may never result in the successful development or commercialization of future tests or other products for a variety of reasons, including because our collaborators may not succeed in performing their obligations or may choose not to cooperate with us. We cannot control the amount and timing of our collaborators’ resources that will be devoted to performing their responsibilities under our agreements with them. Moreover, to the extent we agree to work exclusively with a party in a given area, our opportunities to collaborate with others would be limited. Even if we establish new relationships, they may never result in the successful development or commercialization of future tests or other products. Disputes with our collaborators could also impair our reputation or result in development delays, decreased revenues and litigation expenses.

Our research and development efforts will be hindered if we are not able to contract with third parties for access to archival patient samples.

Our future development of products for clinical indications will require access to archival patient samples for which data relevant to the clinical indication of interest is known. We rely on our ability to secure access to these archived patient samples, including FFPE tissue, plasma, serum, whole blood preserved in PAX gene, or various cytology preparations, together with the information pertaining to the clinical outcomes of the patients from which the samples were taken. Owners or custodians of relevant samples may be difficult to identify and/or identified samples may be of poor quality or limited in number or amount. Additionally, others compete with us for access to these samples for both research and commercial purposes. Even when an appropriate cohort of samples is identified, the process of negotiating access to these samples can be lengthy because it typically involves numerous parties and approval levels to resolve complex issues such as usage rights, institutional review board approval, privacy rights, publication rights, and intellectual property ownership. In addition, in some instances the cost to acquire samples can be prohibitively expensive. If we are not able to negotiate access to archived patient samples on a timely basis and on acceptable terms, or at all, or if our competitors or others secure access to these samples before us, our ability to research, develop and commercialize future products will be limited or delayed.

The life sciences research and diagnostic markets are highly competitive. We face competition from enhanced or alternative technologies and products, which could render our products and/or technologies obsolete. If we fail to compete effectively, our business and operating results will suffer.

We face significant competition in the life sciences research and diagnostics markets. We currently compete with both established and early-stage life sciences research companies that design, manufacture and market instruments and consumables for gene expression analysis, liquid-based specimen analysis (e.g., plasma, blood and urine), single-cell analysis, PCR, digital PCR, other nucleic acid detection and additional applications. These companies use well-established laboratory techniques such as microarrays or quantitative PCR, or qPCR, as well as newer technologies such as next generation sequencing. We believe our principal competitors in the life sciences research market are Agilent Technologies, Inc., ArcherDx, Inc., BioRad Laboratories, Exiqon A/S, Fluidigm Corporation, Foundation Medicine, Inc., Genomic Health, Illumina, Inc., Abbott Molecular, Luminex Corporation, Affymetrix, Inc., NanoString Technologies, Inc., entities owned and controlled by QIAGEN, Roche Diagnostics, a division of the Roche Group of companies, and Thermo Fisher Scientific, Inc. In addition, there are several other market entrants in the process of developing novel technologies for the life sciences market, including companies such as WaferGen Bio-Systems, Inc. One or more of our competitors could develop a product that is superior to a product we offer or intend to offer or our technology and products may be rendered obsolete or uneconomical by advances in existing technologies.

Within the diagnostic market, there are competitors that manufacture systems for sales to hospitals and laboratories and other competitors that offer tests conducted through CLIA laboratories. We will also compete with commercial diagnostics companies. Most of our current competitors are either publicly traded, or are divisions of publicly traded companies, and enjoy a number of competitive advantages over us, including:

 

greater name and brand recognition, financial and human resources;

 

broader product lines;

 

larger sales forces and more established distributor networks;

 

substantial intellectual property portfolios;

 

larger and more established customer bases and relationships; and

 

better established, larger scale, and lower cost manufacturing capabilities.

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We believe that the principal competitive factors in all of our target markets include:

 

cost of capital equipment;

 

cost of consumables and supplies;

 

reputation among customers;

 

innovation in product offerings;

 

flexibility and ease-of-use;

 

accuracy and reproducibility of results; and

 

compatibility with existing laboratory processes, tools and methods.

We believe that additional competitive factors specific to the diagnostics market include:

 

breadth of clinical decisions that can be influenced by information generated by tests;

 

volume, quality, and strength of clinical and analytical validation data;

 

availability of coverage and adequate reimbursement for testing services; and

 

economic benefit accrued to customers based on testing services enabled by products.

Our products may not compete favorably and we may not be successful in the face of increasing competition from new products and technologies introduced by our existing competitors or new companies entering our markets. In addition, our competitors may have or may develop products or technologies that currently or in the future will enable them to produce competitive products with greater capabilities or at lower costs than ours. Any failure to compete effectively could materially and adversely affect our business, financial condition and operating results.

We are dependent on a single third-party supplier to supply a subcomponent of our systems, and the loss of any of these suppliers could harm our business.

We currently rely on a single supplier to supply a subcomponent used in our HTG EdgeSeq processors. Our contracts with this supplier do not commit it to carry inventory or make available any particular quantities, and it may give other customers’ needs higher priority than ours and we may not be able to obtain adequate supplies in a timely manner or on commercially reasonable terms. We also rely on third-party suppliers for various components we use to manufacture our consumable products. We periodically forecast our needs for such components and enter into standard purchase orders with such suppliers. If we were to lose any such suppliers, we may not be able to identify or enter into agreements with alternative suppliers on a timely basis on acceptable terms, or at all. If we should encounter delays or difficulties in securing the quality and quantity of materials we require for our products, our supply chain would be interrupted which would adversely affect our sales. A loss of any of these suppliers could significantly delay the delivery of our applicable product(s), which in turn would materially affect our ability to generate revenue. If any of these events occur, our business and operating results could be materially harmed.

We may encounter manufacturing difficulties that could impede or delay production of our HTG EdgeSeq systems.

We began manufacturing our HTG EdgeSeq system internally in 2016. We have limited experience with manufacturing the system and our internal manufacturing operations may encounter difficulties involving, among other things, scale-up of manufacturing processes, production efficiency and output, regulatory compliance, quality control and quality assurance, and shortages of qualified personnel. Any failure in our planned internal manufacturing operations could cause us to be unable to meet demand for these systems, delay the delivery of the system to customers, and harm our business relationships and reputation.

If we encounter difficulties in our planned internal manufacturing operations, we may need to engage a third-party supplier, provided we cannot be sure we will be able to do so in a timely manner, or at all, or on favorable terms.

Any of these factors could cause us to delay or suspend production of our HTG EdgeSeq system, entail unplanned additional costs and materially harm our business, results of operations and financial condition.

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If our Tucson facilities become unavailable or inoperable, the manufacturing of our instrument and consumable products or our ability to process sales orders will be interrupted and our business could be materially harmed.

We manufacture our consumable products and our HTG EdgeSeq system in our Tucson, Arizona facilities. In addition, our Tucson facilities are the center for order processing, receipt of critical components of our HTG EdgeSeq instrument and shipping products to customers. We do not have redundant facilities. Damage or the inability to utilize our Tucson facilities and the equipment we use to perform research and development and manufacture our products could be costly, and we would require substantial lead-time to repair or replace this facility and equipment. The Tucson facilities may be harmed or rendered inoperable by natural or man-made disasters, including flooding, wind damage, power spikes and power outages, which may render it difficult or impossible for us to perform these critical functions for some period of time. The inability to manufacture consumables, process customer samples or ship products to customers for even a short period of time may result in the loss of customers or harm our reputation, and we may be unable to regain those customers in the future. Although we possess insurance for damage to our property and the disruption of our business, 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, or at all.

We expect to generate a portion of our revenue internationally and are subject to various risks relating to our international activities which could adversely affect our operating results.

During the year ended December 31, 2016, approximately 16% of our revenue was generated from sales to customers located outside of the United States, compared with 13% for the year ended December 31, 2015. We expect that a percentage of our future revenue will continue to come from international sources, and we expect to expand our overseas operations and develop opportunities in additional areas. Engaging in international business involves a number of difficulties and risks, including:

 

required compliance with existing and changing foreign regulatory requirements and laws;

 

required compliance with anti-bribery laws, such as the U.S. Foreign Corrupt Practices Act and U.K. Bribery Act, data privacy requirements, labor laws and anti-competition regulations;

 

export and import restrictions;

 

various reimbursement, pricing and insurance regimes;

 

laws and business practices favoring local companies;

 

longer payment cycles and difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;

 

political and economic instability;

 

potentially adverse tax consequences, tariffs, customs charges, bureaucratic requirements and other trade barriers, including transfer pricing, value added and other tax systems, double taxation and restrictions and/or taxation on repatriation of earnings;

 

tariffs, customs charges, bureaucratic requirements and other trade barriers;

 

difficulties and costs of staffing and managing foreign operations, including difficulties and costs associated with foreign employment laws;

 

increased financial accounting and reporting burdens and complexities; and

 

difficulties protecting, procuring, or enforcing intellectual property rights, including from reduced or varied protection for intellectual property rights in some countries.

As we expand internationally our results of operations and cash flows will become increasingly subject to fluctuations due to changes in foreign currency exchange rates. Historically, most of our revenue has been denominated in U.S. dollars, although we have sold our products and services in local currency outside of the United States, principally the Euro. Our expenses are generally denominated in the currencies in which our operations are located, which is primarily in the United States. As our operations in countries outside of the United States grows, our results of operations and cash flows will increasingly be subject to fluctuations due to changes in foreign currency exchange rates, which could negatively impact our results of operations in the future. For example, if the value of the U.S. dollar increases relative to foreign currencies, in the absence of an offsetting change in local currency prices, our revenue could be adversely affected as we convert revenue from local currencies to U.S. dollars.

If we dedicate significant resources to our international operations and are unable to manage these risks effectively, our business, operating results and prospects will suffer. Moreover, we cannot be certain that the investment and additional resources required in establishing operations in other countries will produce desired levels of revenue or profitability.

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In addition, any failure to comply with applicable legal and regulatory obligations could negatively impact us in a variety of ways that include, but are not limited to, significant criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments and restrictions on certain business activities.

We rely on distributors for sales of our products in several markets outside of the United States.

We have established exclusive and non-exclusive distribution agreements for our HTG EdgeSeq platforms and related profiling panels within parts of Europe, the Middle East and Asia. We intend to continue to grow our business internationally, and to do so, in addition to expanding our own direct sales and support team, we plan to attract additional distributors and sales partners to maximize the commercial opportunity for our products. We cannot guarantee that we will be successful in attracting desirable distribution and sales partners or that we will be able to enter into such arrangements on favorable terms. Distributors and sales partners may not commit the necessary resources to market and sell our products to the level of our expectations or may favor marketing the products of our competitors. If current or future distributors or sales partners do not perform adequately, or we are unable to enter into effective arrangements with distributors or sales partners in particular geographic areas, we may not realize long-term international revenue growth.

Limitations in the use of our products could harm our reputation or decrease market acceptance of our products; undetected errors or defects in our products could harm our reputation, decrease market acceptance of our products or expose us to product liability claims.

Our products are subject to the limitations set forth in the product labeling, which may not satisfy the needs of all customers. For example, in the past we have introduced new panels that initially were intended to be used with specific sample types. Because our customers desire that our panels be broadly applicable to many biological sample types, these initial limitations could harm our reputation or decrease market acceptance of our products. If that occurs, we may incur significant costs, the attention of our key personnel could be diverted, or other significant customer relations problems may arise, which could harm our business and operating results.

Similarly, our products may contain undetected errors or defects when first introduced or as new versions are released. Since our current customers use our products for research and, if cleared or approved for diagnostic applications, disruptions or other performance problems with our products may damage our customers’ businesses and could harm our reputation. If that occurs, we may incur significant costs, the attention of our key personnel could be diverted, or other significant customer relations problems may arise. We may also be subject to warranty and liability claims for damages related to errors or defects in our products. A material liability claim or other occurrence that harms our reputation or decreases market acceptance of our products could harm our business and operating results.

The sale and use of products or services based on our technologies, or activities related to our research and clinical studies, could lead to the filing of product liability claims if someone were to allege that one of our products contained a design or manufacturing defect which resulted in the failure to adequately perform the analysis for which it was designed. A product liability claim could result in substantial damages and be costly and time consuming to defend, either of which could materially harm our business or financial condition. We cannot assure investors that our product liability insurance could adequately protect our assets from the financial impact of defending a product liability claim. Any product liability claim brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing insurance coverage in the future.

The enactment of legislation implementing changes in the U.S. taxation of international business activities or the adoption of other tax reform policies could materially impact our future financial position and results of operations.

Existing U.S. tax laws, including limitations on the ability of taxpayers to claim and utilize foreign tax credits and the deferral of certain tax deductions until earnings outside of the United States are repatriated to the United States, as well as changes to U.S. tax laws that may be enacted in the future, could impact the tax treatment of future foreign earnings. Should the scale of our international business activities expand, any such changes in the U.S. taxation of such activities could increase our worldwide effective tax rate and harm our future financial position and results of operations.

Our ability to use net operating losses to offset future taxable income may be subject to certain limitations.

As of December 31, 2016, we had federal net operating loss carryforwards, or NOLs, to offset future taxable income of approximately $102.2 million, which will begin to expire in 2021 if not utilized. A lack of future taxable income would adversely affect our ability to utilize these NOLs. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” (generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period) is subject to limitations on its ability to utilize its NOLs to offset future taxable income. We believe we may have already experienced an ownership change and may in the future experience one or more additional ownership

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changes, and thus, our ability to use pre-ownership change NOLs and other pre-ownership change tax attributes to offset post-ownership change income may be limited. Such limitations may cause a portion of our NOL and credit carryforwards to expire. In addition, future changes in our stock ownership, including as a result of future financings, as well as changes that may be outside of our control, could result in ownership changes under Section 382 of the Code. Our NOLs may also be impaired under similar provisions of state law. We have recorded a full valuation allowance related to our NOLs and other deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets.

Acquisitions or joint ventures could disrupt our business, cause dilution to our stockholders and otherwise harm our business.

We may acquire other businesses, products or technologies as well as pursue strategic alliances, joint ventures, technology licenses or investments in complementary businesses. We have limited experience with respect to business, product or technology acquisitions or the formation of collaborations, strategic alliances and joint ventures or investing in complementary businesses. Any of these transactions could be material to our financial condition and operating results and expose us to many risks, including:

 

disruption in our relationships with customers, distributors or suppliers as a result of such a transaction;

 

unanticipated liabilities related to acquired companies;

 

difficulties integrating acquired personnel, technologies and operations into our existing business;

 

diversion of management time and focus from operating our business to acquisition integration challenges;

 

increases in our expenses and reductions in our cash available for operations and other uses; and

 

possible write-offs or impairment charges relating to acquired businesses.

Foreign acquisitions involve unique risks in addition to those mentioned above, including those related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. Also, the anticipated benefit of any acquisition may not materialize. Future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, the incurrence of debt, contingent liabilities or amortization expenses or write-offs of goodwill, any of which could harm our financial condition. We cannot predict the number, timing or size of future joint ventures or acquisitions, or the effect that any such transactions might have on our operating results.

If any members of our management team were to leave us or we are unable to recruit, train and retain key personnel, we may not achieve our goals.

Our future success depends on our ability to recruit, train, retain and motivate key personnel, including our senior management, research and development, manufacturing and sales and marketing personnel. If we were to lose one or more of our key employees, we may experience difficulties in competing effectively, developing our technologies and implementing our business strategies. Competition for qualified personnel is intense, and we may not be able to attract talent. Our growth depends, in part, on attracting, retaining and motivating highly trained sales personnel with the necessary scientific background and ability to understand our systems at a technical level to effectively identify and sell to potential new customers, including new biopharmaceutical company customers. In particular, the commercialization of our HTG EdgeSeq system and related panels requires us to continue to establish and maintain a sales and support team to optimize the market for research tools, then to fully optimize a broad array of diagnostic market opportunities if we receive approval for any future diagnostic products. We do not maintain fixed term employment contracts or, except for our Chief Executive Officer, key man life insurance with any of our employees. Because of the complex and technical nature of our products and the dynamic market in which we compete, any failure to retain our management team or to attract, train, retain and motivate other qualified personnel could materially harm our operating results and growth prospects.

Our operating results may be harmed if we are required to collect sales, services or other related taxes for our products and services in jurisdictions where we have not historically done so.

We do not believe that we are required to collect sales, use, services or other similar taxes from our customers in certain jurisdictions. However, one or more countries or states may seek to impose sales, use, services, or other tax collection obligations on us, including for past sales. A successful assertion by one or more jurisdictions that we should collect sales or other taxes on the sale of our products and services could result in substantial tax liabilities for past sales and decrease our ability to compete for future sales. Each country and each state has different rules and regulations governing sales and use taxes and these rules and regulations are subject to varying interpretations that may change over time. We review these rules and regulations periodically and, when we believe sales and use taxes apply in a particular jurisdiction, voluntarily engage tax authorities in order to determine how to comply with their rules and regulations. We cannot assure you that we will not be subject to sales and use taxes or related penalties for past sales in jurisdictions where we presently believe sales and use taxes are not due.

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Providers of goods or services are typically held responsible by taxing authorities for the collection and payment of any applicable sales and similar taxes. If one or more taxing authorities determines that taxes should have, but have not, been paid with respect to our products and services, we may be liable for past taxes in addition to being required to collect sales or similar taxes in respect of our products and services going forward. Liability for past taxes may also include substantial interest and penalty charges. Our customer contracts provide that our customers must pay all applicable sales and similar taxes. Nevertheless, customers may be reluctant to pay back taxes and may refuse responsibility for interest or penalties associated with those taxes or we may determine that it would not be feasible to seek reimbursement. If we are required to collect and pay back taxes and the associated interest and penalties and if our customers do not reimburse us for all or a portion of these amounts, we will have incurred unplanned expenses that may be substantial. Moreover, imposition of such taxes on our products and services going forward will effectively increase the cost of such products and services to our customers.

Many states are also pursuing legislative expansion of the scope of goods and services that are subject to sales and similar taxes as well as the circumstances in which a vendor of goods and services must collect such taxes. Furthermore, legislative proposals have been introduced in Congress that would provide states with additional authority to impose such taxes. Accordingly, it is possible that either federal or state legislative changes may require us to collect additional sales and similar taxes from our customers in the future.

Our insurance policies are expensive and protect us only from some business risks, which will leave us exposed to significant uninsured liabilities.

We do not carry insurance for all categories of risk that our business may encounter. Some of the policies we currently maintain include general liability, foreign liability, employee benefits liability, property, automobile, umbrella, workers’ compensation, crime (including cybercrime), fiduciary, products liability, pollution, errors and omissions and directors’ and officers’ insurance. We do not know, however, if we will be able to maintain existing insurance with adequate levels of coverage. Any significant uninsured liability may require us to pay substantial amounts, which would adversely affect our cash position and results of operations.

Performance issues, service interruptions or price increases by our shipping carriers could adversely affect our business and harm our reputation and ability to provide our services on a timely basis.

Expedited, reliable shipping is essential to our operations. We rely heavily on providers of transport services for reliable and secure point-to-point transport of our HTG Edge and HTG EdgeSeq systems and consumables to our customers and, as applicable, customers’ samples to our laboratory, and for enhanced tracking of these shipments. Should a carrier encounter delivery performance issues such as loss, damage or destruction of any instrumentation, consumables or samples, it would be costly to replace such instrumentation or consumables in a timely manner and may be difficult to replace customers’ samples lost or damaged in shipping, and such occurrences may damage our reputation and lead to decreased demand for our products and increased cost and expense to our business. In addition, any significant increase in shipping rates could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions affecting delivery services we use would adversely affect our ability to process orders for our products or receive recipient samples on a timely basis.

We face risks related to handling of hazardous materials and other regulations governing environmental safety.

Our operations are subject to complex and stringent environmental, health, safety and other governmental laws and regulations that both public officials and private individuals may seek to enforce. Our activities that are subject to these regulations include, among other things, our use of hazardous materials and the generation, transportation and storage of waste. We could discover that we or an acquired business is not in material compliance with these regulations. Existing laws and regulations may also be revised or reinterpreted, or new laws and regulations may become applicable to us, whether retroactively or prospectively, that may have a negative effect on our business and results of operations. It is also impossible to eliminate completely the risk of accidental environmental contamination or injury to individuals. In such an event, we could be liable for any damages that result, and any liability could exceed our resources or any applicable insurance coverage we may have, which events could adversely affect our business.

Cyber security risks and the failure to maintain the confidentiality, integrity, and availability of our computer hardware, software, and internet applications and related tools and functions could result in damage to our reputation and/or subject us to costs, fines or lawsuits.

Our business requires manipulating, analyzing and storing large amounts of data. In addition, we rely on an enterprise software system to operate and manage our business. We also maintain personally identifiable information about our employees. Our business therefore depends on the continuous, effective, reliable and secure operation of our computer hardware, software, networks, Internet servers and related infrastructure. To the extent that our hardware and software malfunction or access to our data by internal personnel is interrupted, our business could suffer. The integrity and protection of our employee and company data is critical to our business and employees have a high expectation that we will adequately protect their personal information. The regulatory environment governing

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information, security and privacy laws is increasingly demanding and continues to evolve. Maintaining compliance with applicable security and privacy regulations may increase our operating costs. Although our computer and communications software is protected through physical and software safeguards, it is still vulnerable to natural or man-made hazards, such as fire, storm, flood, power loss, wind damage, telecommunications failures, physical or software break-ins, software viruses and similar events. These events could lead to the unauthorized access, disclosure and use of non-public information. The techniques used by criminal elements to attack computer systems are sophisticated, change frequently and may originate from less regulated and remote areas of the world. As a result, we may not be able to address these techniques proactively or implement adequate preventative measures. If our computer systems are compromised, we could be subject to fines, damages, litigation and enforcement actions, and we could lose trade secrets, the occurrence of which could harm our business. In addition, any sustained disruption in internet access provided by other companies could harm our business.

Risks Related to Government Regulation and Diagnostic Product Reimbursement

Our “research-use-only” products for the life sciences market could become subject to regulation as medical devices by the FDA or other regulatory agencies in the future which could increase our costs and delay our commercialization efforts, thereby materially and adversely affecting our life sciences business and results of operations.

In the United States, our products are currently labeled and sold for research use only, and not for the diagnosis or treatment of disease, and are sold to a variety of parties, including biopharmaceutical companies, academic institutions and molecular labs. Because such products are not intended for use in clinical practice in diagnostics, and the products cannot include clinical or diagnostic claims, they are exempt from many regulatory requirements otherwise applicable to medical devices. In particular, while the FDA regulations require that RUO products be labeled, “For Research Use Only. Not for use in diagnostic procedures,” the regulations do not otherwise subject such products to the FDA’s pre- and post-market controls for medical devices.

A significant change in the laws governing RUO products or how they are enforced may require us to change our business model in order to maintain compliance. For instance, in November 2013 the FDA issued a guidance document entitled “Distribution of In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only”, or the RUO Guidance, which highlights the FDA’s interpretation that distribution of RUO products with any labeling, advertising or promotion that suggests that clinical laboratories can validate the test through their own procedures and subsequently offer it for clinical diagnostic use as a laboratory developed test is in conflict with RUO status. The RUO Guidance further articulates the FDA’s position that any assistance offered in performing clinical validation or verification, or similar specialized technical support, to clinical laboratories, conflicts with RUO status. If we engage in any activities that the FDA deems to be in conflict with the RUO status held by the products that we sell, we may be subject to immediate, severe and broad FDA enforcement action that would adversely affect our ability to continue operations. Accordingly, if the FDA finds that we are distributing our RUO products in a manner that is inconsistent with its regulations or guidance, we may be forced to stop distribution of our RUO tests until we are in compliance, which would reduce our revenues, increase our costs and adversely affect our business, prospects, results of operations and financial condition. In addition, the FDA’s proposed implementation for a new framework for the regulation of Laboratory Developed Tests, or LDTs, may negatively impact the LDT market and thereby reduce demand for RUO products.

If the FDA requires marketing authorization of our RUO products in the future, there can be no assurance that the FDA will ultimately grant any clearance or approval requested by us in a timely manner, or at all.

Approval and/or clearance by the FDA and foreign regulatory authorities for any diagnostic tests will take significant time and require significant research, development and clinical study expenditures and ultimately may not succeed.

Before we begin to label and market our products for use as clinical diagnostics in the United States, including as companion diagnostics, unless an exemption applies, we will be required to obtain either 510(k) clearance or PMA from the FDA. In addition, we may be required to seek FDA clearance for any changes or modifications to our products that could significantly affect their safety or effectiveness, or would constitute a change in intended use. The 510(k) clearance processes can be expensive, time-consuming and uncertain. In addition to the time required to conduct clinical studies, if necessary, it generally takes from four to twelve months from submission of an application to obtain 510(k) clearance; however, it may take longer and 510(k) clearance may never be obtained. Even if the FDA accepts a 510(k) submission for filing, the FDA may request additional information or clinical studies during its review. Our ability to obtain additional regulatory clearances for new products and indications may be significantly delayed or may never be obtained. In addition, we may be required to obtain PMAs for new products or product modifications. The requirements of the more rigorous PMA process could delay product introductions and increase the costs associated with FDA compliance. As with all IVD products, the FDA reserves the right to redefine the regulatory path at the time of submission or during the review process, and could require a more burdensome approach. Even if we were to obtain regulatory approval or clearance, it may not be for the uses we believe are important or commercially attractive, in which case we would not be permitted to market our product for those uses.

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A 510(k) clearance or PMA submission for any future medical device product would likely place substantial restrictions on how the device is marketed or sold, and we will be required to continue to comply with extensive regulatory requirements, including, but not limited to QSRs, registering manufacturing facilities, listing the products with the FDA, and complying with labeling, marketing, complaint handling, adverse event and medical device reporting requirements and corrections and removals. We cannot assure you that we will successfully maintain the clearances or approvals we may receive in the future. In addition, any clearances or approvals we obtain may be revoked if any issues arise that bring into question our products’ safety or effectiveness. Any failure to maintain compliance with FDA regulatory requirements could harm our business, financial condition and results of operations.

Sales of our diagnostic products outside the United States will be subject to foreign regulatory requirements governing clinical studies, vigilance reporting, marketing approval, manufacturing, product licensing, pricing and reimbursement. These regulatory requirements vary greatly from country to country. As a result, the time required to obtain approvals outside the United States may differ from that required to obtain FDA approval and we may not be able to obtain foreign regulatory approvals on a timely basis or at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other countries or by the FDA and foreign regulatory authorities could require additional testing. In addition, the FDA regulates exports of medical devices. Failure to comply with these regulatory requirements or obtain required approvals could impair our ability to commercialize our diagnostic products outside of the United States.

We expect to rely on third parties to conduct any future studies of our diagnostic products that may be required by the FDA or other regulatory authorities, and those third parties may not perform satisfactorily.

We do not have the ability to independently conduct the clinical studies or other studies that may be required to obtain FDA and other regulatory clearance or approval for our diagnostic products, including the HTG Edge system, the HTG EdgeSeq system and related proprietary panels. Accordingly, we expect to rely on third parties, such as medical institutions and clinical investigators, and providers of NGS instrumentation, to conduct such studies and/or to provide information necessary for our submissions to regulatory authorities. Our reliance on these third parties for clinical development activities or information will reduce our control over these activities. These third-parties may not complete activities on schedule or conduct studies in accordance with regulatory requirements or our study design. Similarly, providers of NGS instrumentation may not place the same importance on our regulatory submissions as we do. Our reliance on third parties that we do not control will not relieve us of any applicable requirement to prepare, and ensure compliance with, the various procedures requires under good clinical practices, or the submission of all information required in connection with requested regulatory approvals. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines if the third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to their failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our studies may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for our diagnostic products.

Even if we are able to obtain regulatory approval or clearance for our diagnostic products, we will continue to be subject to ongoing and extensive regulatory requirements, and our failure to comply with these requirements could substantially harm our business.

If we receive regulatory approval or clearance for our diagnostic products, we will be subject to ongoing FDA obligations and continued regulatory oversight and review, such as compliance with QSRs, inspections by the FDA, continued adverse event and malfunction reporting, corrections and removals reporting, registration and listing, and promotional restrictions, and we may also be subject to additional FDA post-marketing obligations. If we are not able to maintain regulatory compliance, we may not be permitted to market our diagnostic products and/or may be subject to fines, injunctions, and civil penalties; recall or seizure of products; operating restrictions; and criminal prosecution. In addition, we may be subject to similar regulatory compliance actions of foreign jurisdictions.

If Medicare and other third-party payors in the United States and foreign countries do not approve coverage and adequate reimbursement for our future clinical diagnostic tests enabled by our technology, the commercial success of our diagnostic products would be compromised.

We plan to develop, obtain regulatory approval for and sell clinical diagnostics products for a number of different indications. Successful commercialization of our clinical diagnostic products depends, in large part, on the availability of coverage and adequate reimbursement for testing services using our diagnostic products from third-party payors, including government insurance plans, managed care organizations and private insurance plans. There is significant uncertainty surrounding third-party coverage and reimbursement for the use of tests that incorporate new technology, such as the HTG EdgeSeq system and related applications and assays. Reimbursement rates have the potential to fluctuate depending on the region in which the testing is provided, the type of facility or treatment center at which the testing is done, and the third-party payor responsible for payment. If our customers are unable to obtain positive coverage decisions from third-party payors approving reimbursement for our tests at adequate levels, the

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commercial success of our products would be compromised and our revenue would be significantly limited. Even if we do obtain favorable reimbursement for our tests, third-party payors may withdraw their coverage policies, review and adjust the rate of reimbursement, require co-payments from patients or stop paying for our tests, which would reduce revenue for testing services based on our technology and demand for our diagnostic products.

The American Medical Association Current Procedural Terminology, or CPT, Editorial Panel created new CPT codes that could be used by our customers to report testing for certain large-scale multianalyte GSPs, including our diagnostic products, if approved. Effective January 1, 2015, these codes allow for uniform reporting of broad genomic testing panels using technology similar to ours. While these codes standardize reporting for these tests, coverage and payment rates for GSPs remain uncertain and we cannot guarantee that coverage and/or reimbursement for these tests will be provided in the amounts we expect, or at all. Initially, industry associations recommended that payment rates for GSPs be cross-walked to existing codes on the clinical laboratory fee schedule. On October 27, 2014, CMS issued preliminary determinations for 29 new molecular pathology codes, including the GSPs, of gapfill rather than crosswalking as recommended by the Association for Molecular Pathology. This means that local private MACs, such as Palmetto, Novidian, Novitas and Cahaba, were instructed to determine the appropriate fee schedule amounts in the first year, and CMS calculated a national payment rate based on the median of those local fee schedule amounts in the second year. This process may make it more difficult for our customers to obtain coverage and adequate reimbursement for testing services using our diagnostic products. We cannot assure that CMS and other third-party payors will establish reimbursement rates sufficient to cover the costs incurred by our customers in using our clinical diagnostic products, if approved. On September 25, 2015, CMS released final 2015 pricing for 10 of these codes, and did not issue any pricing on the remaining 19. CPTs 81445 and 81450 for the assessment of 5-50 genes in solid and liquid tumors, respectively, and final gapfill pricing of $597 and $648, respectively, was set for 2015 and is the pricing for 2016. CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors has not yet been priced.

Even if we are able to establish coverage and reimbursement codes for our clinical diagnostic products in development, we will continue to be subject to significant pricing pressure, which could harm our business, results of operations, financial condition and prospects.

Third-party payors, including managed care organizations as well as government payors such as Medicare and Medicaid, have increased their efforts to control the cost, utilization and delivery of healthcare services, which may include decreased coverage or reduced reimbursement. From time to time, Congress has considered and implemented changes to the Medicare fee schedules in conjunction with budgetary legislation, and pricing and payment terms, including the possible requirement of a patient co-payment for Medicare beneficiaries for laboratory tests covered by Medicare, and are subject to change at any time. Reductions in the reimbursement rate of third-party payors have occurred and may occur in the future. Reductions in the prices at which testing services based on our technology are reimbursed in the future could result in pricing pressures and have a negative impact on our revenue. In many countries outside of the United States, various coverage, pricing and reimbursement approvals are required. We expect that it will take several years to establish broad coverage and reimbursement for testing services based on our products with payors in countries outside of the United States, and our efforts may not be successful.

We may be subject, directly or indirectly, to federal and state healthcare fraud and abuse laws and other federal and state healthcare laws applicable to our business and marketing practices. If we are unable to comply, or have not complied, with such laws, we could face substantial penalties.

Our operations may be, and may continue to be, directly, or indirectly through our customers, subject to various federal and state fraud and abuse laws, including, without limitation, the federal and state anti-kickback statutes, false claims statutes, civil monetary penalties laws, patient data privacy and security laws, physician transparency laws and marketing compliance laws. These laws may impact, among other things, our proposed sales and marketing and education programs.

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The laws that may affect our ability to operate include, but are not limited to:

 

the Federal Anti-kickback Statute, which prohibits, among other things, knowingly and willfully soliciting, receiving, offering or paying any remuneration (including any kickback, bribe, or rebate), directly or indirectly, overtly or covertly, in cash or in kind, to induce, or in return for, either the referral of an individual, or the purchase, lease, order or recommendation of any good, facility, item or service for which payment may be made, in whole or in part, under a federal healthcare program, such as the Medicare and Medicaid programs; a person or entity does not need to have actual knowledge of the statute or specific intent to violate it to have committed a violation, rather, if one purpose of the remuneration is to induce referrals, the Federal Anti-Kickback Statute is violated;

 

the federal physician self-referral prohibition, commonly known as the Stark Law, which prohibits, among other things, physicians who have a financial relationship, including an investment, ownership or compensation relationship with an entity, from referring Medicare and Medicaid patients to that entity for designated health services, which include clinical laboratory services, unless an exception applies. Similarly, entities may not bill Medicare, Medicaid or any other party for services furnished pursuant to a prohibited referral. Unlike the Federal Anti-Kickback Statute, the Stark Law is a strict liability statute, meaning that all of the requirements of a Stark Law exception must be met in order to be compliant with the law;

 

federal civil and criminal false claims laws, including the False Claims Act, and civil monetary penalties laws, which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment or approval from Medicare, Medicaid or other governmental third-party payors that are false or fraudulent, knowingly making a false statement material to an obligation to pay or transmit money to the Federal Government or knowingly concealing or knowingly and improperly avoiding or decreasing an obligation to pay money to the Federal Government, which may apply to entities that provide coding and billing advice to customers; the Federal 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 Act;

 

HIPAA, which created additional federal criminal statutes that prohibit knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program or obtain, by means of false or fraudulent pretenses, representations, or promises, any of the money or property owned by, or under the custody or control of, any healthcare benefit program, regardless of the payor (e.g., public or private) and knowingly and willfully falsifying, concealing, or covering up by any trick or device a material fact or making any materially false statements in connection with the delivery of, or payment for, healthcare benefits, items or services relating to healthcare matters; similar to the Federal Anti-Kickback Statute, a person or entity does not need to have actual knowledge of the healthcare fraud statute or specific intent to violate it to have committed a violation;

 

HIPAA, as amended by HITECH, and their respective implementing regulations, which impose requirements on certain covered healthcare providers, health plans, and healthcare clearinghouses as well as their respective business associates that perform services for them that involve the use, maintenance, or disclosure of individually identifiable health information, relating to the privacy, security and transmission of individually identifiable health information;

 

the Federal Physician Payments Sunshine Act, which require certain manufacturers of drugs, devices, biologicals and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program (with certain exceptions) to report annually to CMS information related to payments or other transfers of value made to physicians and teaching hospitals, as well as applicable manufacturers and group purchasing organizations to report annually to CMS certain ownership and investment interests held by physicians and their immediate family members; and

 

state law equivalents of each of the above federal laws, such as anti-kickback, self-referral, and false claims laws which may apply to our business practices, including but not limited to, research, distribution, sales and marketing arrangements as well as submitting claims involving healthcare items or services reimbursed by any third-party payor, including commercial insurers; state laws that require device companies to comply with the industry’s voluntary compliance guidelines and the applicable compliance guidance promulgated by the Federal Government that otherwise restricts payments that may be made to healthcare providers; state laws that require device manufacturers to file reports with states regarding marketing information, such as the tracking and reporting of gifts, compensations and other remuneration and items of value provided to healthcare professionals and entities (compliance with such requirements may require investment in infrastructure to ensure that tracking is performed properly, and some of these laws result in the public disclosure of various types of payments and relationships, which could potentially have a negative effect on our business and/or increase enforcement scrutiny of our activities); and state laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways, with differing effects.

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Promotional activities for FDA-regulated products have been the subject of significant enforcement actions brought under healthcare reimbursement laws, fraud and abuse laws, and consumer protection statutes, among other theories. Advertising and promotion of medical devices are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. In addition, under the Federal Lanham Act and similar state laws, competitors and others can initiate litigation relating to advertising claims.

In addition, the approval and commercialization of any of our product candidates outside the United States will also likely subject us to foreign equivalents of the healthcare laws mentioned above, among other foreign laws.

Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under such laws, it is possible that some of our business activities, including our relationships with physicians and other health care providers, and our evaluation, reagent rental and collaboration arrangements with customers, and sales and marketing efforts could be subject to challenge under one or more of such laws.

If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including administrative, civil and criminal penalties, damages, fines, individual imprisonment, disgorgement, exclusion from participation in federal healthcare programs, such as Medicare and Medicaid, contractual damages, reputational harm, additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations, any of which could adversely affect our ability to operate our business and our results of operations.

Our employees, independent contractors, principal investigators, consultants, commercial partners and vendors may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements.

We are exposed to the risk of fraud or other misconduct by our employees, independent contractors, principal investigators, consultants, commercial partners and vendors. Misconduct by these parties could include intentional, reckless or negligent failures to, among other things: (i) comply with the regulations of the FDA, CMS, the Department of Health and Human Services Office of Inspector General, or OIG, and other similar foreign regulatory bodies; (ii) provide true, complete and accurate information to the FDA and other similar regulatory bodies; (iii) comply with manufacturing standards we have established; (iv) comply with healthcare fraud and abuse laws and regulations in the United States and similar foreign fraudulent misconduct laws; or (v) report financial information or data accurately, or disclose unauthorized activities to us. These laws may impact, among other things, our activities with collaborators and key opinion leaders, as well as our sales, marketing and education programs. In particular, the promotion, sales, marketing and business arrangements in the healthcare industry are subject to extensive laws and regulations intended to prevent fraud, misconduct, kickbacks, self-dealing and other abusive practices. These laws may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. Such misconduct could also involve the improper use of information obtained in the course of clinical studies, which could result in regulatory sanctions and cause serious harm to our reputation. We currently have a code of conduct applicable to all of our employees, but it is not always possible to identify and deter employee misconduct, and our code of conduct and the other precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses, or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to comply with these laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of civil, criminal and administrative penalties, damages, monetary fines, disgorgement, individual imprisonment, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws, and curtailment of our operations. Any of these actions or investigations could result in substantial costs to us, including legal fees, and divert the attention of management from operating our business.

Healthcare policy changes, including recently enacted legislation reforming the United States healthcare system, may have a material adverse effect on our financial condition and results of operations.

On April 1, 2014, the Protecting Access to Medicare Act of 2014, or PAMA, was signed into law, which, among other things, significantly alters the current payment methodology under the Medicare Clinical Laboratory Fee Schedule, or CLFS. Under the new law, starting January 1, 2016 and every three years thereafter (or annually in the case of advanced diagnostic lab tests), clinical laboratories must report laboratory test payment data for each Medicare-covered clinical diagnostic lab test that it furnishes during a period to be defined by future regulations. The reported data must include the payment rate (reflecting all discounts, rebates, coupons and other price concessions) and the volume of each test that was paid by each private payor (including health insurance issuers, group health plans, Medicare Advantage plans and Medicaid managed care organizations). Beginning in 2017, the Medicare payment rate for each clinical diagnostic lab test will be equal to the weighted median amount for the test from the most recent data collection period. The payment rate

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will apply to laboratory tests furnished by a hospital laboratory if the test is separately paid under the hospital outpatient prospective payment system. It is too early to predict the impact on reimbursement for our products in development.

Also under PAMA, CMS is required to adopt temporary billing codes to identify new tests and new advanced diagnostic laboratory tests that have been cleared or approved by the FDA. For an existing test that is cleared or approved by the FDA and for which Medicare payment is made as of April 1, 2014, CMS is required to assign a unique billing code if one has not already been assigned by the agency. In addition to assigning the code, CMS was required to publicly report payment for the tests no later than January 1, 2016. We cannot determine at this time the full impact of the new law on our business, financial condition and results of operations.

The Affordable Care Act makes changes that could significantly impact the biopharmaceutical and medical device industries and clinical laboratories. For example, the ACA imposes a multifactor productivity adjustment to the reimbursement rate paid under Medicare for certain clinical diagnostic laboratory tests, which may reduce payment rates. These or any future proposed or mandated reductions in payments may apply to some or all of the clinical laboratory tests that our diagnostics customers use our technology to deliver to Medicare beneficiaries, and may reduce demand for our diagnostic products.

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. Further, the ACA includes a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, which became effective January 1, 2013. However, the Consolidated Appropriations Act of 2016, signed into law in December 2015, includes a two-year moratorium on the medical device excise tax that applies between January 1, 2016 and December 31, 2017. Absent further legislative action, the tax will be automatically reinstated for medical device sales beginning January 1, 2018. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. However, the future of the ACA is uncertain. There have been judicial and Congressional challenges to certain aspects of the ACA. As a result, there have been delays in the implementation of, and action taken to repeal or replace, certain aspects of the ACA. In January 2017, President Trump signed an Executive Order directing federal agencies with authorities and responsibilities under the ACA to waive, defer, grant exemptions from, or delay the implementation of any provision of the ACA that would impose a fiscal or regulatory burden on states, individuals, healthcare providers, health insurers, or manufacturers of pharmaceuticals or medical devices. Further, in January 2017, Congress adopted a budget resolution for fiscal year 2017, or the Budget Resolution, that authorizes the implementation of legislation that would repeal portions of the ACA. Following the passage of the Budget Resolution, in March 2017, the U.S. House of Representatives introduced legislation known as the American Health Care Act, which, if enacted, would amend or repeal significant portions of the ACA. Among other changes, the American Health Care Act would repeal the annual fee on certain brand prescription drugs and biologics imposed on manufacturers and importers, eliminate the 2.3% excise tax on medical devices, eliminate penalties on individuals and employers that fail to maintain or provide minimum essential coverage, and create refundable tax credits to assist individuals in buying health insurance. The American Health Care Act would also make significant changes to Medicaid by, among other things, making Medicaid expansion optional for states, repealing the requirement that state Medicaid plans provide the same essential health benefits that are required by plans available on the exchanges, modifying federal funding, including implementing a per capita cap on federal payments to states, and changing certain eligibility requirements. While it is uncertain when or if the provisions in the American Health Care Act will become law, or the extent to which any changes may impact our business, it is clear that concrete steps are being taken to repeal and replace certain aspects of the ACA.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. 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 reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following passage of the Bipartisan Budget Act of 2015, will stay in effect through 2025 unless Congressional action is taken. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

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Various healthcare reform proposals have also emerged from federal and state governments. Changes in healthcare law or policy, such as the creation of broad test utilization limits for diagnostic products in general or requirements that Medicare patients pay for portions of clinical laboratory tests or services received, could substantially impact the sales of our tests, increase costs and divert management’s attention from our business. Such co-payments by Medicare beneficiaries for laboratory services were discussed as possible cost savings for the Medicare program as part of the debt ceiling budget discussions in mid-2011 and may be enacted in the future. In addition, sales of our tests outside of the United States will subject us to foreign regulatory requirements, which may also change over time.

We cannot predict whether future healthcare initiatives will be implemented at the federal or state level or in countries outside of the United States in which we may do business, or the effect any future legislation or regulation will have on us. The taxes imposed by the new federal legislation and the expansion in government’s effect on the United States healthcare industry may result in decreased profits to us, lower reimbursements by payors for our products or reduced medical procedure volumes, all of which may adversely affect our business, financial condition and results of operations. The full impact of the ACA, as well as other laws and reform measures that may be proposed and adopted in the future, remains uncertain, but may continue the downward pressure on medical device pricing, especially under the Medicare program, and may also increase our regulatory burdens and operating costs, which could have a material adverse effect on our business operations. There have been judicial and congressional challenges to certain aspects of the ACA, and we expect additional challenges and amendments in the future.  

Risks Related to Intellectual Property

If we are unable to protect our intellectual property effectively, our business would be harmed.

We rely on patent protection as well as trademark, copyright, trade secret and other intellectual property rights protection and contractual restrictions to protect our proprietary technologies, all of which provide limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Our U.S. and foreign patent and patent application portfolio relates to our nuclease-protection-based technologies as well as to lung cancer and melanoma and DLBCL biomarker panels discovered using our nuclease-protection-based technology. We have exclusive or non-exclusive licenses to multiple U.S. and foreign patents and patent applications covering technologies that we may elect to utilize in developing diagnostic tests for use on our HTG Edge and HTG EdgeSeq systems. Those licensed patents and patent applications cover technologies related to the diagnosis of breast cancer and melanoma.

If we fail to protect our intellectual property, third parties may be able to compete more effectively against us and we may incur substantial litigation costs in our attempts to recover or restrict use of our intellectual property.

We cannot assure investors that any of our currently pending or future patent applications will result in issued patents, and we cannot predict how long it will take for such patents to be issued. Further, we cannot assure investors that other parties will not challenge any patents issued to us or that courts or regulatory agencies will hold our patents to be valid or enforceable. We cannot guarantee investors that we will be successful in defending challenges made against our patents. Any successful third-party challenge to our patents could result in the unenforceability or invalidity of such patents.

The patent positions of life sciences companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in the United States. Furthermore, in the biotechnology field, courts frequently render opinions that may adversely affect the patentability of certain inventions or discoveries, including opinions that may adversely affect the patentability of methods for analyzing or comparing nucleic acids molecules, such as RNA or DNA.

The patent positions of companies engaged in development and commercialization of molecular diagnostic tests are particularly uncertain. Various courts, including the U.S. Supreme Court, have recently rendered decisions that impact the scope of patentability of certain inventions or discoveries relating to molecular diagnostics. Specifically, these decisions stand for the proposition that patent claims that recite laws of nature (for example, the relationships between gene expression levels and the likelihood of risk of recurrence of cancer) are not themselves patentable unless those patent claims have sufficient additional features that provide practical assurance that the processes are genuine inventive applications of those laws rather than patent drafting efforts designed to monopolize the law of nature itself. What constitutes a “sufficient” additional feature is uncertain. Accordingly, this evolving case law in the United States may adversely impact our ability to obtain new patents and may facilitate third-party challenges to our existing owned and licensed patents.

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The laws of some non-U.S. countries do not protect intellectual property rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting and defending such rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favor the enforcement of patents and other intellectual property protection, particularly those relating to biotechnology, which could make it difficult for us to stop the infringement of our patents. Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial cost and divert our efforts and attention from other aspects of our business.

Changes in either the patent laws or in interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property. We cannot predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents. For example:

 

We might not have been the first to make the inventions covered by each of our patents and pending patent applications.

 

We might not have been the first to file patent applications for these inventions.

 

Others may independently develop similar or alternative products and technologies or duplicate any of our products and technologies.

 

It is possible that none of our pending patent applications will result in issued patents, and even if they issue as patents, they may not provide a basis for commercially viable products, may not provide us with any competitive advantages, or may be challenged and invalidated by third parties.

 

We may not develop additional proprietary products and technologies that are patentable.

 

The patents of others may have an adverse effect on our business.

 

We apply for patents covering our products and technologies and uses thereof, as we deem appropriate. However, we may fail to apply for patents on important products and technologies in a timely fashion or at all.

In addition to pursuing patents on our technology, we take steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, corporate partners and, when needed, our advisors. Such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate. If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States may be less willing to protect trade secrets.

In addition, competitors could purchase our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, willfully infringe our intellectual property rights, design around our protected technology or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected so as to protect our market against competitors’ products and methods, our competitive position could be adversely affected, as could our business.

We have not yet registered certain of our trademarks, including “HTG Edge,” “HTG EdgeSeq,” “VERI/O,” and “qNPA” in all of our potential markets. If we apply to register these trademarks, our applications may not be allowed for registration, and our registered trademarks may not be maintained or enforced. In addition, opposition or cancellation proceedings may be filed against our trademark applications and registrations, and our trademarks may not survive such proceedings. If we do not secure registrations for our trademarks, we may encounter more difficulty in enforcing them against third parties than we otherwise would.

To the extent our intellectual property, including licensed intellectual property, offers inadequate protection, or is found to be invalid or unenforceable, we would be exposed to a greater risk of direct competition. If our intellectual property does not provide adequate protection against our competitors’ products, our competitive position could be adversely affected, as could our business. Both the patent application process and the process of managing patent disputes can be time consuming and expensive.

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We may need to depend on certain technologies that are licensed to us. We would not control these technologies and any loss of our rights to them could prevent us from selling some of our products.

We have entered into several license agreements with third parties for certain licensed technologies that are, or may become relevant to the products we market, or plan to market. In addition, we may in the future elect to license third party intellectual property to further our business objectives and/or as needed for freedom to operate for our products. We do not and will not own the patents, patent applications or other intellectual property rights that are a subject of these licenses. Our rights to use these technologies and employ the inventions claimed in the licensed patents, patent applications and other intellectual property rights are or will be subject to the continuation of and compliance with the terms of those licenses.

We might not be able to obtain licenses to technology or other intellectual property rights that we require. Even if such licenses are obtainable, they may not be available at a reasonable cost or multiple licenses may be needed for the same product (e.g., stacked royalties). We could therefore incur substantial costs related to royalty payments for licenses obtained from third parties, which could negatively affect our gross margins. Further, we could encounter delays in product introductions, or interruptions in product sales, as we develop alternative methods or products.  

In some cases, we do not or may not control the prosecution, maintenance, or filing of the patents or patent applications to which we hold licenses, or the enforcement of these patents against third parties. As a result, we cannot be certain that drafting or prosecution of the licensed patents and patent applications by the licensors have been or will be conducted in compliance with applicable laws and regulations or will result in valid and enforceable patents and other intellectual property rights.

Certain of the U.S. patent rights we own, have licensed or may license relate to technology that was developed with U.S. government grants, in which case the U.S. government has certain rights in those inventions, including, among others, march-in license rights. In addition, federal regulations impose certain domestic manufacturing requirements with respect to any products within the scope of those U.S. patent claims.

We may be involved in lawsuits to protect or enforce our patent or other proprietary rights, to determine the scope, coverage and validity of others’ patent or other proprietary rights, or to defend against third-party claims of intellectual property infringement, any of which could be time-intensive and costly and may adversely impact our business or stock price.

We may from time to time receive notices of claims of infringement and misappropriation or misuse of other parties’ proprietary rights, including with respect to third-party trade secrets, infringement by us of third-party patents and trademarks or other rights, or challenges to the validity or enforceability of our patents, trademarks or other rights. Some of these claims may lead to litigation. We cannot assure investors that such actions will not be asserted or prosecuted against us or that we will prevail in any or all such actions.

Litigation may be necessary for us to enforce our patent and other proprietary rights or to determine the scope, coverage and validity of the proprietary rights of others. The outcome of any litigation or other proceeding is inherently uncertain and might not be favorable to us. In addition, any litigation that may be necessary in the future could result in substantial costs, even if we were to prevail, and diversion of resources and could have a material adverse effect on our business, operating results or financial condition.

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As we move into new markets and applications for our products, incumbent participants in such markets may assert their patents and other proprietary rights against us as a means of slowing our entry into such markets or as a means to extract substantial license and royalty payments from us. Our competitors and others may now and in the future have significantly larger and more mature patent portfolios than we currently have. In addition, future litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our own patents may provide little or no deterrence or protection. Therefore, our commercial success may depend in part on our non-infringement of the patents or proprietary rights of third parties. Numerous significant intellectual property issues have been litigated, and will likely continue to be litigated, between existing and new participants in our existing and targeted markets and competitors may assert that our products infringe their intellectual property rights as part of a business strategy to impede our successful entry into those markets. We have not conducted comprehensive freedom-to-operate searches to determine whether the commercialization of our products or other business activities would infringe patents issued to third parties. Third parties may assert that we are employing their proprietary technology without authorization. In addition, our competitors and others may have patents or may in the future obtain patents and claim that use of our products infringes these patents. We could incur substantial costs and divert the attention of our management and technical personnel in defending against any of these claims. Parties making claims against us may be able to obtain injunctive or other relief, which could block our ability to develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to pay damages and obtain one or more licenses from third parties, or be prohibited from selling certain products. We may not be able to obtain these licenses at a reasonable cost, if at all. We could therefore incur substantial costs related to royalty payments for licenses obtained from third parties, which could negatively affect our gross margins. In addition, we could encounter delays in product introductions while we attempt to develop alternative methods or products to avoid infringing third-party patents or proprietary rights. Defense of any lawsuit or failure to obtain any of these licenses on favorable terms could prevent us from commercializing products, and the prohibition of sale of any of our products could materially affect our ability to grow and gain market acceptance for our products.

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

In addition, our agreements with some of our suppliers, distributors, customers and other entities with whom we do business require us to defend or indemnify these parties to the extent they become involved in infringement claims against us, including the claims described above. We could also voluntarily agree to defend or indemnify third parties in instances where we are not obligated to do so if we determine it would be important to our business relationships. If we are required or agree to defend or indemnify any of these third parties in connection with any infringement claims, we could incur significant costs and expenses that could adversely affect our business, operating results, or financial condition.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of our employees’ former employers.

Many of our employees were previously employed at other medical diagnostic companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights. A loss of key research personnel work product could hamper or prevent our ability to commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

Our products contain third-party open source software components, and failure to comply with the terms of the underlying open source software licenses could restrict our ability to sell our products.

Our products contain software tools licensed by third-party authors under “open source” licenses. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses contain requirements that we make available source code for modifications or derivative works we create based upon the type of open source software we use. If we combine our proprietary software with open source software in a certain manner, we could, under certain open source licenses, be required to release the source code of our proprietary software to the public. This would allow our competitors to create similar products with less development effort and time and ultimately could result in a loss of product sales.

Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a

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way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. Moreover, we cannot assure investors that our processes for controlling our use of open source software in our products will be effective. If we are held to have breached the terms of an open source software license, we could be required to seek licenses from third parties to continue offering our products on terms that are not economically feasible, to re-engineer our products, to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, or to make generally available, in source code form, our proprietary code, any of which could adversely affect our business, operating results, and financial condition.

We use third-party software that may be difficult to replace or cause errors or failures of our products that could lead to lost customers or harm to our reputation.

We use software licensed from third parties in our products. In the future, this software may not be available to us on commercially reasonable terms, or at all. Any loss of the right to use any of this software could result in delays in the production of our products until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. In addition, any errors or defects in third-party software, or other third-party software failures could result in errors, defects or cause our products to fail, which could harm our business and be costly to correct. Many of these providers attempt to impose limitations on their liability for such errors, defects or failures, and if enforceable, we may have additional liability to our customers or third-party providers that could harm our reputation and increase our operating costs.

We will need to maintain our relationships with third-party software providers and to obtain software from such providers that do not contain any errors or defects. Any failure to do so could adversely impact our ability to deliver reliable products to our customers and could harm our results of operations.

Risks Related to Being a Public Company

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements on a timely basis could be impaired.

We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act and the rules and regulations of The NASDAQ Stock Market, or NASDAQ. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. For the year ending December 31, 2016, we have performed system and process evaluation and testing of our internal controls over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. This has required and will require that we incur substantial additional professional fees and internal costs to expand our accounting and finance functions and that we expend significant management efforts as we continue to make this assessment and ensure maintenance of proper internal controls on an ongoing basis.

If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, or if we fail to establish and maintain proper and effective internal control over financial reporting, we may not be able to produce timely and accurate financial statements, and our ability to accurately report our financial results could be adversely affected. If that were to happen, the market price of our stock could decline and we could be subject to sanctions or investigations by NASDAQ, the Securities and Exchange Commission, or SEC, or other regulatory authorities.

Complying with the laws and regulations affecting public companies will increase our costs and the demands on management and could harm our operating results.

As a public company, and particularly after we cease to be an “emerging growth company,” we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act and rules subsequently implemented by the SEC and NASDAQ impose numerous requirements on public companies, including requiring changes in corporate governance practices. Also, the Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. Our management and other personnel will need to devote a substantial amount of time to compliance with these laws and regulations. These requirements have increased and will continue to increase our legal, accounting, and financial compliance costs and have made and will continue to make some activities more time consuming and costly. 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 accept reduced policy limits and coverage or to incur substantial costs to maintain the same or similar coverage. These rules and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors or our board committees or as executive officers.

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As an “emerging growth company,” we expect to avail ourselves of the exemption from the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404. However, we may no longer avail ourselves of this exemption when we cease to be an “emerging growth company.” When our independent registered public accounting firm is required to undertake an assessment of our internal control over financial reporting, the cost of our compliance with Section 404 will correspondingly increase. Our compliance with applicable provisions of Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance-related issues as we implement additional corporate governance practices and comply with reporting requirements. Moreover, if we are not able to comply with the requirements of Section 404 applicable to us in a timely manner, or if we or our independent registered public accounting firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.

Furthermore, investor perceptions of our company may suffer if deficiencies are found, and this could cause a decline in the market price of our stock. Irrespective of compliance with Section 404, any failure of our internal control over financial reporting could have a material adverse effect on our stated operating results and harm our reputation. If we are unable to implement these requirements effectively or efficiently, it could harm our operations, financial reporting, or financial results and could result in an adverse opinion on our internal controls from our independent registered public accounting firm.

We are an “emerging growth company,” and any decision on our part to comply only with certain reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.

We are an “emerging growth company,” as defined in the JOBS Act, enacted in April 2012, and, for as long as we continue to be an “emerging growth company,” we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to “emerging growth companies,” including, but not limited to, not being required to have our independent registered public accounting firm audit our internal control over financial reporting under Section 404, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an “emerging growth company” for up to five years following the completion of our May 5, 2015 IPO, however, we would cease to be an “emerging growth company” before the end of that five-year period as of the following December 31, if we have more than $1.0 billion in annual revenue, or if the market value of our common stock that is held by non-affiliates exceeds $700 million as of June 30 of any year, or as of the date we issue more than $1.0 billion of non-convertible debt over a three-year period. We cannot predict if investors will find our common stock less attractive if we choose to rely on these exemptions. If some investors find our common stock less attractive as a result of any choices to reduce future disclosure, there may be a less active trading market for our common stock and our stock price may be more volatile.

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Risks Related to Our Common Stock

We may not be able to satisfy the applicable continued listing requirements of NASDAQ.

Our common stock is currently listed on The NASDAQ Global Market under the symbol “HTGM.” On August 15, 2016, we received notice from NASDAQ that our stockholders’ equity as reported in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2016 did not satisfy The NASDAQ Global Market continued listing requirements. Following our submission to NASDAQ of a plan to regain compliance with the stockholders’ equity requirements in September 2016, NASDAQ granted us an extension until February 13, 2017 to regain compliance with the stockholders’ equity requirement. On February 14, 2017, we received a letter (the “Delisting Notice”) from NASDAQ stating that we did not regain compliance with the stockholders’ equity requirement and that, as a result, our common stock would be removed from listing unless we requested on appeal to a NASDAQ Hearings Panel. On February 21, 2017, we appealed the delisting determination to a NASDAQ Hearings Panel (the “Panel”), pursuant to the procedures set forth in the NASDAQ Listing Rule 5800 series. The hearing request will stay any delisting action in connection with the Delisting Notice and allow the continued listing of our common stock on The NASDAQ Global Market until the Panel renders a decision. A hearing before the Panel has been scheduled for March 30, 2017. There can be no assurance that we will be successful in our appeal before the Panel or that we will otherwise be able to regain and maintain compliance with the stockholders’ equity requirement or satisfy alternative criteria for continued listing on The NASDAQ Global Market, or for listing on any other tier of NASDAQ, such as The NASDAQ Capital Market. If we are not afforded additional time by the Panel to regain compliance or if we are afforded additional time but are unable to timely regain compliance, our common stock will be delisted from trading on NASDAQ. The delisting of our common stock from trading on NASDAQ may have a material adverse effect on the market for, and liquidity and price of, our common stock and impair our ability to raise capital. Delisting from NASDAQ could also have other negative results, including, without limitation, the potential loss of confidence by customers and employees, the loss of institutional investor interest and fewer business development opportunities. If our common stock is delisted from trading on NASDAQ, trading of our common stock could be conducted in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the OTC Markets or OTC Bulletin Board. In such event, it could become more difficult to dispose of or obtain accurate quotations for the price of our common stock, and there may also be a reduction in our coverage by security analysts and the news media, which may cause the price of our common stock to decline further.

We expect that our stock price will fluctuate significantly.

The trading price of our common stock may be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. These factors include:

 

actual or anticipated quarterly variation in our results of operations or the results of our competitors;

 

announcements by us or our competitors of new products, significant contracts, commercial relationships or capital commitments;

 

failure to obtain or delays in obtaining product approvals or clearances from the FDA or foreign regulators;

 

adverse regulatory or reimbursement announcements;

 

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

 

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

 

commencement of, or our involvement in, litigation;

 

market conditions in the life sciences and molecular diagnostics markets;

 

manufacturing disruptions;

 

any future sales of our common stock or other securities;

 

any change to the composition of our board of directors, executive officers or key personnel;

 

our failure to meet applicable NASDAQ listing standards and the possible delisting of our common stock from NASDAQ;

 

announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

 

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

 

the other factors described in this report under the caption “Risk Factors – Risks Related to Our Common Stock.”

The stock market in general, and market prices for the securities of health technology companies like ours in particular, have from time to time experienced volatility that often has been unrelated to the operating performance of the underlying companies.

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These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating performance. In several recent situations where the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit against us, the defense and disposition of the lawsuit could be costly and divert the time and attention of our management and harm our operating results.

In addition, to date our common stock has generally been sporadically and thinly traded. As a consequence, the trading of relatively small quantities of our shares may disproportionately influence the price of our common stock in either direction. The price for our common stock could decline precipitously if even a moderate amount of our common stock is sold on the market without commensurate demand.  

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

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of the analysts who cover us issues an adverse opinion about our company, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

Sales of a substantial number of shares of our common stock in the public market could cause our stock price to fall.

Sales of a substantial number of shares of our common stock in the public market or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that sales may have on the prevailing market price of our common stock.

Certain holders of our securities are entitled to rights with respect to the registration of their shares under the Securities Act of 1933, as amended, or the Securities Act. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.

Future sales and issuances of our common stock or rights to purchase common stock, including pursuant to our equity incentive plans, could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to fall.

We expect that significant additional capital will be needed in the future to continue our planned operations. We may sell common stock, convertible securities or other equity securities in one or more transactions at prices and in a manner we determine from time to time. If we sell common stock, convertible securities or other equity securities in more than one transaction, investors may be materially diluted by these and subsequent sales. New investors could also gain rights superior to our existing stockholders.

Pursuant to our 2014 Equity Incentive Plan, or 2014 Plan, our board of directors is authorized to grant stock options and other equity-based awards to our employees, directors and consultants. The number of shares available for future grant under the 2014 Plan will automatically increase on January 1 of each year by 4% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year, subject to the ability of our board of directors to take action to reduce the size of the increase in any given year. In addition, our board of directors approved the granting of rights to eligible employees to purchase shares of our common stock pursuant to our 2014 Employee Stock Purchase Plan, or ESPP, beginning January 1, 2016. The number of shares of our common stock reserved for issuance under the ESPP will automatically increase on January 1 of each calendar year by the lesser of 1% of the total number of shares of our common stock outstanding on December 31 of the preceding calendar year and 195,000 shares, subject to the ability of our board of directors to take action to reduce the size of the increase in any given year. Currently, we plan to register the increased number of shares available for issuance under the 2014 Plan and ESPP each year. Increases in the number of shares available for future grant or purchase may result in additional dilution, which could cause our stock price to decline.

Our principal stockholders and management own a significant percentage of our stock and will be able to exercise significant influence over matters subject to stockholder approval.

Our executive officers, directors and principal stockholders, together with their respective affiliates, beneficially owned a majority of our capital stock at March 17, 2017. Accordingly, our executive officers, directors and principal stockholders acting together will be able to determine the composition of the board of directors, and may be able to approve all matters requiring stockholder approval, including mergers and other business combinations, and continue to have significant influence over our operations. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise

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discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on our stock price and may prevent attempts by our stockholders to replace or remove the board of directors or management.

We do not intend to pay dividends on our common stock so any returns will be limited to the value of our stock.

We have never declared or paid any cash dividend on our common stock. We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends is currently prohibited by the terms of our debt facility, and any future debt financing arrangement may contain terms prohibiting or limiting the amount of dividends that may be declared or paid on our common stock. Any return to stockholders will therefore be limited to the appreciation of their stock.

Provisions in our amended and restated certificate of incorporation and bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us or increase the cost of acquiring us, even if doing so would benefit our stockholders or remove our current management.

Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders and may prevent attempts by our stockholders to replace or remove our current management. These provisions include:

 

authorizing the issuance of “blank check” preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval;

 

limiting the removal of directors by the stockholders;

 

creating a staggered board of directors;

 

prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;

 

eliminating the ability of stockholders to call a special meeting of stockholders; and

 

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at stockholder meetings.

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with an interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder, unless such transactions are approved by our board of directors. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders. Further, other provisions of Delaware law may also discourage, delay or prevent someone from acquiring us or merging with us.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties.

Our 30,100 square feet of corporate facilities, including our administrative, laboratory and manufacturing spaces, are located in Tucson, Arizona. We occupy these facilities pursuant to two separate leases. The first lease concerns 17,500 square feet housing our administrative, manufacturing, and lab services facilities. The second lease concerns 12,600 square feet of space used for our research and development facilities. We amended these facilities leases in August 2015 to, among other things, align and extend the lease terms to expire in January 2021. In connection with the first lease term extension the landlord agreed to perform certain capital improvements to expand and improve the existing manufacturing facilities. In addition, we completed the expansion and improvement of our administrative and research and development facilities, resulting in the capitalization of additional leasehold improvements in 2016, which will be amortized over the remaining life of the lease. Base rent payable under the first lease is approximately $27,000 per month, and base rent payable under the second lease is approximately $16,000 per month, in each case for the remaining terms of the respective leases. The aggregate rents payable over the renewal term of the amended first lease represent an increase of $804,000, over the prior term rental rates for a five-year period. The amended second lease specified no rent increase over the prior term and the annual rent increases for the applicable space were eliminated.

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Our landlord holds security deposits equal to a total of approximately $23,000. We believe that our existing facilities are adequate to meet our business requirements for the reasonably foreseeable future and that additional space will be available on commercially reasonable terms, if required.

Item 3. Legal Proceedings.

We are not engaged in any material legal proceedings. However, in the normal course of business, we may from time to time be named as a party to legal claims, actions and complaints, including matters involving employment, intellectual property others.

Item 4. Mine Safety Disclosures.

Not applicable.

 

 

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock is traded on The NASDAQ Global Market under the symbol “HTGM.” Trading of our common stock commenced on May 6, 2015 in connection with our initial public offering. The following table sets forth, for the periods indicated, the high and low sales prices for our common stock as reported on The NASDAQ Global Market.

 

Year ended December 31, 2015

 

High

 

 

Low

 

Second quarter (beginning May 6, 2015)

 

 

19.75

 

 

 

10.22

 

Third quarter

 

 

13.10

 

 

 

4.64

 

Fourth quarter

 

 

9.59

 

 

 

4.08

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 2016

 

High

 

 

Low

 

First quarter

 

 

4.68

 

 

 

2.03

 

Second quarter

 

 

4.17

 

 

 

2.07

 

Third quarter

 

 

3.09

 

 

 

2.13

 

Fourth quarter

 

 

4.45

 

 

 

1.82

 

 

On March 17, 2017, the last reported sale price of our common stock was $2.06 per share.

Holders

As of March 17, 2017, there were approximately 192 holders of record of our common stock. The actual number of stockholders is greater than this number of record holders and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees.

Dividends

We have never declared or paid any cash dividends on our common stock. We anticipate that we will retain all available funds and any future earnings, if any, for use in the operation of our business and do not anticipate paying cash dividends in the foreseeable future. In addition, our term loan agreement materially restricts, and future debt instruments we issue may materially restrict, our ability to pay dividends on our common stock. Payment of future cash dividends, if any, will be at the discretion of the board of directors after considering various factors, including our financial condition, operating results, current and anticipated cash needs, the requirements of current or then-existing debt instruments and other factors the board of directors deems relevant.

Use of Proceeds

On May 5, 2015, we commenced our IPO pursuant to a registration statement on Form S-1 (File 333-201313) that was declared effective by the SEC on May 5, 2015 and registered an aggregate of 4,105,500 shares of our common stock for sale to the public at a price of $14.00 per share and an aggregate offering price of approximately $57.5 million. On May 11, 2015 and May 29, 2015, we sold 3,570,000 and 90,076 shares, respectively, to the public at a price of $14.00 per share for an aggregate gross offering price of $51.3 million. Leerink Partners acted as book-running manager for the offering, and Canaccord Genuity and JMP Securities served as co-managers for the offering.

Underwriting discounts and commissions connected with the offering totaled approximately $3.6 million. We incurred additional costs of approximately $2.3 million in offering expenses, which when added to the underwriting discounts and commissions paid by us, amounts to total fees and costs of approximately $5.9 million. Thus, net offering proceeds to us, after deducting underwriting discounts and commissions and offering costs, were approximately $45.4 million. No offering costs were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning ten percent or more of any class of our equity securities or to any of our other affiliates.    

Pending their use, the net proceeds from our IPO are being held in cash and cash equivalents or used to purchase low risk available-for-sale securities, of which $4.3 million were short-term available-for-sale securities, at fair value at December 31, 2016. As of December 31, 2016, we have expended approximately $44.6 million of the proceeds from our IPO on the following: (1) approximately $22.3 for sales and marketing and general and administrative expenses; (2) approximately $9.4 million for research and development expansion efforts, including expansion of our research and development team and development of new applications and

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profiling panels; (3) approximately $6.1 million for the payment of principal and interest on our growth term loan; and (4) approximately $6.8 million to purchase inventory and to fund working capital and other general corporate purposes.

There has been no material change in the expected use of net proceeds from our IPO as described in our final prospectus filed with the SEC on May 6, 2015.

Item 6. Selected Financial Data.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide the information otherwise required under this item.

 

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis together with our financial statements and related notes included elsewhere in this Annual Report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those expressed or implied in any forward-looking statements due to various factors, including those set forth under the caption “Item 1A. Risk Factors.”

 

 

Overview

We are a commercial stage company that develops and markets products and services based on a proprietary technology that facilitates the routine use of targeted molecular profiling. Molecular profiling is the collection of information about multiple molecular targets, such as DNA and RNA, also called biomarkers, in a biological sample. Molecular profiling information has many important applications, from basic research to molecular diagnostics in personalized medicine. Our technology can be used throughout that range of applications, which is just one of its many benefits. Our focus is on clinical applications. Our primary customer segments include biopharmaceutical companies, academic research centers and molecular testing laboratories.

As part of our business model, we seek to leverage key business drivers in molecular profiling, including the acceleration of precision medicine, the migration of molecular testing to next generation sequencing, the movement to less invasive biopsies, the need for greater diagnostic sensitivity, the need to conform to changing healthcare economics and the need for automation and an easily deployable workflow. Our products include instrumentation (or platforms), consumables, including assay kits, and software analytics that, as an integrated system, automate sample processing and can quickly, robustly and simultaneously profile tens, hundreds or thousands of molecular targets from samples a fraction of the size required by prevailing technologies. Our objective is to establish our solutions as the standard in molecular profiling, and to make their benefits accessible to all molecular labs from research to the clinic. We believe that our target customers desire high quality molecular profiling information in a multiplexed panel format from increasingly smaller and less invasive samples, with the ability to collect such information locally to minimize turnaround time and cost.

In 2014, we launched our HTG EdgeSeq technology, which generates a molecular profiling library for detection of RNA using NGS. Our HTG EdgeSeq assays are automated on either our HTG Edge or HTG EdgeSeq platform. Our HTG Edge platform is capable of running both our original, plate-based assays and our NGS-based HTG EdgeSeq assays. We continue to support a small number of customers interested in utilizing our plate-based assays (on a custom manufacturing basis); however, in 2016, based on market trends and customer feedback, we shifted our product focus fully to our NGS-based HTG EdgeSeq system. Our innovative platforms and menu of molecular profiling panels are being utilized by a wide range of customers including biopharmaceutical companies, academic institutions and molecular labs to simultaneously analyze a comprehensive set of molecular information from valuable clinical samples and improve the lab’s workflow efficiency. Customers can also obtain the advantages of our proprietary technologies by engaging our VERI/O laboratory for pre-clinical and clinical research-related services. We currently market several proprietary molecular profiling panels that address the needs of customers in translational research, biomarker discovery and potentially companion diagnostics. In addition, we have a focused development pipeline that includes planned panels for translational research, drug development and molecular diagnostics. Our product strategy is to develop a suite of profiling panels with initial focus in immuno-oncology and next generation pathology.

We have incurred significant losses since our inception, and we have never been profitable. We incurred net losses of $26.0 million and $21.4 million for the years ended December 31, 2016 and 2015, respectively, and had an accumulated deficit of $115.6 million as of December 31, 2016. As of December 31, 2016, we had available cash and cash equivalents totaling approximately $7.5 million and investments in highly liquid corporate and government debt securities totaling $4.3 million and had current liabilities of approximately $10.0 million plus an additional $14.0 million in long-term liabilities primarily attributable to our growth term loan and NuvoGen obligation. We believe that these factors raise substantial doubt about our ability to continue as a going concern. While we believe that our existing cash resources are sufficient to fund our operations until mid-way through the second quarter of 2017, we cannot provide assurances that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate.

We will need to raise additional capital in the near future to fund our continued operations. Additional capital may not be available in amounts needed by us. Even if sufficient capital is available to us, it might be available only on unfavorable terms. If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly reduce expenses, sell assets (potentially at a discount to their fair value or carrying value), enter into relationships with third parties to develop or commercialize products or technologies that we otherwise would have sought to develop or commercialize independently, cease operations altogether, pursue an acquisition of our company at a price that may result in up to a total loss on investment to our stockholders, file for bankruptcy, seek other protection from creditors, or liquidate all of our assets. In addition, if we default under our term loan agreement, our lenders could foreclose on our assets, including substantially all of our cash which is held in accounts with our lenders.

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Factors Affecting our Performance

Our business model has evolved and expanded since our IPO was completed in May 2015 primarily due to our success in the development of a biopharmaceutical customer base, entry into collaboration agreements with certain biopharmaceutical customers and changing customer demand from product sales to service offerings in our VERI/O laboratory. We believe the mix of product- and service-based revenues will continue to evolve over time as our product menu expands and, particularly, if we successfully develop one or more companion diagnostic products as a result of our work with biopharmaceutical customers. We believe that our future results of operations are dependent on several factors discussed below. While each of these areas present significant opportunities for us, they also pose significant risks and challenges that we must successfully address. See the section entitled “Risk Factors” for further discussion of these risks.

Biopharmaceutical Biomarker and Companion Diagnostic Solutions

Biopharmaceutical companies are working to improve the efficacy of their drugs by better targeting appropriate patients for specific therapies. Our products and services are being used by our biopharmaceutical company customers to identify molecular biomarkers that can help determine which patients will or will not respond to a drug candidate. These customers can obtain the benefits of our technology by purchasing our platform and assays for their internal use or by engaging us to perform certain services. Due to the increasing demand of our biopharmaceutical customers for services throughout 2016, we announced and branded our VERI/O service laboratory. Our VERI/O laboratory offers support for our biopharmaceutical customers in biomarker research and companion diagnostic development, and further expands our traditional service offerings, including molecular profiling of retrospective cohorts to support development of targeted and immuno-oncology therapies, building custom research-use-only panels to support early stage clinical programs and developing investigational-use companion diagnostic assays for use in Phase 3 registration trials. We believe our product and service solutions provide us with a growing number of opportunities to collaborate with biopharmaceutical companies in their drug development programs. Because our technology is being used for biomarker detection and, ultimately, patient registration in such programs, we believe we are well positioned to manufacture and commercialize high-value companion diagnostic assays required in the corresponding drug approvals. We track our pipeline of biopharmaceutical company programs as well as the number of such customers with whom we are working to measure our progress.

Customer Adoption of HTG Technology

Today we believe the primary measure of adoption for our technology is our companion diagnostic pipeline with biopharmaceutical companies discussed above. In the future, we expect increased sales of our instruments and consumables to our pharma customers or their contractors to support their internal research and drug development efforts and, as discussed below, to other customer segments as we add to our assay menu and, especially, as we launch high value diagnostic, including companion diagnostic, products. We currently market and sell on a limited and targeted basis our research use only applications to biopharmaceutical companies, academic translational research centers and in Europe, molecular testing labs.

Our ability to increase instrument and consumable revenue depends on several factors, including (i) adoption of our HTG EdgeSeq platforms by our customer base, including increasing market share for our proprietary panels for the research market; (ii) the efforts of our sales and marketing teams to demonstrate the utility of our products and technology; (iii) our ability to develop and market novel molecular profiling panels designed to meet customer needs, including unmet medical needs; (iv) our ability to demonstrate the benefits of our products to key opinion leaders so they will publish information supporting those benefits; (v) pricing and reimbursement; (vi) our ability to expand the addressable market of our HTG EdgeSeq platform through the development of new applications; (vii) our product capabilities compared with competition; and (viii) successful outcomes to our companion diagnostic collaborations. Given the length of our sales cycle, we have in the past experienced, and will likely in the future experience, fluctuations in our instrument and consumables sales on a period-to-period basis.

A key element of increasing adoption of our technology measured by instrument placements is our assay and panel “menu.” Menu is defined as what assays are available for use on the instruments to satisfy customer needs. To sell additional instruments, grow our installed base and drive larger consumable annuities we must develop and commercialize new assays. Our arrangements with biopharmaceutical companies are expected to generate new menu items as well as our diagnostic development strategies in immuno-oncology and next generation pathology. As of December 31, 2016, we had an installed base of 47 HTG Edge and HTG EdgeSeq systems in various stages of use, including units that are under evaluation. We are focused on high quality instrument placements and consumable pull through as the primary indicators of commercial adoption and success in our business.  

Timing and effectiveness of research and development expenses

Our spending on research and development may vary substantially from period to period due to the availability and cost of clinical samples, prioritization of research and development projects or timing of milestone payments under technology development

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agreements. We have instituted a stage-gate based method of new product development managed by an innovation council which is led by our Chief Executive Officer. All programs are reviewed by time, quality and budgetary metrics at each phase of the project.

Financial Operations Overview and Results of Operations

Comparison of the Years Ended December 31, 2016 and 2015

 

 

 

Years Ended December 31,

 

 

Change

 

 

 

2016

 

 

2015

 

 

$

 

 

%

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product

 

$

2,759,942

 

 

$

3,532,028

 

 

$

(772,086

)

 

 

(22

%)

Service

 

 

2,372,788

 

 

 

183,758

 

 

 

2,189,030

 

 

 

1191

%

Other

 

 

 

 

 

325,789

 

 

 

(325,789

)

 

 

(100

%)

Total revenue

 

 

5,132,730

 

 

 

4,041,575

 

 

 

1,091,155

 

 

 

27

%

Cost of revenue

 

 

4,135,884

 

 

 

3,335,511

 

 

 

800,373

 

 

 

24

%

Gross margin

 

 

996,846

 

 

 

706,064

 

 

 

290,782

 

 

 

41

%

Gross margin percentage

 

 

19

%

 

 

17

%

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

17,427,777

 

 

 

14,994,410

 

 

 

2,433,367

 

 

 

16

%

Research and development

 

 

7,900,311

 

 

 

4,601,718

 

 

 

3,298,593

 

 

 

72

%

Total operating expenses

 

 

25,328,088

 

 

 

19,596,128

 

 

 

5,731,960

 

 

 

29

%

Operating loss

 

 

(24,331,242

)

 

 

(18,890,064

)

 

 

(5,441,178

)

 

 

29

%

Other income (expense)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss from change in stock warrant valuation

 

 

 

 

 

(239,683

)

 

 

239,683

 

 

 

(100

%)

Interest expense

 

 

(1,867,466

)

 

 

(1,719,475

)

 

 

(147,991

)

 

 

9

%

Interest income

 

 

112,413

 

 

 

85,859

 

 

 

26,554

 

 

 

31

%

Loss on settlement of convertible debt

 

 

 

 

 

(705,217

)

 

 

705,217

 

 

 

(100

%)

Other

 

 

56,863

 

 

 

80,978

 

 

 

(24,115

)

 

 

(30

%)

Total other income (expense)

 

 

(1,698,190

)

 

 

(2,497,538

)

 

 

799,348

 

 

 

(32

%)

Net loss before income taxes

 

 

(26,029,432

)

 

 

(21,387,602

)

 

 

(4,641,830

)

 

 

22

%

Income taxes

 

 

10,118

 

 

 

10,189

 

 

 

(71

)

 

 

(1

%)

Net loss

 

$

(26,039,550

)

 

$

(21,397,791

)

 

$

(4,641,759

)

 

 

22

%

 

Revenue

We generate revenue from the sale of our HTG Edge and HTG EdgeSeq platforms and our consumables, which consist primarily of our proprietary molecular profiling panels and other assay components. Together, all such consumables may be referred to as assays, assay kits or kits. We also generate revenue through the sale of services related to our proprietary technology, such as sample processing, custom research-use-only assay development and, pursuant to collaboration agreements with our biopharmaceutical customers, development of IVD assays. Because of increased demand for sample processing by our biopharmaceutical customers, a trend that we expect to continue in future reporting periods, we announced and branded of our VERI/O laboratory service in the second quarter of 2016. Total revenue for the year ended December 31, 2016 increased by 27% to $5.1 million compared with total revenue of $4.0 million for the year ended December 31, 2015.    

Product revenue

Product revenue includes revenue from the sale of our HTG Edge and HTG EdgeSeq instruments and related consumables, and was $2.8 million compared with $3.5 million for the year ended December 31, 2015, and was comprised of the following:

 

 

 

Years Ended December 31,

 

 

Change

 

 

 

2016

 

 

2015

 

 

$

 

 

%

 

Instruments

 

$

522,813

 

 

$

789,231

 

 

$

(266,418

)

 

 

(34

%)

Consumables

 

 

2,237,129

 

 

 

2,742,797

 

 

 

(505,668

)

 

 

(18

%)

Total product sales

 

$

2,759,942

 

 

$

3,532,028

 

 

$

(772,086

)

 

 

(22

%)

 

Revenue from the sale of our instruments for the year ended December 31, 2016 was $523,000 compared with $789,000 for the year ended December 31, 2015, and represented 10% and 20% of our total revenue for the years ended December 31, 2016 and 2015, respectively. The decrease in instrument revenue from 2016 to 2015 is primarily attributable to our focus on biopharmaceutical

72


 

customers whose preference has been to access our technology via services through our VERI/O laboratory. We expect our revenue mix to continue to contain a higher portion of biopharmaceutical service revenue in the near term until we enter the commercial clinical diagnostic market.

Revenue from the sale of consumables is derived from the sale of our research-use-only molecular profiling assays for use on our HTG EdgeSeq platform and from the sale of custom molecular profiling assays that we have developed for customers. Consumable revenue for the year ended December 31, 2016 was $2.2 million compared with $2.7 million for the year ended December 31, 2015, and represented 44% and 68% of our total revenue for the years ended December 31, 2016 and 2015, respectively. In addition to the increase in biopharmaceutical customer demand for services discussed above, we also experienced a significant reduction in consumable sales to a single customer from 2015 to 2016. The customer completed a large, retrospective sample analysis project in late 2015. While this customer continues to place orders for our miRNA panel, its 2016 consumable orders were significantly below their 2015 levels. We believe this is not an unusual occurrence in the research market where orders are project driven. Our total consumable sales to all other customers increased from 2015 to 2016.

Service revenue

Service revenue consists primarily of sample processing and molecular profiling of retrospective cohorts through our VERI/O laboratory, though it also includes the design of custom panels for biopharmaceutical customers and research services, resulting from research and development collaboration agreements with biopharmaceutical customers. Service revenue represented 46% and 5% of our total revenue for the years ended December 31, 2016 and 2015, respectively, and was comprised of the following:

 

 

 

Years Ended December 31,

 

 

Change

 

 

 

2016

 

 

2015

 

 

$

 

 

%

 

Custom assay development

 

$

235,818

 

 

$

101,792

 

 

$

134,026

 

 

 

132

%

Sample processing

 

 

2,136,970

 

 

 

81,966

 

 

 

2,055,004

 

 

 

2507

%

Total service revenue

 

$

2,372,788

 

 

$

183,758

 

 

$

2,189,030

 

 

 

1191

%

 

The increase in service revenue for the period ended December 31, 2016 compared with 2015 reflects our success in continuing to grow our biopharmaceutical customer base and expand our ability to serve the needs of those customers through our VERI/O laboratory. We have been able to enter into new and expanding biopharmaceutical collaborations, partnering with biopharmaceutical company customers who have chosen the HTG EdgeSeq system for use in their drug development programs, and who primarily prefer to access our technology via services in our VERI/O laboratory. Because of existing development agreements with biopharmaceutical customers such as BMS and Merck KGaA, which were entered into in 2016, and continued efforts to expand our services to biopharmaceutical customers going forward, we expect our service revenue may continue to increase in both absolute dollars and as a percentage of total revenue in 2017.        

Cost of revenue and gross margin

Cost of revenue includes the aggregate costs incurred in manufacturing, delivering, installing and servicing instruments and consumables, as well as the costs incurred for services performed for customers in our VERI/O laboratory. The components of our 2016 cost of revenue are material, subcomponent and service costs, manufacturing costs incurred internally (which include direct labor costs), and equipment and infrastructure expenses associated with the manufacturing and distribution of our products. Additionally, internal costs incurred in our VERI/O laboratory, including direct labor and consumables, are included in cost of revenue.

For the year ended December 31, 2015, cost of revenue also included manufacturing costs that were paid to third-party manufacturers who were responsible for the manufacturing of our instruments at that time. We completed capital improvements to our manufacturing facilities the first quarter of 2016, at which point we began manufacturing our instruments internally. Further, cost of revenue for the year ended December 31, 2015 included costs associated with our NIH grant program.  

For the years ended December 31, 2016 and 2015, cost of revenue included significant fixed costs comprised primarily of manufacturing and service headcount, field service engineers and facilities. Due to the fixed nature of expenses associated with direct labor, equipment and infrastructure, we expect our cost of revenue as a percentage to decrease over time as we increase product and service revenue, further absorbing these fixed costs.  

Cost of revenue increased by $800,000, or 24% for the year ended December 31, 2016 compared with the year ended December 31, 2015. Since 2014, we have directed most of our commercial and marketing efforts to our HTG EdgeSeq products that do not utilize our chemiluminescent reader technology. Based on market demand, we discontinued the active marketing of our original HTG Edge technology in December 2016; provided that we will continue to support HTG Edge consumable needs for a limited

73


 

number of customers on an as-requested custom manufacturing basis for some period of time. The increased cost of revenue in 2016 was primarily due to the write off of the remaining $360,000 value of our HTG Edge Reader inventory, the recording of a $133,000 excess inventory reserve for our original HTG Edge system and additional inventory write offs to cost of product revenue of approximately $167,000 relating to our HTG Edge and plate-based consumables technology during the year ended December 31, 2016.

Despite these non-cash charges, gross margin as a percentage of total revenue improved from 17% for the year ended December 31, 2015 to 19% for the year ended December 31, 2016. This percent improvement reflects an increase in product and service revenues, allowing us to further absorb our largely fixed manufacturing costs and an overall the reduction of manufacturing costs resulting from a change to internally manufactured instruments, which began early in 2016.

Research and development expenses

Research and development expenses represent costs to develop new proprietary panels and corresponding assays, to obtain FDA approval for our first U.S. IVD assay and to continue to develop and improve our HTG EdgeSeq platform. These expenses include payroll and related expenses, consulting expenses, laboratory supplies and equipment and amounts incurred under collaborative supply or development agreements. Research and development costs are expensed as incurred. Research and development expenses increased by $3.3 million, or 72%, for the year ended December 31, 2016 compared with the year ended December 31, 2015. We expect research and development costs to continue to increase in 2017 due to the ongoing development of our V2 chemistry and the possible resumption of our Project JANUS development efforts in the second half of 2017. In addition, we expect higher costs from collaboration projects under agreements with our biopharmaceutical customers and costs associated with the fourth and final submission for our first PMA.

Selling, general and administrative expenses

Selling, general and administrative expenses consist primarily of personnel costs for our sales and marketing, regulatory, legal, executive management and finance and accounting functions. The expenses also include third-party professional and consulting fees incurred by these functions, promotional expenses and facility and overhead costs for our administrative offices. Selling, general and administrative expenses increased by $2.4 million, or 16%, for the year ended December 31, 2016, compared with the year ended December 31, 2015. This year over year increase was primarily a result of operating as a public company for a full year, including expenses related to compliance with the rules and regulations of the Securities and Exchange Commission and The NASDAQ Global Market, non-cash stock-based compensation expense, additional director and officer insurance costs, investor relations activities and other administrative and professional services. This increase also included higher sales and marketing costs related to a reorganization of our US-based commercial sales team, increased commercial sales activities in Europe, expansion of marketing efforts to accelerate market adoption of our products and commissions on overall increased revenue generated in 2016.

Loss from change in stock warrant valuation

Loss from the change in stock warrant valuation for the year ended December 31, 2015 was a result of an increase in the fair value of our preferred stock warrants just prior to the exercise of Series D preferred stock warrants, and the conversion to common stock warrants of our Series C-2 preferred stock warrants, convertible note warrants and growth term loan warrants at the time of our initial public offering. The increase in the fair value of our preferred stock warrants until their conversion to common stock warrants was primarily attributable to the proximity to and increased likelihood of completing an initial public offering. There was no loss from change in stock warrant valuation for the year ended December 31, 2016.

Interest expense

As of December 31, 2016, we had an obligation due to NuvoGen Research, LLC, or NuvoGen, in the amount of $8.6 million under an asset purchase agreement and an obligation due to a syndicate of two lending institutions of $11.8 million, net of discount and deferred financing costs under a growth term loan entered into in August 2014 and amended in August 2015 and June 2016.

Interest expense relating to borrowings under our term loan agreements and non-cash interest expense related to our obligation to NuvoGen increased by $148,000 for the year ended December 31, 2016 as compared with the year ended December 31, 2015. The year over year increase was primarily the result of interest, discount and final fee premium recognized in 2016 on the $5.0 million growth term loan borrowed in March 2016, partially offset by reduced interest on the original growth term loan and the NuvoGen obligation as principal payments were made on both liabilities in 2016.  

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Loss on settlement of convertible debt

With completion of our initial public offering in May 2015, our remaining convertible note debt discount and deferred financing costs relating to the convertible notes totaling $0.7 million were charged to loss on settlement of convertible debt with the issuance of common stock in settlement of the convertible notes and related accrued interest. There were no convertible notes outstanding during the year ended December 31, 2016.  

Cash Flows for the Years Ended December 31, 2016 and 2015

The following table summarizes the primary sources and uses of cash for each of the periods presented:

 

 

 

Years Ended December 31,

 

 

 

2016

 

 

2015

 

Net cash provided by (used in):

 

 

 

 

 

 

 

 

Operating activities

 

$

(22,234,208

)

 

$

(19,243,273

)

Investing activities

 

 

24,422,214

 

 

 

(32,184,889

)

Financing activities

 

 

2,025,670

 

 

 

51,108,753

 

Increase (decrease) in cash and cash equivalents

 

$

4,213,676

 

 

$

(319,409

)

 

Operating Activities

Net cash used in operating activities for the year ended December 31, 2016 was $22.2 million and reflected (i) the net loss of $26.0 million, (ii) net non-cash items of $4.1 million, consisting primarily of depreciation and amortization of $1.5 million, amortization of the discount on the NuvoGen obligation of $0.2 million, amortization of the discount, deferred financing costs and final payment premium on the growth term loan of $0.6 million, provision for excess inventory of $0.7 million, stock-based compensation of $0.9 million and accrued interest on available-for-sale securities of $0.2 million and (iii) a net cash outflow from changes in balances of operating assets and liabilities of $0.3 million. The significant items comprising the changes in balances of operating assets and liabilities were an increase of $0.7 million in accounts receivable and an increase in deferred revenue of $0.3 million due primarily to up-front payments received from development agreements entered into in 2016.