S-1 1 d749180ds1.htm S-1 S-1
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As filed with the Securities and Exchange Commission on December 22, 2014

Registration No. 333-            

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

AltheaDx, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Delaware   8071   26-2018451

(State or Other Jurisdiction of

Incorporation or Organization)

 

(Primary Standard Industrial

Classification Code Number)

  (I.R.S. Employer Identification Number)

 

3550 Dunhill Street

San Diego, California 92121

(858) 224-7200

(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)

 

 

 

Greg Hamilton

Chief Executive Officer

AltheaDx, Inc.

3550 Dunhill Street

San Diego, California 92121

(858) 224-7200

(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent for Service)

 

Copies to:

Kenneth J. Rollins, Esq.

Karen E. Deschaine, Esq.

Cooley LLP

4401 Eastgate Mall

San Diego, California 92121

(858) 550-6000

  

Cheston J. Larson, Esq.

Matthew T. Bush, Esq.

Brian J. Cuneo, Esq.

Latham & Watkins LLP

12670 High Bluff Drive

San Diego, California 92130

(858) 523-5400

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

 

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

 

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

 

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

 

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

 

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

 

Large accelerated filer ¨    Accelerated filer ¨   

Non-accelerated filer x

(Do not check if a smaller reporting company)

     Smaller reporting company ¨

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class of

securities to be registered

 

Proposed

maximum

aggregate

offering price(1)

  Amount of
registration fee(1)

Common Stock, $0.0001 par value per share

  $69,000,000   $8,018

 

 

(1)   Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(o) under the Securities Act. Includes the offering price of shares that the underwriters have the option to purchase to cover over-allotments, if any.

 

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


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

 

SUBJECT TO COMPLETION, DATED DECEMBER 22, 2014

 

PRELIMINARY PROSPECTUS

 

             Shares

 

LOGO

 

Common Stock

 

$         per share

 

 

 

This is the initial public offering of our common stock. We are selling             shares of our common stock. We currently expect the initial public offering price of our common stock to be between $         and $         per share of common stock.

 

We have granted the underwriters an option to purchase up to             additional shares of common stock to cover over-allotments.

 

We have applied to have the common stock listed on the NASDAQ Global Market under the symbol “IDGX.”

 

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

 

 

 

Investing in our common stock involves risks. See “Risk Factors” beginning on page 12.

 

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

 

 

 

     Per Share      Total  

Public Offering Price

   $                   $               

Underwriting Discount(1)

   $        $    

Proceeds to AltheaDx, Inc. (before expenses)

   $        $    

 

(1)   We have agreed to reimburse the underwriters for certain expenses. See “Underwriting.”

 

The underwriters expect to deliver the shares to purchasers on or about                     , 2015 through the book-entry facilities of The Depository Trust Company.

 

 

 

Citigroup      Jefferies   

 

 

 

William Blair      Cantor Fitzgerald & Co.   

 

                    , 2015


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TABLE OF CONTENTS

 

     Page  

Summary

     2   

Risk Factors

     12   

Special Note Regarding Forward-Looking Statements

     48   

Use of Proceeds

     49   

Dividend Policy

     51   

Capitalization

     52   

Dilution

     54   

Selected Consolidated Financial Data

     57   

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

     59   

Business

     85   

Management

     117   

Executive and Director Compensation

     127   

Certain Relationships and Related Party Transactions

     147   

Principal Stockholders

     151   

Description of Capital Stock

     154   

Shares Eligible for Future Sale

     159   

Underwriting

     161   

Legal Matters

     167   

Experts

     167   

Where You Can Find Additional Information

     167   

Index to Consolidated Financial Statements

     F-1   

 

 

 

We are responsible for all of the information contained in this prospectus. Neither we nor any of the underwriters has authorized anyone to provide you with information different from, or in addition to, that contained in this prospectus or any free writing prospectus prepared by or on behalf of us and to which we may have referred you in connection with this offering. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. Neither we nor any of the underwriters is making an offer to sell or seeking offers to buy these securities in any jurisdiction where or to any person to whom the offer or sale is not permitted. The information in this prospectus is accurate only as of the date on the front cover of this prospectus, regardless of the time of delivery of this prospectus or of any sale of shares of our common stock and the information in any free writing prospectus that we may provide you in connection with this offering is accurate only as of the date of that free writing prospectus. Our business, financial condition, results of operations and prospects may have changed since those dates.

 

This prospectus includes statistical and other industry and market data that we obtained from industry publications and research, surveys and studies conducted by third parties. Industry publications and third-party research, surveys and studies generally indicate that their information has been obtained from sources believed to be reliable.

 

For investors outside the United States: neither we nor any of the underwriters has done anything that would permit this offering or possession or distribution of this prospectus or any free writing prospectus we may provide to you in connection with this offering in any jurisdiction where action for that purpose is required, other than in the United States. You are required to inform yourselves about and to observe any restrictions relating to this offering and the distribution of this prospectus and any free writing prospectus outside of the United States.

 

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SUMMARY

 

This summary highlights information contained in other parts of this prospectus. Because it is only a summary, it does not contain all of the information that you should consider before investing in shares of our common stock and it is qualified in its entirety by, and should be read in conjunction with, the more detailed information appearing elsewhere in this prospectus. You should read the entire prospectus carefully, especially “Risk Factors” and our consolidated financial statements and the related notes, before deciding to invest in our common stock. Unless the context requires otherwise, references in this prospectus to “AltheaDx,” “we,” “us” and “our” refer to AltheaDx, Inc.

 

Overview

 

We are a commercial stage molecular diagnostics company specializing in the field of personalized medicine. IDgenetix, our pharmacogenetic, or PGx, testing portfolio, enables personalized therapeutic decisions for patients suffering from some of the most prevalent clinical conditions in the United States, including cardiovascular disease, neuropsychiatric disorders and pain. Our proprietary algorithm-based bioinformatic platform and PGx testing portfolio are intended to serve as a tool to assist healthcare providers in identifying optimal drugs for their patients as well as dosing guidelines based on a patient’s genetic make-up, current prescription regimen and other key factors. IDgenetix is designed to enable healthcare providers to make timely and evidence-based decisions, which we believe can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response.

 

In 2013, the U.S. healthcare system spent in excess of $260 billion on prescription drugs and that amount is expected to exceed $450 billion in 2022. Nearly 50% of the U.S. population, and almost 90% of people 65 years and over (or approximately 36 million patients), take at least one prescription drug and more than 10% of the U.S. population, and almost 40% of people 65 years and over (or approximately 16 million patients), take five or more prescription drugs, which we refer to as polypharmacy. We estimate that the overall potential market opportunity for IDgenetix is greater than 150 million patients in the United States, representing the number of people that take at least one prescription drug, which includes the more than 30 million people who are polypharmacy.

 

We believe there are significant health concerns and unnecessary costs associated with the trial-and-error manner in which physicians prescribe drugs, without prior knowledge of an individual patient’s genetic profile. There are an estimated 100,000 deaths and more than two million serious adverse reactions attributable to prescription drug use in the United States each year, at a cost to the healthcare industry that exceeds $136 billion annually. It has been estimated that genetics can account for up to 95% of variability in drug disposition and effects and as much as 40-60% of adverse drug reactions. We believe IDgenetix can improve clinical outcomes and reduce the overall cost of prescription drugs by enabling better drug selection, earlier favorable results and lower occurrence of adverse events.

 

In October 2013, we commercially launched IDgenetix in the United States. Since launch and through September 30, 2014, we completed IDgenetix tests for more than 13,500 patient samples, of which more than 7,500 samples were completed in the quarter ended September 30, 2014. IDgenetix examines genes involved in both the metabolism and pharmacological activity of numerous drugs. It provides physicians with information on the functionality of critical metabolic enzymes and key biological drug targets, where applicable, for each patient. In addition, our algorithm screens for unfavorable metabolic interactions resulting from multiple prescription drugs, over-the-counter drugs and herbal supplements, and environmental and dietary factors that may significantly alter the metabolism of certain drugs. We currently offer 13 tests in the therapeutic areas of cardiovascular disease, neuropsychiatric disorders and pain, and we are developing additional tests/offerings in the therapeutic areas of neurology and rheumatology.

 

 

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We designed IDgenetix to provide a comprehensive PGx test offering to best meet the needs of our target customers such as long-term and post-acute care facilities, government facilities, integrated delivery networks, or IDNs, and managed care organizations. These institutional healthcare providers require broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions. These customers often operate under fixed-fee-per-patient or fixed-fee-per-procedure arrangements and are searching for ways to improve clinical outcomes at the lowest possible cost. In addition, IDgenetix addresses the needs of physicians across multiple specialties, such as cardiologists, general practitioners, obstetricians and neurologists.

 

In addition to IDgenetix, we provide research and development services, primarily in oncology, to numerous biopharmaceutical partners. We use our expertise in next-generation sequencing, or NGS, and our computational biology and information technology capabilities to analyze subject samples from preclinical through clinical development. We are validating a number of companion diagnostic test assays in late stage clinical trials.

 

We believe that IDgenetix will have commercial success due to the following factors:

 

Significant market need for personalized, genetic based information in treating patients.    There is a significant need to address the current trial-and-error method of prescribing drugs and reduce healthcare costs due to drug-related adverse events and over-prescribing practices. We believe the use of IDgenetix can address both physician and patient needs as well as the financial burden of the current trial-and-error method of prescribing drugs. Government agencies also acknowledge the importance of PGx. For example, the U.S. Food and Drug Administration, or FDA, has required, for certain drugs, the incorporation of PGx information into drug labeling and currently recommends genetic testing for patients taking a subset of these drugs. Additionally, the National Institutes of Health, or NIH, has established the Clinical Pharmacogenetics Implementation Consortium, or CPIC, guidelines intended to assist healthcare providers in translating laboratory genetic test results into actionable prescribing decisions for specific drugs.

 

Broad test portfolio that comprehensively identifies information that will enable decisions to improve patient outcomes.    IDgenetix tests are designed to evaluate genes encoding critical metabolic enzymes and key biological drug targets, where applicable, for which clinical data exists. IDgenetix examines clinically significant gene duplication and deletion events and covers more than 85 genetic mutations in 19 different genes, which we believe is the most comprehensive offering on the market today. We continue to enhance IDgenetix by updating our proprietary algorithm as well as evaluating additional genes to incorporate into our tests. We believe this is a competitive advantage as institutional healthcare providers require broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions.

 

Speed and ease of use for routine clinical practice.    The IDgenetix process, from order initiation and sample acquisition through report delivery and availability of our genetic counseling team, enables healthcare providers to obtain and interpret the information we provide in a convenient and simple manner. Patient samples are easily collected via a cheek swab and sent to our laboratory for analysis. Once received, our proprietary laboratory workflow and bioinformatic algorithm enable us to detect, interpret and report clinically relevant information to healthcare providers, generally within 48 hours of sample receipt, which we believe is an industry-leading turnaround time. Our concise, easy-to-interpret reports and analysis provide healthcare providers with actionable information on therapeutic options regarding drugs and dosing for their patients, based upon the complex genetic, pharmacological and environmental analysis performed by our algorithm.

 

Healthcare cost reduction.    We provide healthcare providers a tool that enables them to make decisions regarding treatment that may result in the elimination, replacement, supplementation or revision of dosing regimens for prescribed drugs, fewer adverse events and faster therapeutic response. We believe this can reduce

 

 

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overall treatment costs, a particular concern for healthcare providers operating under fixed-fee-per-patient or fixed-fee-per-procedure arrangements who are searching for ways to improve clinical outcomes at the lowest possible cost.

 

Clinical studies supporting the use of PGx testing.    While there have not been any IDgenetix-specific studies to date, there are more than 5,000 published studies on the use of PGx testing in a clinical setting. For example, there have been several publications linking the CYP2C19 gene to the use of clopidogrel (marketed by Bristol-Myers Squibb under the name Plavix) anticoagulant therapy, including meta-analysis studies totaling more than 150,000 patients. We believe that further studies, including studies that are specific to IDgenetix, will increase awareness and drive adoption of PGx testing, and help establish PGx testing as a standard of care in drug selection.

 

Our Strategy

 

Our goal is to become the premier provider of PGx testing services to institutional healthcare providers and physicians across the United States. To achieve this objective, we intend to:

 

Target large institutions where polypharmacy is a significant cost driver.    IDgenetix may address polypharmacy by enabling healthcare providers to make timely and evidence-based decisions, which we believe can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response. As such, we believe institutional healthcare providers represent the largest opportunity for IDgenetix. Currently, we have more than 10 agreements with institutional healthcare providers for our IDgenetix testing services, all of which are in the early stages of implementation.

 

We recently entered into an agreement with a subsidiary of Universal Health Services, Inc., or UHS, a hospital management company covering 25 acute care hospitals, 195 behavior health facilities and three surgery centers, to initiate a pilot roll-out of IDgenetix testing among different specialties at its Aiken Regional Medical Center in South Carolina. We also recently entered into an agreement with a nationally-ranked medical center within a large healthcare system in the southeastern United States to perform IDgenetix testing. This medical center is staffed by more than 390 physicians and specialists across numerous areas of clinical expertise. While we market our IDgenetix service across several specialties within this healthcare system, the initial focus of IDgenetix testing will be for patients undergoing neurosurgery in an effort to optimize post-operative pain management and reduce both the costs and length of stay following surgery.

 

Highlight our value proposition and clinical utility through clinical studies.    We are currently conducting an ongoing pilot study with a large managed care organization to evaluate patient outcomes in approximately 300 nursing home patients over a 12-month period following IDgenetix testing, and, in September 2014, we entered into an agreement for a second pilot study to be conducted at an acute care facility run by Universal Health Services, Inc., a hospital management company covering 25 acute care hospitals, 195 behavior health facilities and three surgery centers. We intend to continue to sponsor or co-sponsor IDgenetix-guided clinical studies within institutional healthcare organizations to analyze the impact of the use of IDgenetix by physicians on defined endpoints such as the number of prescription drugs, hospitalizations and length of stay, and other health assessments.

 

Differentiate our IDgenetix offering through superior customer service.    As part of our IDgenetix customer service department, we provide physicians with access to individuals with doctorate degrees in pharmacy (Pharm.D.), certified genetic counselors and additional customer service support personnel at no additional charge. Our customer service department has the capability to address a range of inquiries, from routine questions to complex patient cases, with healthcare providers. We believe this differentiated service

 

 

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offering increases the quality of care to patients, thereby facilitating adoption of our IDgenetix tests by institutional healthcare providers and physicians.

 

Leverage operational efficiency.    Our automated and efficient testing platform enables us to maintain a low-cost, scalable laboratory operation. As our sample volume increases, we expect our average cost per sample to decrease.

 

Expand the IDgenetix portfolio and offerings.    We recently expanded our IDgenetix tests from 16 to 19 genes, and, in the near term, expect to expand our tests from three to five therapeutic areas. Because we currently test more than 85 genetic mutations in 19 different genes that are most commonly associated with drug metabolism, we are able to add additional tests at an accelerated pace, with limited additional cost.

 

IDgenetix

 

Our proprietary bioinformatic algorithm incorporates complex genetic, pharmacological and environmental factors which we use to provide a simple, easy-to-read, actionable report for use by healthcare providers. In addition to this patient report, we currently offer a polypharmacy analysis for certain institutional healthcare provider customers that allows physicians to identify potentially harmful interactions and possibly avoid adverse events through elimination of drugs or selection of more appropriate drugs. We believe that our polypharmacy analysis is especially beneficial to institutional healthcare providers. Polypharmacy patients tend to be the most costly for institutional healthcare providers to treat, as they typically suffer from multiple clinical conditions and experience increased adverse events due to the number of prescription drugs these patients take on a regular basis. Optimization of treatment therapies for these patients represents an opportunity to reduce the overall cost of healthcare for these patients while potentially improving patient outcomes.

 

In October 2013, we launched eight IDgenetix tests covering three therapeutic areas: cardiovascular disease, neuropsychiatric disorders and pain. We have since launched five new tests to expand our offering to 13 tests within our three therapeutics areas of focus. We initially targeted these therapeutic areas as they include six of the top ten prescription classes written in the United States, according to a 2011 Annual Prescription Audit by IMS Health (a leading healthcare information company), representing more than 1.3 billion prescriptions and $80 billion in spending per year. In the near term, we intend to expand the IDgenetix portfolio by adding additional tests and categorizing current tests to better fit specific physician specialties in the therapeutic areas of neurology and rheumatology. Similar to our initial strategy, we have targeted these therapeutic areas as they satisfy our development criteria that include: clinical utility of PGx testing, high prescription volume, commercial potential, synergy with our current IDgenetix test offerings and clinical relevance to institutional healthcare providers.

 

Sales and Marketing

 

Our selling strategy divides the market into two categories: (1) institutional healthcare providers and (2) physicians. We have more than 100 account representatives dedicated to optimizing near-term growth in both categories. We designed the IDgenetix service for the institutional healthcare provider category and believe that this market category will be a significant driver of growth for the company both near and longer-term due to the many types and significant number of potential institutional healthcare providers. Currently, we have an institutional sales team of six account managers and a contract sales organization, or CSO, that provides an additional three account managers focused on institutional healthcare providers. Institutional healthcare providers typically represent sizeable patient populations of 2,000 to 500,000 patients, allowing a relatively large number of patients to be targeted with a limited number of account managers. We also market directly to individual physicians. We currently have a sales force composed of several fully dedicated CSOs and a limited distributor network. While this sales force focuses exclusively on physicians, they have also generated a significant number of leads for the institutional sales team due to deep client relationships within their respective geographical areas.

 

 

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Risks Associated With Our Business

 

Our business is subject to numerous risks, as more fully described in the section entitled “Risk Factors” immediately following this prospectus summary. You should read these risks before you invest in our common stock. We may be unable, for many reasons, including those that are beyond our control, to implement our business strategy. In particular, risks associated with our business include:

 

   

We have a limited operating history and have incurred significant operating losses since our inception, including an accumulated deficit of $19.2 million as of September 30, 2014.

 

   

Our financial results are largely dependent on the commercial success of IDgenetix, and we may not be able to generate sufficient revenue from our existing tests or new tests that we may develop to achieve profitability.

 

   

Our IDgenetix tests may never achieve significant market acceptance.

 

   

Changes in laws, regulations, payor policies or contracting arrangements with payors have adversely affected, and may continue to adversely affect, coverage or reimbursement for IDgenetix testing services, which may decrease our revenue and adversely affect our results of operations and financial condition.

 

   

Changes in FDA policies regarding oversight over laboratory developed tests could cause us to experience significantly increased development costs and may delay or prevent commercialization of new tests and impact our ability to continue marketing our current tests.

 

   

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

 

   

Increased competition, including from competitors replicating our key service offerings in the future, and the failure to provide a higher quality of service than that of our competitors could adversely affect our revenue and profitability.

 

   

If our laboratory facility becomes inoperable, we will be unable to perform our IDgenetix tests and our business will be harmed.

 

   

We rely on a limited number of third parties for manufacture and supply of all of our laboratory instruments, tests and materials, including consumables, and we may not be able to find replacement suppliers or manufacturers in a timely manner in the event of any disruption, which could adversely affect our business.

 

   

If our tests do not perform as expected, our operating results, reputation and business will suffer.

 

   

We will need to grow the size of our organization, and we may experience difficulties in managing this growth.

 

   

We rely on third-party organizations and their sales representatives to market IDgenetix to healthcare providers, and these contracted sales representatives are outside our direct control.

 

Corporate Information

 

We were incorporated in Delaware in January 2008. Our principal executive offices are located at 3550 Dunhill Street, San Diego, California 92121, and our telephone number is (858) 224-7200. Our corporate website address is www.AltheaDx.com. Information contained on or accessible through our website is not a part of this prospectus, and the inclusion of our website address in this prospectus is an inactive textual reference only.

 

We have obtained a registered trademark for IDgenetix in the United States. This prospectus contains references to our trademark and to trademarks belonging to other entities. Solely for convenience, trademarks and trade names referred to in this prospectus, including logos, artwork and other visual displays, may appear

 

 

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without the ® or TM symbols. 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.

 

Implications of Being an Emerging Growth Company

 

As a company with less than $1.0 billion in revenue during our last fiscal year, we qualify as an “emerging growth company” as defined in the Jumpstart Our Business Startups Act, or JOBS Act, enacted in April 2012. An “emerging growth company” may take advantage of reduced reporting requirements that are otherwise applicable to public companies and other exemptions. These exemptions include, but are not limited to:

 

   

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

 

   

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

 

   

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

 

   

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

 

We may rely on these exemptions until the last day of our fiscal year following the fifth anniversary of the completion of this offering. However, if certain events occur prior to the end of such five-year period, including if we become a “large accelerated filer,” our annual gross revenues exceed $1.0 billion or we issue more than $1.0 billion of non-convertible debt in any three-year period, we will cease to be an emerging growth company prior to the end of such five-year period.

 

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

 

The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. We have irrevocably elected not to avail ourselves of this exemption and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

 

 

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The Offering

 

Common stock offered by us

            shares

 

Common stock to be outstanding after this offering

            shares

 

Over-allotment option

We have granted to the underwriters the option, exercisable for 30 days from the date of this prospectus, to purchase up to             additional shares of common stock at the initial public offering price.

 

Use of proceeds

We estimate that we will receive net proceeds of approximately $         million (or approximately $         million if the underwriters exercise their over-allotment option in full) from the sale of the shares of common stock offered by us in this offering, based on the assumed initial public offering price, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the net proceeds from this offering as follows: (1) to fund research and development, including clinical studies to demonstrate the utility of our products and support reimbursement efforts, as well as expansion of our IDgenetix testing portfolio; (2) to expand our commercial capabilities in selling and marketing related to our IDgenetix tests; (3) to fund expansion of our facilities and laboratory operations; and (4) the remaining proceeds for working capital and other general corporate purposes. See “Use of Proceeds.”

 

Risk factors

You should read the “Risk Factors” section of this prospectus for a discussion of certain of the factors to consider carefully before deciding to purchase any shares of our common stock.

 

Proposed NASDAQ Global Market symbol

IDGX

 

The number of shares of our common stock to be outstanding after this offering is based on 17,918,900 shares of common stock outstanding as of November 30, 2014 after giving effect to the automatic conversion of all shares of our outstanding redeemable convertible preferred stock as of November 30, 2014 into an aggregate of 11,639,977 shares of common stock, and excludes:

 

   

1,924,295 shares of common stock issuable upon the exercise of outstanding stock options as of November 30, 2014, at a weighted-average exercise price of $2.19 per share;

 

   

             shares of common stock issuable upon the net exercise of certain outstanding warrants as of November 30, 2014, or the common stock warrants, based on the assumed initial public offering price, which outstanding common stock warrants will be automatically net exercised immediately prior to the closing of this offering if not previously exercised;

 

   

414,380 shares of common stock issuable upon the exercise of outstanding warrants as of November 30, 2014, at a weighted-average exercise price of $1.57 per share;

 

 

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             shares of common stock reserved for future issuance under our 2014 employee stock purchase plan, or the ESPP, which will become effective upon the execution and delivery of the underwriting agreement for this offering; and

 

   

            shares of common stock reserved for future issuance under our 2014 equity incentive plan, or the 2014 plan, which will become effective upon the execution and delivery of the underwriting agreement for this offering, plus 557,244 shares of common stock reserved for issuance under our 2008 equity incentive plan, or the 2008 plan, as of November 30, 2014, which shares will be added to the shares reserved under the 2014 plan upon its effectiveness.

 

Unless otherwise indicated, all information contained in this prospectus assumes:

 

   

the conversion of all our outstanding redeemable convertible preferred stock as of November 30, 2014 into an aggregate of 11,639,977 shares of common stock, which will occur automatically immediately prior to the closing of this offering;

 

   

the adjustment of outstanding warrants to purchase 414,380 shares of our Series B redeemable convertible preferred stock into warrants to purchase 414,380 shares of our common stock, which will occur automatically immediately prior to the closing of this offering;

 

   

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

 

   

that the initial public offering price of our shares of common stock will be $         per share (which is the mid-point of the estimated price range set forth on the cover page of this prospectus);

 

   

the filing of our amended and restated certificate of incorporation and the adoption of our amended and restated bylaws immediately prior to the closing of this offering; and

 

   

a 1-for-         reverse stock split of our common stock to be effected prior to the closing of this offering.

 

 

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Summary Consolidated Financial Data

 

The following summary consolidated financial data should be read together with our consolidated financial statements and related notes, “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. We derived the summary consolidated statements of comprehensive loss data for the years ended December 31, 2012 and 2013 from our audited consolidated financial statements and related notes appearing elsewhere in this prospectus. We derived the summary consolidated statements of comprehensive loss data for the nine months ended September 30, 2013 and 2014 and consolidated balance sheet data as of September 30, 2014 from our unaudited consolidated financial statements also appearing elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements included in this prospectus and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state our financial position as of September 30, 2014 and results of operations for the nine months ended September 30, 2013 and 2014. Our historical results are not necessarily indicative of the results that may be expected in the future and results of interim periods are not necessarily indicative of the results for the entire year.

 

    

Year Ended

December 31,

   

Nine Months Ended

September 30,

 
     2012     2013     2013     2014  
                 (unaudited)  
     (in thousands, except per share data)  

Consolidated Statements of Comprehensive Loss Data:

        

Revenue:

        

Diagnostic testing

   $ —        $ 196      $ —        $ 9,067   

Research services and other

     6,915        7,150        4,235        4,542   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     6,915        7,346        4,235        13,609   

Cost of revenue:

        

Diagnostic testing

     —          101        —          1,763   

Research services and other

     4,772        4,663        3,036        3,008   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     4,772        4,764        3,036        4,771   

Gross profit

     2,143        2,582        1,199        8,838   

Total operating expenses

     3,737        6,667        4,159        14,163   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (1,594     (4,085     (2,960     (5,325

Interest and other income (expense)

     9        27        24        (388

Change in fair value of warrant liability

     —          —          —          (194
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss and comprehensive loss

   $ (1,585   $ (4,058   $ (2,936 )   $ (5,907

Accretion on redeemable convertible preferred stock

     (585     (1,000     (680     (987
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss applicable to common stockholders – as restated for the years ended December 31, 2012 and 2013

   $ (2,170   $ (5,058   $ (3,616   $ (6,894
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted – as restated for the years ended December 31, 2012 and 2013 (1)

   $ (1.08   $ (2.51   $ (1.80   $ (3.12
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding used in computing net loss per share attributable to common stockholders, basic and diluted (1)

     2,014        2,014        2,014        2,207   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited) (1)

        
    

 

 

     

 

 

 

Weighted average shares outstanding used in computing pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited) (1)

        
    

 

 

     

 

 

 

 

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

 

 

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     As of September 30, 2014
     Actual     Pro Forma(1)    Pro Forma as
Adjusted(1)(2)
     (unaudited, in thousands)

Consolidated Balance Sheet Data:

       

Cash and cash equivalents

   $ 7,458        

Working capital

     2,338        

Total assets

     27,274        

Debt, at carrying value, including working capital line of credit

     11,774        

Redeemable convertible preferred stock

     16,853        

Accumulated deficit

     (19,177     

Total stockholders’ deficit

     (19,177     

 

(1)   Gives effect to:

 

   

the automatic conversion of 10,628,684 shares of our redeemable convertible preferred stock into 11,639,977 shares of our common stock immediately prior to the closing of the offering;

 

   

the conversion of warrants to purchase 414,380 shares of our Series B redeemable convertible preferred stock into warrants to purchase 414,380 shares of our common stock, and the resultant reclassification of our preferred stock warrant liability to additional paid-in capital, a component of stockholders’ deficit, in connection with such conversion;

 

   

the issuance of                    shares of common stock as a result of the automatic net exercise of the common stock warrants, based on the assumed initial public offering price, which outstanding common stock warrants will be automatically net exercised immediately prior to the closing of this offering if not previously exercised;

 

   

borrowings of $10.0 million subsequent to September 30, 2014 under our credit facility with Silicon Valley Bank, or SVB, in connection with the November 2014 amendment to our loan and security agreement with SVB; and

 

   

the cancellation of our working capital line of credit with SVB in November 2014.

 

(2)   Gives further effect to the issuance and sale of                    shares of common stock in this offering at the assumed initial public offering price of $            per share, the midpoint of the price range listed on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $            per share would increase (decrease) the pro forma as adjusted amount of each of cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) by approximately $            , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million shares in the number of shares offered by us at the assumed initial public offering price would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) by approximately $            . The pro forma information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of our initial public offering determined at pricing.

 

 

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RISK FACTORS

 

An investment in shares of our common stock involves a high degree of risk. You should carefully consider the following information about these risks, together with the other information appearing elsewhere in this prospectus, before deciding to invest in 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. In these circumstances, the market price of our common stock could decline, and you may lose all or part of your investment in our common stock.

 

Risks Relating to Our Business

 

We have a limited operating history and have incurred significant operating losses since our inception.

 

Our operations began in 2008 and we have only a limited operating history upon which you can evaluate our business and prospects. Substantially all of our revenue to date has been derived from research and development services. We commercially launched our pharmacogenetics, or PGx, testing service, IDgenetix, in late 2013. Our limited commercial history makes it difficult to evaluate our current business and makes predictions about our future results, prospects or viability subject to significant uncertainty. We will continue to encounter risks and difficulties frequently experienced by early commercial-stage companies, including scaling up our infrastructure and headcount, and may encounter unforeseen expenses, difficulties or delays in connection with our growth.

 

To date, we have financed our operations primarily through private placements of our equity and debt securities, our credit facility and our research and development services agreements, and we have incurred significant operating losses since our inception, including net losses of $1.6 million and $4.1 million for the years ended December 31, 2012 and December 31, 2013, respectively. As of September 30, 2014, we had an accumulated deficit of $19.2 million. Our prior losses, combined with expected future losses, have had and will continue to have an adverse effect on our stockholders’ equity and working capital. Our losses have resulted principally from costs incurred in our development and commercialization activities. Because of the numerous risks and uncertainties related to developing and commercializing our IDgenetix tests, we are unable to predict the extent of any future losses or whether and when we will become profitable. If we are unable to achieve profitability, the market value of our stock will likely decline.

 

Our financial results are largely dependent on the commercial success of IDgenetix, and we may not be able to generate sufficient revenue from our existing tests or new tests that we may develop to achieve profitability.

 

To date, we have generated limited revenue from our existing portfolio of tests. We believe our future success is dependent upon our ability to successfully market our existing IDgenetix test portfolio to additional healthcare providers within the United States and to develop and commercialize enhanced tests or additional tests aimed at additional therapeutic areas. The demand for our existing tests may decrease or may not continue to increase at historical rates for a number of reasons. Our pipeline of new tests is in various states of development and may take more time to commercialize than we currently anticipate. Furthermore, enhancing or developing new tests requires us to anticipate patients’, healthcare providers’ and payors’ needs and emerging technology trends accurately. We may experience research and development, regulatory, marketing and other difficulties that could delay or prevent our introduction of enhanced or new tests. The research and development process in diagnostics is conducted in various stages, and each stage presents the risk that we will not achieve our goals. We may have to abandon a test in which we have invested substantial resources. In order to successfully commercialize tests that we may develop in the future, we may need to conduct lengthy, expensive clinical studies and develop dedicated sales and marketing operations or enter into collaborative agreements to achieve market awareness and demand. Any delay in the research and development, regulatory clearance or approval (if necessary for a particular test), production, marketing or distribution of enhanced or new tests could adversely affect our competitive position, branding and results of operations.

 

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We cannot assure you that:

 

   

our tests will prove to be effective in clinical practice or clinical studies;

 

   

when necessary we will be able to obtain, in a timely manner or at all, regulatory clearances, licenses or approvals;

 

   

our tests will be used by healthcare providers;

 

   

our tests will receive or will continue to receive adequate coverage and reimbursement from third-party payors;

 

   

our tests can be provided at acceptable cost and with appropriate quality; or

 

   

any of our tests can be successfully marketed.

 

These factors and other factors beyond our control could limit the commercial success of our existing tests or delay the launch of enhanced or new tests. Even if we succeed in marketing our existing tests for use in new patients and new healthcare settings and in developing and commercializing any enhanced or additional tests, we may not be able to generate sufficient revenue to achieve profitability.

 

Our IDgenetix tests may never achieve significant market acceptance.

 

We may not succeed in achieving significant market acceptance of the IDgenetix tests that we have launched in the past year or that we are currently developing. Our ability to successfully commercialize our current IDgenetix tests, as well as any future tests that we may develop, will depend on several factors, including:

 

   

adequate coverage and reimbursement of our tests by third-party payors, which will affect healthcare providers’ willingness or ability to recommend and order our tests; and

 

   

our ability to prove to the medical community, including large institutional healthcare providers and individual physicians, key opinion leaders, and professional medical organizations and societies, the clinical utility of our tests and their potential advantages for patients and healthcare providers.

 

These factors present obstacles to commercial market acceptance of our IDgenetix tests, which we will have to spend substantial time and resources to overcome, if we can do so at all. In addition, we believe that important factors in the growth of our industry and the commercial success of PGx testing services are the continued and increased incorporation of PGx information on drug labeling and continued attention to PGx testing in peer-reviewed publications. Our inability to achieve market acceptance of our IDgenetix tests would adversely affect our business and prospects.

 

Increased competition, including from competitors replicating our key service offerings in the future, and the failure to provide a higher quality of service than that of our competitors could adversely affect our revenue and profitability.

 

The biotechnology and genetic testing fields are intensely competitive both in terms of service and price, and continue to undergo significant consolidation, permitting larger clinical laboratory service providers to increase cost efficiencies and service levels, resulting in more intense competition. Some of our existing competitors and many potential competitors have substantially greater financial, selling, logistical and laboratory resources, more experience in dealing with third-party payors, and greater market penetration, purchasing power and marketing budgets, as well as more experience in providing diagnostic services.

 

The molecular diagnostics field is characterized by rapid technological changes, frequent new product introductions, changing customer preferences, emerging competition, evolving industry standards, reimbursement uncertainty and price competition. As a PGx testing services provider, we rely extensively on our high quality of service to attract and retain healthcare providers as our customers. We compete primarily based

 

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on the breadth, depth, speed and quality of testing, reporting and information systems, reliability in patient sample transport, ease-of-use and speed of our service, reputation in the medical community and access to our genetic counseling services and new technologies and tests as they become available. Moreover, many companies in this market are offering, or may soon offer, products and services that compete with our tests. We cannot assure you that research and discoveries by other companies will not render our existing or potential tests uneconomical or result in tests superior to those we develop. We also cannot assure you that any technologies or tests that we develop will be preferred to any existing or newly developed technologies or tests.

 

We face competition from other laboratories offering PGx testing services, companies developing and commercializing PGx assays, and from various companies researching and developing PGx technology. Our competition arises from other parties using the same or similar methods as well as alternative methods of PGx testing. Competitors and potential competitors include, among others, American International Biotechnology LLC, AssureRx Health, Inc., Iverson Genetic Diagnostics, Inc., Millennium Laboratories, LLC and PGXL Laboratories. We also face competition from national reference laboratories, which typically offer a full suite of tests to a variety of medical professionals including general practitioners, hospitals and specialists, such as Quest Diagnostics Incorporated, Laboratory Corporation of America and Bio-Reference Laboratories, Inc. We expect additional competition as other established and emerging companies enter the genetic testing market and new tests and technologies are introduced. These competitors could have technological, financial, reputational and market access advantages over us.

 

Our competitors may enter into collaborative relationships or preferred provider relationships with large institutional customers, third-party payors or government agencies that may provide those competitors with access to greater resources and opportunities to establish market-leading positions. As a result, they may be able to respond more quickly to changes in customer requirements or devote greater resources to the development, promotion and sale of their tests than we do. We may not be able to compete effectively against these organizations. Increased competition and governmental and commercial payor cost-saving initiatives are likely to result in pricing pressures, which could harm our sales, profitability or market share. If we are unable to compete successfully, we may be unable to increase or sustain our revenue or achieve profitability.

 

Because we do not rely on our intellectual property portfolio to impede others from copying our business, there are no significant patent barriers to entry into our business, and new or existing laboratories could replicate our key service offerings and business model and enter our market to compete with us with relatively low upfront investments, which would adversely affect our business and prospects.

 

If our laboratory facility becomes inoperable, we will be unable to perform our IDgenetix tests and our business will be harmed.

 

Although we have entered into a lease agreement for approximately 70,000 square feet of space in San Diego, California to be used for our corporate offices and laboratory operations, this facility is currently undergoing improvements and is expected to be ready for our use in the first quarter of 2015. We perform all of our diagnostic testing in our current laboratory facility located in San Diego, California, and all testing will be moved to the new facility when it is ready. In the event our facility is damaged or destroyed, we would need to engage a third party to perform laboratory testing services on our behalf. In order to rely on a third party to perform these testing services, we could only use another facility with established state licensure and CLIA accreditation. We cannot assure you that we would be able to find another CLIA-certified facility, or that another laboratory would be willing to perform the necessary tests for us on commercially reasonable terms, or at all. Finding a new laboratory that meets the required state licensure and CLIA accreditation standards or developing new systems necessary to operate our business would be time-consuming and costly and could result in delays in our ability to provide IDgenetix testing services or to provide the same level of quality in IDgenetix testing services as we currently provide, which would harm our reputation and adversely affect our business, results of operations and financial condition. In addition, requirements of third-party payors and regulatory limitations on marking-up of laboratory testing could substantially limit our ability to profit from testing that we do not ourselves perform.

 

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Our laboratory facilities could become inoperable due to circumstances beyond our control, which could adversely affect our business and operations. Our facilities, the equipment we use to perform our tests and services and our other business process systems would be costly to replace and could require substantial time to repair or replace. The facilities may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, wildfires, floods, acts of terrorism or other criminal activities, infectious disease outbreaks and power outages, which may render it difficult or impossible for us to perform our tests for some period of time. In particular, the San Diego area is situated on or near earthquake fault lines and, in recent years, has experienced several wildfires. Any of these disasters may temporarily interrupt our ability to receive specimens or materials from our suppliers and to have access to our various systems necessary to operate our business. The inability to perform our tests and services would result in the loss of customers and harm our reputation, and we may be unable to regain those customers in the future. We carry insurance for damage to our property and the disruption of our business, but this insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.

 

We rely on a limited number of third parties for manufacture and supply of all of our laboratory instruments, tests and materials, including consumables, and we may not be able to find replacement suppliers or manufacturers in a timely manner in the event of any disruption, which could adversely affect our business.

 

Many of the consumable supplies and reagents used as raw materials in our IDgenetix testing process are procured from a limited number of suppliers, some of which are sole-source. Two suppliers accounted for approximately 54% and 12%, respectively, of our materials purchases for the year ended December 31, 2013 and approximately 54% and 15%, respectively, for the nine months ended September 30, 2014. In addition, we rely on a limited number of suppliers, or in some cases a single supplier, for certain equipment with which we perform IDgenetix testing services. To date we have acquired all of our equipment and materials on a purchase order basis, and we do not have contracts with our suppliers and manufacturers that commit them to supply equipment and materials to us. Because we cannot ensure the actual production or manufacture of such critical equipment and materials, or the ability of our suppliers to comply with applicable legal and regulatory requirements, we may be subject to significant delays caused by interruption in production or manufacturing. If any of our third-party suppliers or manufacturers were to become unwilling or unable to provide this equipment or these materials in required quantities or on our required timelines, we would need to identify and acquire acceptable replacement sources on a timely basis. Even if we were to identify other suppliers and manufacturers for such equipment and materials, there can be no assurance that we would be able to enter into agreements with such suppliers and manufacturers or otherwise obtain such items on a timely basis or on acceptable terms, if at all. If we encounter delays or difficulties in securing necessary laboratory equipment or materials, including consumables, we could face an interruption in our ability to perform IDgenetix testing services and experience other disruptions that would adversely affect our business, results of operations and financial condition.

 

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

 

Expedited, reliable shipping is essential to our operations. One of our marketing strategies entails highlighting our ability to perform testing services and deliver an actionable report to healthcare providers in a timely manner. We rely almost exclusively on a single carrier, Federal Express, for reliable and secure point-to-point transport of patient samples. Should Federal Express encounter delivery performance issues such as loss, damage or destruction of a sample, it would be difficult to replace our patient samples in a timely manner and such occurrences may damage our reputation and lead to decreased referrals from healthcare providers for our services and increased cost and expense to our business. In addition, any significant increase in shipping rates or fuel surcharges could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions by delivery services we use would adversely affect our ability to receive and process patient samples on a timely basis.

 

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

 

Adverse, or even mixed, results from third-party clinical studies may affect our ability to successfully market our IDgenetix testing services.

 

We intend to sponsor or co-sponsor IDgenetix-guided clinical studies within institutional healthcare organizations, and recently entered into an agreement for our first pilot study with a managed care organization. The intent of this and other studies will be to collect clinical data on IDgenetix-guided therapy, as compared to the current standard of care, against defined clinical endpoints, such as number of prescription drugs, hospitalizations and length of stay, and other health assessments. However, we expect that we may have very little control over, or insight into, the conduct of any such clinical studies. Negative, or even mixed, results from any such study or from similar studies undertaken independently by healthcare providers or our competitors could harm our reputation and could have a negative impact on our relationship with the applicable healthcare organization and on our ability to market our services to other healthcare organizations which could harm our business.

 

If our tests do not perform as expected, our operating results, reputation and business will suffer.

 

Our success depends on adoption by healthcare providers of IDgenetix and their confidence that we can provide reliable, high-quality results. We cannot assure you that the accuracy and reproducibility we have demonstrated to date will continue as our test volume increases. IDgenetix uses a number of complex and sophisticated biochemical and informatics processes, many of which are highly sensitive to external factors. An operational or technology failure in one of these complex processes or fluctuations in external variables may result in sensitivity and specificity rates that are lower than we anticipate or that vary between test runs. In addition, we are regularly evaluating and refining our testing process. These refinements may initially result in unanticipated technological difficulties. To date, we have launched 13 tests covering multiple therapeutic areas, including cardiovascular disease, neuropsychiatric disorders and pain. The utility of IDgenetix testing is currently limited to patients taking drugs that are metabolized by liver enzymes. We believe that our customers are likely to be particularly sensitive to test limitations, defects and errors, including inaccurate test results. As a result, if our tests do not perform as expected, our operating results, reputation and business could suffer. The failure of our current or planned tests to perform as expected could significantly impair our reputation and the public image of our products and services, and we may be subject to legal claims arising from any defects or errors.

 

The effectiveness and utility of IDgenetix has not been demonstrated in any clinical studies.

 

While there are more than 5,000 published studies on the use of PGx testing, 130 drug labels with PGx language and published CPIC guidelines, there have not been any completed clinical studies or published clinical data on IDgenetix, our proprietary PGx testing portfolio. Accordingly, previously published studies which suggest the effectiveness of PGx testing in general may not be predictive of the effectiveness or utility of IDgenetix. Furthermore, we cannot assure you that our ongoing or future clinical studies will demonstrate the effectiveness and utility of our IDgenetix tests. If we are unable to demonstrate the effectiveness and utility of our IDgenetix tests, our business and prospects may be hindered.

 

If our research and development services and other collaborations are not successful, our business and reputation could be harmed.

 

We have entered into a number of research and development services agreements with third parties, and these partnerships have historically been an important part of our business. For example, we currently provide polymerase chain reaction-, or PCR, and next-generation sequencing-, or NGS, based services, assay

 

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development, biomarker analysis and companion diagnostic programs to select biopharmaceutical companies through fee-based collaborations. We expect these partnerships will continue to contribute to our operating margins, enhance our name recognition and reputation among healthcare providers, and to potentially provide us with early access to new technologies for commercialization. We also intend to sponsor or co-sponsor IDgenetix-guided clinical studies within institutional healthcare organizations to analyze the impact of the use of IDgenetix by physicians on defined clinical endpoints such as the number of prescription drugs, hospitalizations and length of stay, and other health assessments. Accordingly, we may enter into discussions with potential collaborators from time to time. We cannot be certain that any discussions will result in a consummated collaboration. Further, once news of discussions regarding possible collaborations are known in the medical or pharmaceutical community, regardless of whether the news is accurate, failure to announce a collaboration agreement, or the entity’s announcement of a collaboration with an entity other than us, could result in adverse speculation about us, our tests or our technology, resulting in harm to our reputation and our business. In addition, establishing collaborations is difficult and time consuming. Potential collaborators may elect not to work with us based on their assessment of our financial, regulatory or intellectual property position. Even if we establish new collaborations, they may not result in the successful development or commercialization of current or future tests.

 

We will need to grow the size of our organization, and we may experience difficulties in managing this growth.

 

Our current organization and our systems and facilities may not be adequate to support our future growth. In order to effectively manage our operations and any significant growth, we may need to:

 

   

scale our internal infrastructure, including establishing laboratory facilities and purchasing capital equipment, while continuing to provide quality services on a timely basis;

 

   

maintain and strengthen our relationships with our customers as we increase the number of our sales and marketing personnel and increase our presence in the various geographic markets we serve;

 

   

attract and retain sufficient numbers of talented employees, including marketing personnel and contracted sales representatives, geneticists and genetic counselors, clinical laboratory scientists, laboratory technicians and administrative employees, to handle the increasing number of tests we are requested to conduct;

 

   

manage our relationships with shipping partners to ensure their ability to handle increasing sample transport and deliveries;

 

   

expand our compliance and quality assurance systems; and

 

   

advance our operational, financial and management controls and reporting systems and procedures.

 

In the near term, we expect to expand our IDgenetix tests from three to five therapeutic areas and, in the future, we plan to invest in continued expansion of IDgenetix and enhance our bioinformatic algorithm, with the intent to continually increase the clinical utility of our services. As our test volume grows, we will need to continue to expand our testing capacity, implement increases in scale and related processing, customer service, billing and systems process improvements, and expand our internal quality assurance program and technology platform. We will also need additional certified laboratory scientists and other scientific and technical personnel to process higher volumes of our tests. We cannot assure you that any increases in scale, related improvements and quality assurance will be successfully implemented or that appropriate personnel will be available. As additional products and services are developed, we may need to bring new equipment on-line, implement new systems, technology, controls and procedures and hire personnel with different qualifications.

 

The value of IDgenetix depends, in large part, on our ability to perform the tests on a timely basis and at a high quality standard, and on our reputation for such timeliness and quality. Any failure to implement necessary procedures, transition to new equipment or processes or hire the necessary personnel could result in higher costs of processing or an inability to meet market demand. We may not be able to perform tests on a timely basis at a

 

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level consistent with demand, our efforts to scale our commercial operations could negatively affect the quality of test results and we may not be successful in responding to the growing complexity of our testing operations. If we encounter difficulty meeting market demand or quality standards for our tests, our reputation could be harmed, and our prospects and business could suffer.

 

In addition, our growth may place a significant strain on our management, operating and financial systems and our sales, marketing and administrative resources. As a result of our growth, our operating costs may escalate even faster than planned, and some of our internal systems may need to be enhanced or replaced. If we cannot effectively manage our expanding operations and our costs, we may not be able to grow effectively or we may grow at a slower pace, and our business could be adversely affected.

 

If we are not able to successfully implement the tasks necessary to further expand our operations, our business, results of operations and financial results could be adversely affected. If we are not able to effectively expand our organization by hiring new employees and engaging additional consultants and contractors, we may not be able to successfully implement the tasks necessary to further develop and commercialize our tests and, accordingly, may not achieve our research, development and commercialization goals.

 

We rely on third-party organizations and their sales representatives to market IDgenetix to healthcare providers, and these contracted sales representatives are outside our direct control.

 

Our sales force is primarily composed of multiple third-party contract sales organizations and a limited distributor network, and their respective sales account managers and field sales representatives. Our ability to retain existing customers for IDgenetix and to attract new customers may be dependent upon retaining these organizations and their sales representatives and, although our own employees are involved in monitoring these third parties, we have limited control over their activities. In addition, we face additional risks in our reliance on these third parties, including the following:

 

   

these organizations may not apply the expected financial resources or required expertise to successfully promote IDgenetix, or they may not invest in the continued development of a sales force and the related infrastructure at levels that ensure that sales of IDgenetix reach their full potential;

 

   

these organizations may not comply with applicable legal or regulatory requirements;

 

   

disputes may arise between us and these organizations that may adversely affect IDgenetix sales or profitability; and

 

   

certain of these organizations may enter into agreements with other parties that have products that could compete with IDgenetix.

 

In addition, we and these third-party organizations face intense competition for qualified sales personnel and our and their inability to hire or retain an adequate number of sales representatives could limit our ability to maintain or expand our business and increase sales. For example, our current contracted sales representatives are highly trained and experienced, with strong technical knowledge and an extensive understanding of physicians’ practices, and each representative has completed extensive in-house sales training programs, including training on applicable regulatory and compliance issues. There may be a limited pool of qualified sales representatives from which we and our third-party sales organizations may draw upon.

 

As our business grows, we expect to need to increase our contracted sales force and/or develop an internal sales force. Even if we are able to increase our contracted sales force or hire internal sales personnel, new sales personnel may not commit the necessary resources or provide sufficient high quality service and attention to our target customers to effectively market and sell IDgenetix testing services. If we are unable to maintain and expand our marketing and sales networks or if our contracted or internal sales personnel do not perform as expected, we may be unable to maintain or grow our existing business and our results of operations and financial condition will likely suffer accordingly.

 

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We may need to raise additional capital after this offering and, if we cannot raise additional capital when needed, we may have to curtail or cease operations.

 

The proceeds of this offering may not be sufficient to fully fund our business and growth strategy. We estimate that our net proceeds from this offering will be approximately $         million, based upon the assumed initial public offering price, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. We believe that such proceeds, together with our existing cash and cash equivalents and anticipated future revenue, will be sufficient to fund our operations through at least the next 12 months. We may need to raise additional funds through public or private equity or debt financings, collaborations or licensing arrangements to continue to fund or expand our operations.

 

Our actual liquidity and capital funding requirements will depend on numerous factors, including:

 

   

the commercial success of IDgenetix;

 

   

our ability to maintain adequate coverage and reimbursement for our tests;

 

   

our ability to collect our accounts receivable;

 

   

the costs and timing of further expansion of our sales and marketing activities and research and development activities;

 

   

the degree to which we require additional sales, marketing and reimbursement personnel;

 

   

our need to finance capital expenditures and further expand our clinical laboratory operations;

 

   

our general and administrative expenses; and

 

   

the timing and results of any regulatory approvals that we are required to obtain for our tests.

 

Additional capital, if needed, may not be available on satisfactory terms, or at all. Furthermore, any additional capital raised through the sale of equity or equity-linked securities will dilute your ownership interest in us and may have an adverse effect on the price of our common stock. In addition, the terms of such financing may adversely affect your holdings or rights. Debt financing, if available, may include restrictive covenants, and, subject to limited exceptions, our existing credit facility prohibits us from incurring indebtedness without the prior written consent of the lender. To the extent that we raise additional funds through collaborations and licensing arrangements, it may be necessary to relinquish some rights to our technologies or grant licenses on terms that may not be favorable to us.

 

If we are not able to obtain adequate funding when needed, we may have to delay development programs or selling and marketing initiatives. In addition, we may have to work with collaboration partners on one or more of our tests or development programs, which could lower the economic value of those programs to our company.

 

We may be unable to adequately prevent disclosure of trade secrets, proprietary databases and algorithms and other proprietary information.

 

We rely on trade secrets to protect our proprietary technologies and databases, especially where we do not believe that patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. We protect our proprietary rights through a variety of methods, including confidentiality agreements with our suppliers, employees, consultants, collaborators, researchers and others who may have access to proprietary information. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy if unauthorized disclosure of confidential information occurs. In addition, others may independently discover our trade secrets and proprietary information and may independently develop substantially equivalent proprietary information. Further, we cannot be certain that the steps we have taken will prevent the misappropriation of our trade secrets and other confidential information. In addition, courts outside the United States may be less willing to protect trade secrets. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive position.

 

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If we were sued for patent infringement by third parties, we could incur significant costs and delays in commercializing our tests.

 

Our tests may conflict with patents that have been or may be granted to others. Our industry includes many organizations that have or are seeking to discern genetic biomarkers and develop genomic, proteomic and other technologies. To the extent any patents are issued or have been issued to those organizations, the risk increases that the sale of IDgenetix tests currently being marketed or under development may give rise to claims of patent infringement. Others may have filed and in the future are likely to file patent applications covering genes or proteins that are similar or identical to our tests. Because patent applications can take many years to issue and may be confidential for 18 months or more after filing, there may be currently pending third-party patent applications which may later result in issued patents that IDgenetix may infringe, or which such third parties claim are infringed by the use of IDgenetix. Any of these patent applications may have priority over any patent applications which we may file in the future and these entities or persons could bring legal proceedings against us seeking damages or seeking to enjoin us from testing or marketing our tests. Patent litigation is costly, and even if we prevail, the cost of such litigation could have a material adverse effect on us. If the other parties in any such actions are successful, in addition to any liability for damages, we could be required to cease the infringing activity or obtain a license, pay royalties or redesign our infringing products, which may be impossible or require substantial time and monetary expenditure. Any license required may not be available to us on commercially acceptable terms, if at all. Our failure to obtain a license to any technology that we may require to commercialize our tests could have a material adverse effect on our business. We believe that, in the future, there may be significant litigation in the industry regarding patent and other intellectual property rights. If we become involved in this litigation, it could consume a substantial portion of our managerial and financial resources.

 

We are highly dependent on our key personnel, and if we are not successful in attracting and retaining highly qualified personnel, we may not be able to successfully implement our business strategy.

 

Our ability to compete depends upon our ability to attract and retain highly qualified managerial, scientific and medical personnel. For example, we are highly dependent on the operational and financial expertise of our executive officers, particularly our Chief Executive Officer, President and Chief Operating Officer, Chief Financial Officer and Chief Medical Officer, and on our clinical laboratory scientists and laboratory directors. The loss of the services of any of our executive officers or other key employees or the inability to find suitable replacements could potentially harm our business, prospects, financial condition or results of operations.

 

We conduct our operations at our facility in San Diego, California. This region is headquarters to many other biotechnology and diagnostic companies, pharmaceutical companies and academic and research institutions. Competition for skilled personnel in our market is intense and may limit our ability to hire and retain highly qualified personnel on acceptable terms or at all.

 

To induce valuable employees to remain with us, in addition to salary and cash incentives, we have provided stock options that vest over time. The value to employees of stock options that vest over time may be significantly affected by movements in our stock price that are beyond our control, and may at any time be insufficient to counteract more lucrative offers from other companies. Despite our efforts to retain valuable employees, members of our management, scientific and development teams may terminate their employment with us on short notice. Although we have employment agreements with our key employees, these employment agreements provide for at-will employment, which means that any of our employees could leave our employment at any time, with or without notice. We do not maintain “key man” insurance policies on the lives of these individuals or the lives of any of our other employees. Our success also depends on our ability to continue to attract, retain and motivate highly skilled junior, mid-level and senior managers as well as junior, mid-level and senior scientific and medical personnel.

 

Many of the other companies that we compete against for qualified personnel have greater financial and other resources, different risk profiles and a longer history in the industry than we do. They may also provide more diverse opportunities and better chances for career advancement. Some of these characteristics may be more appealing to high quality candidates than what we can offer. If we are unable to continue to attract and retain high quality personnel, the rate and success at which we can discover, develop and commercialize product candidates will be limited.

 

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The marketing, sale and use of IDgenetix could result in substantial damages arising from product liability or professional liability claims that exceed our resources.

 

The marketing, sale and use of IDgenetix could lead to product liability claims against us if someone were to allege that our test failed to perform as it was designed, or if someone were to misinterpret test results or improperly rely on them for clinical decisions. For example, IDgenetix testing could provide incorrect results which a patient or physician may rely upon. In addition, we may be subject to liability for errors in, a misunderstanding of, or inappropriate reliance upon, the information we provide as part of the results generated by IDgenetix. A product liability or professional liability claim could result in substantial damages and be costly and time-consuming for us to defend. Although we maintain product and professional liability insurance, our insurance may not fully protect us from the financial impact of defending against product liability or professional liability claims or any judgments, fines or settlement costs arising out of any such claims. Any product liability or professional liability claim brought against us, with or without merit, could increase our insurance rates or prevent us from securing insurance coverage in the future. Additionally, any product liability lawsuit could harm our reputation, result in a stoppage of IDgenetix testing services or cause current customers or partners to terminate existing agreements and potential customers or partners to seek other PGx testing solutions, any of which could impact our results of operations.

 

Our employees, independent contractors (including sales representatives), consultants, strategic partners and vendors may engage in misconduct or other improper activities, including noncompliance with regulatory standards and requirements and misuse of proprietary information.

 

We are exposed to the risk that employees, independent contractors, consultants, commercial partners and vendors may engage in fraudulent or other illegal activity. Misconduct by these parties could include intentional, reckless and/or negligent failures to: (1) comply with government regulations that are applicable to us; (2) comply with clinical laboratory standards we have established; (3) comply with healthcare fraud and abuse laws in the United States and similar foreign fraudulent misconduct laws; or (4) report financial information or data accurately, or disclose unauthorized activities to us. These laws and regulations may impact, among other things, our current as well as proposed and future sales, marketing and education programs. In particular, the promotion, sales and marketing of healthcare items and services, as well as certain business arrangements in the healthcare industry, are subject to extensive laws designed to prevent misconduct, including fraud, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, structuring and commission(s), certain customer incentive programs and other business arrangements generally. It is not always possible to identify and deter employee and other third-party misconduct. The precautions we take to detect and prevent inappropriate conduct 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 actions are instituted against us under these laws or regulations, 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, disgorgement, monetary fines, possible exclusion from participation in Medicare, Medicaid and other federal and state healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, and curtailment of our operations, any of which could adversely affect our ability to operate our business and our results of operations.

 

In addition, many of our employees, consultants and independent contractors were previously employed at or may have previously been or are currently providing consulting services to, other clinical laboratories or diagnostics companies, including our competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that we or these consultants have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers or their former or current customers. Further, we may be subject to ownership disputes in the future arising, for example, from conflicting obligations of consultants or others who are involved in developing our tests. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

 

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

 

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

 

   

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

 

   

test results must be monitored and reported on a timely basis;

 

   

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

 

   

third-party ancillary billing services require proper tracking and reporting;

 

   

pricing and other information related to IDgenetix is needed by our sales force and other personnel in a timely manner to conduct business;

 

   

centralized procurement and test inventory management systems are required for effective test inventory management;

 

   

regulatory compliance requires proper tracking and reporting; and

 

   

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

 

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

 

   

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

 

   

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

 

   

our information technology, telephone or other systems become unable to support expanded operations and increased levels of business;

 

   

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

 

   

information security is breached.

 

Our success depends, in part, on the continued and uninterrupted performance of our information technology, telephone and other systems, which are vulnerable to damage from a variety of sources, including telecommunications or network failures, computer viruses, natural disasters and physical or electronic break-ins. We are especially vulnerable to losses of patient information which could result in violations of federal and state privacy and security laws. Despite the precautionary measures we have taken to prevent breakdowns in our information technology and telephone systems, sustained or repeated system failures that interrupt our ability to process test orders, deliver test results or perform tests in a timely manner or that cause us to lose patient information could adversely affect our business, results of operations and financial condition.

 

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

 

In the ordinary course of our business, we and our third-party billing and collections provider collect and store sensitive data, including legally-protected health information, credit card information and personally identifiable information about our customers, payors, recipients and collaboration partners, including PGx test results. We also store sensitive intellectual property and other proprietary business information, including that of our customers, payors and collaboration partners. We manage and maintain our applications and data utilizing a combination of on-site systems, managed data center systems and cloud-based data center systems. These applications and data encompass a wide variety of business critical information, including research and development information, commercial information and business and financial information. We face four primary risks relative to protecting this critical information: loss of access risk, inappropriate disclosure risk, inappropriate modification risk, and the risk of our being unable to identify and audit our controls over the first three risks.

 

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We are highly dependent on information technology networks and systems, including the Internet, to securely process, transmit and store this critical information. Security breaches of this infrastructure, including physical or electronic break-ins, computer viruses, attacks by hackers and similar breaches, can create system disruptions, shutdowns or unauthorized disclosure or modification of confidential information. The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting such information. Although we take measures to protect sensitive information from unauthorized access or disclosure, our information technology and infrastructure, and that of our third-party billing and collections provider, may be vulnerable to attacks by hackers or viruses or breached due to employee error, malfeasance or other disruptions.

 

A security breach or privacy violation that leads to disclosure or modification of or prevents access to patient information, including personally identifiable information or protected health information, could harm our reputation, compel us to comply with federal and/or state breach notification laws, subject us to mandatory corrective action, require us to verify the correctness of database contents and otherwise subject us to liability under laws and regulations that protect personal data, resulting in increased costs or loss of revenue. If we are unable to prevent such security breaches or privacy violations or implement satisfactory remedial measures, our operations could be disrupted, and we may suffer loss of reputation, financial loss and other regulatory penalties because of lost or misappropriated information, including sensitive patient data. In addition, these breaches and other inappropriate access can be difficult to detect, and any delay in identifying them may lead to increased harm of the type described above.

 

Any such breach or interruption could compromise our networks or those of our third-party billing and collections provider, and the information stored there could be inaccessible or could be accessed by unauthorized parties, publicly disclosed, lost or stolen. Any such interruption in access, improper access, disclosure, modification of, or other loss of information could result in legal claims or proceedings, and liability under laws and regulations that protect the privacy and security of personal information, such as the Health Insurance Portability and Accountability Act of 1996, or HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, or HITECH, and the regulations promulgated thereunder. Unauthorized access, loss or dissemination could also disrupt our operations, including our ability to perform tests, provide test results, bill payors or patients, process claims and appeals, provide customer assistance services, conduct research and development activities, develop and commercialize tests, collect, process and prepare company financial information, provide information about our tests, educate patients and clinicians about our service and manage the administrative aspects of our business, any of which could damage our reputation and adversely affect our business. Any such breach could also result in the compromise of our trade secrets and other proprietary information, which could adversely affect our competitive position.

 

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

 

If technological innovations or other advances in medicine were to reduce the need to conduct diagnostic testing or allow our customers or other third parties to perform PGx testing services similar to ours, our business, prospects, results of operations and financial condition could be adversely affected.

 

Technological innovations or other advances in medicine that result in the creation of enhanced diagnostic tools may enable other clinical laboratories, hospitals, physicians or other healthcare providers to provide PGx testing services similar to ours in a more convenient, efficient or cost-effective manner than is currently possible. Advances in technology or medicine may also result in a cure or prophylactic treatment for some of the diseases

 

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on which we focus which could reduce or eliminate the need for our testing services. In addition, there are approved drugs and drugs in development that are not metabolized by the liver. PGx testing is less useful for patients taking such drugs. Any of these innovations would substantially reduce or eliminate our market opportunity and adversely affect our business, prospects, results of operations and financial condition.

 

The terms of our credit facility require us to meet certain operating and financial covenants and place restrictions on our operating and financial flexibility. If we raise additional capital through debt financing, the terms of any new debt could further restrict our ability to operate our business.

 

In December 2014, we entered into a Third Amended and Restated Loan and Security Agreement with SVB which we refer to as the LSA. The LSA is secured by a lien covering the majority of our assets, subject to limited exceptions. As of the date hereof, we have drawn down $20.0 million in principal as a term loan. We are obligated to make monthly payments of interest only through March 31, 2015 and monthly payments of principal and interest from April 1, 2015 through the maturity date of September 1, 2017, assuming there is no default that results in acceleration of the debt.

 

The LSA contains customary affirmative and negative covenants, indemnification provisions and events of default. The affirmative covenants include, among others, covenants requiring us to maintain our legal existence and governmental approvals, deliver certain financial reports, maintain insurance and maintain minimum revenue requirements. The negative covenants include, among others, restrictions on transferring or licensing our assets, changing our business, incurring additional indebtedness, engaging in mergers or acquisitions, paying cash dividends or making other distributions, and creating other liens on our assets, in each case subject to customary exceptions. If we default under the LSA, SVB may accelerate all of our repayment obligations and take control of our pledged assets, potentially requiring us to renegotiate our agreement on terms less favorable to us or to immediately cease operations. Further, if we are liquidated, SVB’s right to repayment would be senior to the rights of the holders of our common shares to receive any proceeds from the liquidation. SVB could declare a default under the LSA upon the occurrence of any event that SVB interprets as a material adverse change as defined under the loan agreement, thereby requiring us to repay the loan immediately or to attempt to reverse the declaration of default through negotiation or litigation. Any declaration by SVB of an event of default could significantly harm our business and prospects and could cause the price of our common shares to decline. If we raise any additional debt financing, the terms of such additional debt could further restrict our operating and financial flexibility.

 

We use hazardous materials that require considerable expertise and expense for handling, storage or disposal and may result in claims against us.

 

We work with hazardous materials, including chemicals, biological agents and compounds, and human tissue, that could be dangerous to human health and safety or the environment. Our operations also produce hazardous and biohazardous waste products. Federal, state and local laws and regulations govern the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations may be expensive, and current or future environmental laws and regulations may impair business efforts. If we do not comply with applicable regulations, we may be subject to fines and penalties. In addition, we cannot entirely eliminate the risk of accidental injury or contamination from these materials or wastes. Although we believe that the safety procedures utilized by our third-party manufacturers for handling and disposing of these materials generally comply with the standards prescribed by these laws and regulations, we cannot assure you that this is the case or eliminate the risk of accidental contamination or injury from these materials. Our general liability insurance and/or workers’ compensation insurance policy may not cover damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our operations could be suspended or otherwise adversely affected.

 

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Risks Relating to Regulatory and Compliance Matters

 

Our failure to comply with governmental payor regulations could result in our being excluded from participation in Medicare, Medicaid or other governmental payor programs, which would substantially decrease our revenue and adversely affect our results of operations and financial condition.

 

Through September 30, 2014, 83% of our recognized diagnostic testing revenue has been derived from Medicare. The Medicare program is administered by the Centers for Medicare and Medicaid Services, or CMS, which, like the states that administer their respective state Medicaid programs, imposes extensive and detailed requirements on diagnostic services providers, including, but not limited to, rules that govern how we structure our relationships with physicians, how and when we submit reimbursement claims and how we provide IDgenetix testing services. Our failure to comply with applicable Medicare, Medicaid and other governmental payor rules could result in exclusion from participation in one or more governmental payor programs, our returning funds already paid to us, civil monetary penalties, criminal penalties and/or limitations on the operational function of our laboratory. If we were unable to receive reimbursement under a governmental payor program, a material portion of our revenue would decline, which could adversely affect our results of operations and financial condition.

 

Healthcare reform measures could hinder or prevent the commercial success of our diagnostic tests.

 

The pricing and reimbursement environment may change in the future and become more challenging as a result of any of several possible regulatory developments, including policies advanced by the U.S. government, new healthcare legislation or fiscal challenges faced by government health administration authorities. Specifically, there have been a number of legislative and regulatory proposals and initiatives to change the healthcare system in ways that could affect our ability to profitably sell any diagnostic products we may develop and commercialize. Some of these proposed and implemented reforms could result in reduced reimbursement rates for our diagnostic products from governmental agencies or other third-party payors, which would adversely affect our business strategy, operations and financial results.

 

The Patient Protection and Affordable Care Act of 2010 (as amended by the Health Care and Education Reconciliation Act of 2010), or ACA, made substantial changes to the current system for paying for healthcare in the United States. Beginning in 2013, certain medical device manufacturers were required to pay an excise tax in an amount equal to 2.3% of the price for which such manufacturer sells its medical devices that are listed with the FDA. Although the FDA has contended that clinical laboratory tests that are developed and validated by a laboratory for its own use, or LDTs, such as IDgenetix tests, are medical devices, has provided notice to Congress of its intent to phase out the discretion that the FDA has historically exercised not to regulate our tests, and has issued draft guidance documents with its draft oversight framework, none of our products are currently listed with the FDA. We cannot assure you that the tax will not be extended to services such as ours in the future.

 

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. In addition, the ACA establishes an Independent Payment Advisory Board, or IPAB, to reduce the per capita rate of growth in Medicare spending. The IPAB has broad discretion to propose policies to control healthcare expenditures for consideration by Congress. If Congress fails to act on such proposal(s) and does not pass alternative legislation achieving similar savings, the Secretary of the U.S. Department of Health and Human Services is required to implement the IPAB’s proposal(s). IPAB proposals may have a negative impact on payment rates for services, including IDgenetix tests.

 

In addition to the ACA, other recent legislative changes have been proposed and adopted in the United States since the ACA was enacted. Recent legislative changes specific to coverage and reimbursement of laboratory tests are addressed under the heading “—Risks Related to Billing and Reimbursement—Changes in laws, regulations, payor policies or contracting arrangements with payors may adversely affect coverage or reimbursement for IDgenetix, which may decrease our revenue and adversely affect our results of operations and

 

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financial condition.” Healthcare legislative reforms affecting providers generally include the Budget Control Act of 2011, which, among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation’s automatic reduction to several government programs. On April 1, 2013, the cuts to the federal budget resulting from sequestration were implemented, requiring a 2% cut in Medicare payment for all services, including our diagnostic tests. These cuts will remain in effect through 2024 unless additional Congressional action is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, further reduced Medicare payments to providers such as hospitals, imaging centers and cancer treatment centers, and increased the government’s statutory recovery period for overpayments to providers from three to five years. Congress is also considering major changes to the way in which Medicare pays for services under the Physician Fee Schedule.

 

Federal budgetary limitations and changes in healthcare policy, such as the creation of broad limits for diagnostic products could substantially diminish the sale, or inhibit the utilization, of future diagnostic tests, increase costs, divert management’s attention and adversely affect our ability to generate revenue and achieve profitability. Additionally, on several occasions, Congress has considered imposing a 20% co-insurance amount for clinical laboratory services, which would require beneficiaries to pay a significant portion of the cost of their clinical laboratory testing. Although that requirement has not been enacted at this time, Congress could decide to impose such an obligation at some point in the future, which would make it more difficult for us to collect adequate reimbursement for, and increase use of, our diagnostic test.

 

Additional recent legislative and regulatory changes that are specific to coverage and reimbursement of laboratory tests are addressed under the heading “Risks Related to Billing and Reimbursement.” These laboratory-specific changes as well as the above and other non-laboratory specific changes in laws, regulations, payor policies or contracting arrangements with payors may adversely affect coverage or reimbursement for IDgenetix, which may decrease our revenue and adversely affect our results of operations and financial condition.

 

We conduct business in a heavily regulated industry, and changes in regulations or violations of regulations may, directly or indirectly, reduce our revenue, adversely affect our results of operations and financial condition and harm our business.

 

The clinical laboratory testing industry is highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely to us in the future. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:

 

   

federal and state laws applicable to test ordering, documentation of tests ordered, billing practices and claims payment and/or regulatory agencies enforcing those laws and regulations;

 

   

federal and state laboratory anti-mark-up laws;

 

   

coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;

 

   

restrictions on coverage of and reimbursement for IDgenetix tests;

 

   

federal and state laws governing laboratory testing, including the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and state licensing laws;

 

   

federal and state laws governing the development, use and distribution of diagnostic medical devices and laboratory developed tests;

 

   

federal, state and local laws governing the handling and disposal of medical and hazardous waste; and

 

   

Occupational Safety and Health Administration, or OSHA, rules and regulations.

 

These laws and regulations are extremely complex and in many instances there are no significant regulatory or judicial interpretations of these laws and regulations. While we believe that we are currently in material

 

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compliance with applicable laws and regulations, a determination that we have violated these laws, or the public announcement that we are being investigated for possible violations of these laws, would adversely affect our business, prospects, results of operations and financial condition. In addition, a significant change in any of these laws may require us to change our business model in order to maintain compliance with these laws, which could reduce our revenue or increase our costs and adversely affect our business, prospects, results of operations and financial condition.

 

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

 

Our business operations and activities are directly, or indirectly, subject to certain healthcare laws and regulations promulgated by both the federal government and the states in which we conduct our business. 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 for recommending or arranging for the purchase, lease or order 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. Under the broad sweep of the Anti-Kickback Statute, even commonplace activities such as a laboratory paying non-employee sales representatives to generate business from physician practices, could be viewed as prohibited remuneration to the sales representatives in exchange for their recommending or arranging for the purchase, by the physician practices, of laboratory services reimbursable by a federal healthcare program. We contract with marketing companies that have marketing representatives who promote our laboratory tests directly to physician practices. We pay commissions to these contracted marketing companies. There are “safe harbors” under the federal Anti-Kickback Statute that could potentially protect a laboratory’s marketing arrangements; however, the safe harbors would require, among other things, either that any commission-based marketing representatives be employed by the laboratory, or that any marketing company hired by the laboratory be paid a fixed, annual amount, rather than on a commission basis. Because we pay marketing companies on a commission basis, our arrangements do not fit within a safe harbor. While that does not make the marketing arrangements unlawful per se under the Anti-Kickback Statute, it does mean they could be subject to scrutiny and even prosecution, if an enforcement agency believed an unlawful intent were present. A number of court cases have determined that paying commission-based compensation to independent contractor marketers can violate the Anti-Kickback Statute. The Office of Inspector General has also issued unfavorable advisory opinions regarding such compensation arrangements. We have taken steps to reduce this risk, such as contracting not only with the marketing companies, but also with their individual marketers, providing the marketers with scripts to follow, prohibiting them from providing remuneration to physicians and bringing the marketers to our office in San Diego for compliance training which we conduct. All of these steps help to establish a level of control that arguably is similar to that which we would have over an employee. However, this does not bring the arrangement into the employment safe harbor, and there can be no assurance that these arrangements will not be scrutinized and prosecuted under the Anti-Kickback Statute;

 

   

the Stark Law, which prohibits, among other things, physicians who have a financial relationship, including an investment, ownership or compensation relationship with an entity, from referring Medicare patients to that entity for designated health services, which include clinical laboratory services, unless an exception applies. Similarly, entities may not bill Medicare or any other party for services furnished pursuant to a prohibited referral. Recent case law has extended the Stark law’s prohibition to referrals of Medicaid patients as well. 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 for referrals to an entity by a physician with a financial relationship with the entity to be compliant with the law. Under the Stark Law, any financial relationship of a physician’s immediate family members is also attributed to

 

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the physician. There is no Stark Law exception that would protect physicians’ (or their immediate family members’) ownership in us, and hence the Stark Law would be violated if any physician orders Medicare-covered tests from us, if that physician or an immediate family member of that physician owns any shares of our common stock. Certain state laws have corresponding provisions. For example, in California, physicians who own our shares (or have immediate family members who own our shares) will be prohibited from referring any testing to us, not just Medicare testing. While we intend to notify physicians of these referral prohibitions and require them to certify that neither they nor their immediate family members have a prohibited ownership interest in our company, we cannot assure you that these efforts will be entirely successful in preventing violations of the Stark Law, or similar self-referral state laws;

 

   

federal civil and criminal false claims laws and civil monetary penalty 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, apply to clinical laboratories that submit claims to Medicare and other federal healthcare programs; the federal government may assert that a claim, including items or services resulting from a violation of the federal Anti-Kickback Statute or the Stark Law, constitutes a false or fraudulent claim for purposes of the federal False Claims Act (“knowingly” is defined under the false Claims Act as acting with actual knowledge, reckless disregard or deliberate ignorance);

 

   

federal and state laws, including HIPAA and HITECH, addressing health information practices, patient privacy and electronic data security;

 

   

federal and state laws governing the certification and licensing of clinical laboratories, including operational, personnel and quality requirements designed to ensure that testing services are accurate and timely, and federal and state laws governing the health and safety of clinical laboratory employees;

 

   

federal and state consumer protection and unfair competition laws, which broadly regulate marketplace activities and activities that potentially harm consumers;

 

   

state law equivalents of each of the above federal laws, such as anti-kickback, self-referral, false claims, consumer protection and unfair competition 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. In particular, state anti-kickback laws and self-referral laws may be more restrictive than their federal counterparts. For example, the anti-kickback laws in the states of Florida and New York may be more restrictive than the federal Anti-Kickback Statute with respect to compensation paid to independent contractor marketers;

 

   

the provisions of the federal Civil Monetary Penalties Law, which prohibit the offering or giving of remuneration to a Medicare or Medicaid beneficiary, including the provision of free items and services, that the person knows or should know is likely to influence the beneficiary’s selection of a particular supplier of items or services reimbursable by a Federal or state governmental program. Medicare currently does not cover and reimburse us for every gene included in our IDgenetix tests, and we do not generally

 

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bill the beneficiary for these non-covered tests. While we have worked to structure these arrangements to comply with the Civil Monetary Penalties Law, regulatory agencies may nonetheless view these transactions as prohibited arrangements that must be restructured, or discontinued, or which we could be subject to other significant penalties. Violations could lead to civil money penalties of up to $10,000 for each wrongful act, assessment of three times the amount claimed for each item or service and exclusion from the governmental healthcare programs, and civil or criminal exposure under the federal Anti-Kickback Statute, any of which could adversely affect our reputation, business, results of operations and financial condition; and

 

   

the Physician Payment Sunshine Act, subject to specific exceptions, requires drug and medical device manufacturers to disclose to HHS any direct or indirect payments that they make to physicians or any direct ownership interests that physicians or their immediate family members hold in them. While we do not believe we are currently subject to the requirements of the Sunshine Act, if we are subject to the Act in the future and we fail to meet the its reporting requirements, civil monetary penalties may be imposed on us.

 

In addition, the approval and commercialization of any of our tests outside the United States will also likely subject us to foreign equivalents of the healthcare laws mentioned above, among other foreign laws and the U.S.’s Foreign Corrupt Practices Act.

 

Our efforts to ensure that our business arrangements will comply with applicable healthcare laws may involve substantial costs. Effective upon the closing of this offering, we will adopt a code of business conduct and ethics, but it is not always possible to identify and deter employee misconduct, and the precautions we take to detect and prevent inappropriate conduct 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 be in compliance with such laws or regulations.

 

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 healthcare providers, our sales and marketing efforts and our billing and claims processing practices 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 laws and regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, the curtailment or restructuring of our operations, the exclusion from participation in federal and state healthcare programs and imprisonment, any of which could adversely affect our ability to operate our business and our results of operations.

 

Failure to comply with state and federal laws and regulations affecting the transmission, security and privacy of health information could result in significant penalties.

 

There are currently numerous federal and state laws addressing health information practices, patient privacy and electronic data security that apply to us. These laws require us to acquire, implement and maintain expensive computer systems, employee training programs and business procedures to protect the privacy and security of each patient’s health information. These laws have had and are expected to continue to have a considerable financial impact on the healthcare industry because they impose extensive requirements and restrictions on the use and disclosure of individually identifiable patient information.

 

Such laws, including HIPAA and HITECH, require us to comply with standards for the use and disclosure of individually identifiable health information, also called “protected health information” or “PHI,” within our company and with third parties. Regulations issued under HIPAA and HITECH establish a set of national privacy and security standards for the protection of PHI by health plans, healthcare clearinghouses and certain healthcare providers, referred to as “covered entities,” and contractors who provide services to covered entities involving the use of PHI, called “business associates.”

 

The HIPAA Privacy Standards establish standards for the use and disclosure of PHI, and for patients’ rights with respect to their health information. In general, the Privacy Standards preclude us from using or disclosing

 

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patient identifiable laboratory data without patient authorization, except to provide treatment, obtain payment for services we provide, and to conduct our own healthcare operations (as defined by HIPAA). The Privacy Standards also require us to afford patients certain rights with respect to health information about them.

 

The HIPAA Security Standards create standards for safeguarding health information. These standards require us to adopt administrative, technical and physical measures to ensure the confidentiality, integrity and availability of electronic PHI.

 

HIPAA also established standards, called the HIPAA Transaction Standards, for common payment-related electronic transactions among health care providers and health plans, including claims for payment by a provider, inquiries from a health care provider to a health plan concerning an individual’s eligibility for benefits under the plan, and inquiries from a health care provider to a health plan concerning the status of a claim for payment. The standards prescribe the format and content of these and other electronic transactions. Covered entities, such as healthcare providers, are required to conform to these transaction standards.

 

HITECH established additional standards, the Data Breach Notification Standards, which require covered entities to report certain breaches of the privacy or security of PHI to the Secretary of the U.S. Department of Health and Human Services, or HHS, the affected individual, and in some cases also the press.

 

As a health care provider, we are a covered entity under HIPAA, and are required to comply with the HIPAA Privacy Standards, the Security Standards, the Transaction Standards and the Data Breach Notification Standards. Failure to do so can result in substantial civil and criminal penalties, as well as costs of investigating breaches, providing required notification, and undertaking other mitigation. HIPAA has a tiered system of money penalties, based on the degree of negligence or willfulness of the breach, and whether or not it was timely corrected. Possible penalties range up to $50,000 for each violation, subject to a $1.5 million maximum for identical violations during a calendar year. Criminal penalties may be imposed on any person who knowingly obtains or discloses PHI in violation of HIPAA. The penalties depend on intent; violations committed with intent to sell, transfer, or use the information for commercial advantage, personal gain, or malicious harm, carry the largest penalties—fines up to $250,000, imprisonment up to 10 years, or both.

 

The Office for Civil Rights of HHS, which enforces the HIPAA regulations, has been taking an increasingly rigorous approach to enforcement, and sometimes imposes penalties or settlements in excess of one million dollars.

 

While HIPAA does not afford a right of action to individuals whose privacy rights have been violated, the laws of some states do, and data breaches may result in suits under state law to recover damages on behalf of individuals whose health information is affected. Such suits could result in material costs and damages.

 

The HIPAA Privacy and Security Standards establish a complex regulatory framework on a variety of subjects, including but not limited to:

 

   

the circumstances under which uses and disclosures of PHI are permitted or required without a specific authorization by the patient, including but not limited to treatment purposes, activities to obtain payment for services and healthcare operations activities;

 

   

a patient’s rights with respect to health information, including the rights to access and amend health information, and to receive an accounting of certain disclosures of PHI;

 

   

the content of notices of privacy practices for PHI, which most covered entities are required to provide to patients; and

 

   

administrative, technical and physical safeguards required of covered entities that use or receive electronic PHI.

 

HIPAA requires healthcare providers like us to develop and maintain policies and procedures with respect to the use and disclosure of protected health information, including privacy policies and procedures, and administrative, physical and technical safeguards to protect such information. We have implemented policies and procedures related to compliance with HIPAA and HITECH and their implementing regulations.

 

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In addition to creating a notification requirement for breaches of health information, HITECH further restricted certain uses and disclosures of PHI (such as the sale of PHI and use of PHI for marketing), and strengthened provisions for enforcement of HIPAA violations. Regulations issued in 2013 – referred to as the HITECH Omnibus Rule – modified the breach reporting standard in a manner that will likely make more data security incidents qualify as reportable breaches, as a breach is now presumed where there is an acquisition, access, use or disclosure not otherwise permitted, unless the covered entity can demonstrate that there is a low probability that the protected health information was compromised, based on a risk assessment. HITECH also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney fees and costs associated with pursuing federal civil actions. On February 6, 2014, CMS issued a final rule amending CLIA and HIPAA regulations to provide individuals with the right to access test reports directly from laboratories. The HITECH Omnibus Rule and subsequent regulations indicate that the laws governing transmission, privacy and security of health information are complex and evolving.

 

The HIPAA Privacy and Security Standards establish a uniform federal “floor” and do not supersede state laws that are more stringent or provide individuals with greater rights with respect to the privacy or security of, and access to, their records containing PHI. As a result, we are required to comply with both HIPAA privacy and security regulations and varying state privacy and security laws.

 

In addition, more stringent federal and state privacy regulations apply to certain categories of information that we either handle, or plan to handle, as part of our operations, including information concerning treatment for alcohol and drug abuse, mental health information, genetic information, HIV information and information related to research. We are required to comply with any regulations that apply a more stringent standard to the use or disclosure of such information.

 

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

 

Our business could be harmed from the loss or suspension of a license or imposition of a fine or penalties under, or future changes in, the law or regulations of the Clinical Laboratory Improvement Amendments of 1988, or those of other state or local agencies.

 

We are subject to CLIA, which is administered by CMS and extends federal oversight to virtually all clinical laboratories by requiring that they be certified by the federal government or by a federally-approved accreditation agency. CLIA is designed to ensure the quality and reliability of clinical laboratories by, among other things, mandating specific standards in the areas of personnel qualifications, administration, and participation in proficiency testing, patient test management, quality control, quality assurance and inspections. Laboratories must undergo on-site surveys by the Federal CLIA program at least every two years or accreditation by a private CMS approved accrediting agency such as the College of American Pathologists, among others. The sanction for failure to comply with CLIA requirements may be suspension, revocation or limitation of a laboratory’s CLIA certificate, which is necessary to conduct business, as well as significant fines criminal penalties, expanded regulatory monitoring, and/or cancelled or suspended Medicare payments.

 

We are also subject to regulation of laboratory operations under state clinical laboratory laws of California, where our facility is located, and of certain other states, from where we accept specimens. State clinical laboratory

 

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laws may require that laboratories and/or laboratory personnel meet certain qualifications, specify certain quality controls or require maintenance of certain records. For example, California requires that we maintain a license to conduct testing in California, and California law establishes standards for our day-to-day laboratory operations, including the training and skill required of laboratory personnel and quality control. In some respects, notably with respect to qualifications of testing personnel, California’s clinical laboratory laws impose more rigorous standards than does CLIA. Certain other states, including Florida, Maryland, New York and Pennsylvania, require that we hold licenses to test specimens from patients residing in those states, and additional states may require similar licenses in the future. Potential sanctions for violation of these statutes and regulations include significant fines and the suspension or loss of various licenses, certificates and authorizations, which could adversely affect our business and results of operations.

 

Our products are currently subject to the FDA’s exercise of enforcement discretion, and we could incur substantial costs and delays associated with meeting requirements for premarket clearance or approval or experience decreased demand or reimbursement for our products if the FDA’s enforcement policies change.

 

The U.S. Food and Drug Administration, or FDA, regulates the sale and distribution in interstate commerce of products classified as medical devices under the Federal Food, Drug, and Cosmetic Act, or FDCA, including in vitro diagnostic, or IVD, devices such as IDgenetix tests. Generally, medical devices must undergo premarket review by the FDA, either through clearance of a 510(k) premarket notification or approval of a premarket approval application, or PMA, which can be a lengthy, expensive and uncertain process. However, the FDA has historically exercised enforcement discretion with respect to IVD tests that are developed by a single laboratory for its own use, called laboratory developed tests, or LDTs, which are therefore not subject to FDA regulation or premarket review. See “Business—Governmental Regulation.” We believe that our products all qualify as LDTs, which are currently subject to the FDA’s exercise of enforcement discretion. As a result, we believe our products are exempt from regulation under current FDA enforcement policies.

 

CLIA presently requires us to establish that our LDTs accurately identify the specific genes, proteins and other substances that they purport to identify. Regulation by the FDA would be expected to require us to also establish that our LDTs have the clinical significance in terms of patient care that we hold them out as having through our marketing activities. On July 31, 2014, the FDA notified Congress of its intent to modify, in a risk-based manner, its policy of enforcement discretion with respect to LDTs, and on October 3, 2014, the FDA published two draft guidances setting out that proposed framework. Our IDgenetix tests may, therefore, become subject to the FDA’s enforcement of its medical device regulatory requirements, including the requirement for premarket clearance or approval. While the FDA has proposed that devices that are already in use at the time the FDA initiates enforcement of the premarket review requirements will be permitted to remain in use – pending the FDA’s review and consideration of the premarket submission – so long as a premarket submission is timely made, we may nevertheless be required to cease commercial sales of our products and conduct additional clinical testing prior to making submissions to the FDA to obtain premarket clearance or approval. While it may take many months for the FDA to review comments on these future draft guidances and finalize the guidances for enforcement, we cannot predict the ultimate timing or form of any such regulation of LDTs and the potential impact on our existing products, our products in development or the materials used in our products.

 

The FDA has issued other draft guidance documents that may impact our products or our future products if they were to become subject to FDA regulation, including draft guidance on mobile medical applications and final guidance on in vitro companion diagnostic devices. We cannot predict the potential impact of these guidance documents on our existing products, our products in development or the materials used in our products. We expect that new legislative proposals regarding the FDA’s oversight of LDTs will continue to be introduced from time to time. The uncertainty regarding the status of LDTs under FDA regulation may negatively impact the willingness of third parties to supply us with necessary reagents and testing devices or promote our tests and may ultimately require us to seek 510(k) clearance or PMA approval for our existing products and products under development. It is also possible that the FDA might require our suppliers of reagents and testing devices to obtain approvals or additional approvals for their products, thereby making those products unavailable to us, or interfering with their availability, and potentially interfering with our ability to perform testing.

 

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While we qualify all materials used in our products in accordance with CLIA regulations and guidelines, the FDA could promulgate regulations or guidance documents impacting our ability to purchase materials necessary for the performance of our products. Should any of the reagents we obtain from suppliers and use in our products be affected by future regulatory actions, our business could be adversely affected, including by increasing the cost of testing or delaying, limiting or prohibiting the purchase of reagents necessary to perform testing with our products.

 

We cannot provide any assurance that FDA regulation, including premarket review, will not be required in the future for our products, whether through finalization of the draft guidances issued by the FDA, new enforcement policies adopted by the FDA or new legislation enacted by Congress. Such guidance, enforcement policies or legislation may result in increased regulatory burdens, including a requirement to obtain clearance or approval to market our products. Depending on their intended use, some or all of our products may be categorized as “high risk” by the FDA, which could require us to seek premarket review for some or all of our products in order to distribute them commercially. This could affect our ability to continue marketing our products and to develop and introduce new products.

 

If premarket review is required for some or all of our products, our business could be negatively impacted until clearance or approval to market our products is obtained, and the FDA could require that we stop selling our products pending clearance or approval. Even if our products are allowed to remain on the market prior to completion of premarket review, orders or reimbursement may decline if there is uncertainty about our products, if we are required to label our products as investigational by the FDA and to offer them only for investigational purposes, or if the labeling claims the FDA allows us to make are very limited. The premarket review process may involve, among other things, successfully completing additional clinical trials and submitting a 510(k) or PMA to the FDA. If we are required to conduct premarket clinical trials, whether using prospectively acquired samples or archival samples, delays in the commencement or completion of clinical testing could significantly increase our product development costs, delay commercialization of any future products and interrupt sales of our current products. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial. If premarket review is required by the FDA, there can be no assurance that our products will be cleared or approved on a timely basis, if at all, nor can there be any assurance that any cleared or approved labeling claims will be consistent with our current claims or adequate to support continued adoption of and reimbursement for our products. As a result, we could experience significantly increased development costs and a delay in generating additional revenue from our products, or from other products now in development, which could adversely affect our business, financial condition and results of operations.

 

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

 

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

 

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

 

   

restrictions on manufacturing processes;

 

   

restrictions on product marketing;

 

   

untitled or warning letters;

 

   

withdrawal or recall of products from the market;

 

   

refusal to approve pending PMAs or PMA supplements to approved PMAs or to clear pending 510(k)s that we submit;

 

   

fines, restitution or disgorgement of profits or revenue;

 

   

suspension or withdrawal of regulatory clearances or approvals;

 

   

limitation on, or refusal to permit, import or export of our products;

 

   

product seizures;

 

   

injunctions; or

 

   

imposition of civil or criminal penalties.

 

Until the FDA finalizes a new oversight framework, we will continue to market our products under the FDA’s exercise of enforcement discretion for LDTs. We do not currently have an FDA submission in process for any of our products, and we may be unable to compile and submit any required validation and other data to the FDA in the necessary timeframe to successfully obtain FDA clearance for these products if and when a final FDA oversight framework is put into effect.

 

Failure to comply with the requirements of the FDA or any other regulatory authority may subject us to administrative or judicial sanctions.

 

Even under the FDA’s current exercise of enforcement discretion for LDTs, the FDA is empowered to impose sanctions for violations of the FDCA and FDA’s implementing regulations, including warning letters, civil and criminal penalties, injunctions, product seizure or recall, import bans, restrictions on the conduct of our operations, and total or partial suspension of production. Any of the aforementioned sanctions could cause reputational damage, undermine our ability to maintain and increase our revenue and harm our business, financial condition and results of operations. In particular, if we or the FDA discover that any of our IVD products have defects that call into question the accuracy of their results, we may be required to undertake a re-test of all results and analyses provided during the period relevant to the defect, or recall the affected products. The direct costs incurred in connection with such a recall in terms of management time, administrative and legal expenses and lost revenue, together with the indirect costs to our reputation could harm our business, financial condition and results of operations, and our ability to execute our business strategy. See “—Risks Relating to Our Business—If our tests do not perform as expected, our operating results, reputation and business will suffer.” While we believe that we are currently in material compliance with applicable laws and regulations, the FDA or other regulatory agencies may not agree, and a determination that we have violated these laws or a public announcement that we are being investigated for possible violations of these laws could adversely affect our business, financial condition, results of operations and prospects.

 

We may be subject to fines, penalties, licensure requirements or legal liability, if it is determined that through our IDgenetix reports and analysis we are practicing medicine without a license.

 

IDgenetix reports and analysis delivered to healthcare providers include information regarding FDA-approved therapies that healthcare providers may use in making treatment decisions for patients. We make

 

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members of our organization available to discuss the information provided in the reports and analysis. State laws prohibit the practice of medicine without a license. Our customer service representatives provide support to our customers, including assistance in interpreting the IDgenetix report and analysis results. A governmental authority or individual actor could allege that the identification of available therapies in our reports and analysis and the related customer service we provide constitute the practice of medicine. A state may seek to have us discontinue the inclusion of certain aspects of our reports or the related services we provide or subject us to fine, penalties or licensure requirements. Any determination that we are practicing medicine without a license may result in significant liability to us.

 

The FDA, FTC and other regulatory agencies strictly regulate the promotional claims that may be made about medical devices. If we are found to have made false or misleading claims about our products, or otherwise to have violated promotion or advertising restrictions, we may become subject to significant fines and other liabilities.

 

The FDA prohibits the dissemination of false or misleading claims regarding medical devices and the promotion of them for uses outside the product’s FDA-cleared labeling in any physician- or patient-directed material. The U.S. government has levied large civil and criminal fines against companies for alleged improper promotion and has enjoined several companies from engaging in off-label activities. The FDA has also required companies to enter into consent decrees or permanent injunctions under which specified promotional conduct is changed or curtailed.

 

Although we market IDgenetix tests without 510(k) clearance pursuant to the FDA’s exercise of enforcement discretion for LDTs, the tests produce a report categorizing the FDA-approved therapies best-suited for the individual patient, which, in some cases, may not be approved for the patient’s disease or condition. If the FDA determines that we are engaging in off-label promotion by providing information regarding unapproved therapies, even though IDgenetix tests are not FDA-cleared products, we may be subject to civil or criminal fines or other enforcement action.

 

In addition, certain laws feature incentives that encourage competitors, employees and physicians to report potential violations of the rules governing medical product promotion. These incentives could lead to so-called whistleblower lawsuits in which such persons seek to collect a portion of the monies allegedly overbilled to government agencies due to, for example, promotion of medical devices beyond the cleared label claims. These incentives could also lead to allegations that we have mischaracterized a competitor’s product in the marketplace and, as a result, we could be sued for alleged damages to our competitors. Such lawsuits, regardless of merit, are typically time-consuming and costly to defend. They may also result in related shareholder lawsuits, which are also costly to defend.

 

If we fail to perform our services in accordance with contractual requirements, regulatory standards and ethical considerations, we could be subject to significant costs or liability and our reputation could be harmed.

 

We contract with biopharmaceutical companies to perform services based upon our genetic testing platform to assist them in bringing new drugs to market. Such services are subject to contractual requirements, regulatory standards and ethical considerations. For example, we must adhere to applicable regulatory requirements such as the FDA current Good Laboratory Practice regulations. If we fail to perform our services in accordance with these requirements, regulatory agencies may take action against us or our customers. Such actions may include sanctions such as injunctions or failure of such regulatory authorities to grant marketing approval of products, imposition of clinical holds or delays, suspension or withdrawal of approvals, rejection of data collected in the clinical studies, license revocation, product seizures or recalls, operational restrictions, civil or criminal penalties or prosecutions, damages or fines. Customers may also bring claims against us for breach of our contractual obligations, and subjects in the clinical trials and subjects taking drugs approved on the basis of those trials may bring personal injury claims against us. Additionally, there is a risk that actions by regulatory authorities, if they

 

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result in significant inspectional observations or other measures, could harm our reputation and cause customers not to award us future contracts or to cancel existing contracts. Any such action could have a material adverse effect on our business, financial condition, results of operations or reputation.

 

Risks Related to Billing and Reimbursement

 

Billing complexities associated with obtaining payment or reimbursement for our tests may negatively affect our revenue, cash flow and profitability.

 

Substantially all of our current revenue is derived from IDgenetix for which we bill on a fee-for-service basis, including reimbursements by third-party payors, such as Medicare, Medicaid and other governmental payor programs, hospitals, private insurance plans and managed care organizations and direct payments from individual patients. Billing for PGx testing services is generally highly complex. We currently outsource our billing operations to a third-party provider that specializes in billing solutions for clinical laboratories and other healthcare organizations. We also staff a small internal billing department that works closely with our third-party provider to ensure accuracy of billing, timely collections, and resolution of appeals and billing discrepancies.

 

Depending on our billing arrangement with each third-party payor and applicable law, we are often obligated to bill in the specific manner prescribed by the various payors, each of which may have different requirements. Among the potential factors complicating our billing of third-party payors are:

 

   

disputes among payors regarding which party is responsible for payment;

 

   

disparity in coverage among various payors;

 

   

different process, information and billing requirements among payors; and

 

   

incorrect or missing billing information.

 

We also face risks in our collection efforts, including potential write-offs of doubtful accounts and long collection cycles for accounts receivable.

 

Additionally, from time to time, payors change processes that may affect timely payment. These changes may result in uneven cash flow or impact the timing of revenue recognized with these payors. With respect to payments received from governmental programs, factors such as a prolonged government shutdown could cause significant regulatory delays or could result in attempts to reduce payments made to us by government healthcare programs. These billing complexities, and the related uncertainty in obtaining payment for IDgenetix testing services, could negatively affect our revenue, cash flow and profitability. In addition, increases in write-offs of doubtful accounts, delays in receiving payments or potential retroactive adjustments and penalties resulting from audits by payors could adversely affect our business, results of operations and financial condition.

 

Changes in laws, regulations, payor policies or contracting arrangements with payors may adversely affect coverage or reimbursement for IDgenetix testing services, which may decrease our revenue and adversely affect our results of operations and financial condition.

 

Governmental payors, as well as private insurers, and other private payors have implemented and will continue to implement measures to control the cost, utilization and delivery of healthcare services, including laboratory services. Congress has from time to time considered and implemented changes to laws and regulations governing healthcare service providers, including specialized diagnostic service providers. These changes have adversely affected and may in the future adversely affect coverage for laboratory services, including the PGx testing services we provide. We also believe that healthcare professionals will not use IDgenetix if third-party payors do not provide adequate coverage and reimbursement for them.

 

Reimbursement to healthcare providers, such as specialized diagnostic service providers like us, is subject to continuing change in policies by governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations, and other private payors, such as hospitals and private medical groups.

 

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As a Medicare-participating laboratory based in California, we bill Noridian Healthcare Solutions, or Noridian, the Medicare Administrative Contractor, or MAC, for California, and are subject to Noridian’s local coverage and reimbursement policies. Effective July 2014, Noridian no longer covers and reimburses for CYP1A2 testing, which negatively affects our future revenue and gross margin. This change in coverage decreased our average Medicare reimbursement rate per sample from approximately $1,000 to $1,100 to approximately $720 to $780.

 

In addition, in August 2014, Noridian issued a draft local coverage determination, or LCD, that proposes to revise coverage and impose policy limits related to genetic testing, including testing for the CYP2D6 and CYP2C19 enzymes which are part of our IDgenetix tests. The draft LCD would impact all three therapeutic areas in which we currently offer testing (cardiovascular disease, neuropsychiatric disorders and pain) as well as those therapeutic areas we intend to expand in (neurology and rheumatology). The draft LCD is similar to the LCDs of two other MACs (Palmetto GBA and CGS Administrators) that already restrict coverage of the CYP2D6 and CPY2C19 enzymes to only certain patients with depression who are initiating therapy with one of three specified medications (for CYP2D6) and patients with acute coronary syndrome (ACS) undergoing percutaneous coronary interventions (PCI) who are initiating or reinitiating Plavix therapy (for CPY2C19). Palmetto and CGS currently consider all other clinical indications as investigational at this time. Noridian’s draft LCD, if finalized, would adopt the same coverage criteria. The draft LCD was subject to a 60-day comment period beginning on September 3, 2014 and ending on November 3, 2014. If the proposed LCD as currently drafted is finalized, it would limit coverage of CPY2D6 and CYP2C19 testing, which would impact all three therapeutic areas in which our IDgenetix tests are offered and adversely affect our business. We currently have plans in place that we expect may mitigate some of the expected impacts of this proposed LCD on our business, primarily through re-configuring our IDgenetix tests to harmonize with the LCD in a manner consistent with approaches by other industry providers. With the projected implementation of these plans, and based upon the historical ordering patterns of our customers, we expect that our average Medicare reimbursement per sample will decrease to approximately $600 to $620 if the LCD is implemented as drafted.

 

Palmetto GBA, the current MAC for North Carolina, South Carolina, Virginia and West Virginia and the former MAC for California, developed the Molecular Diagnostic Services Program, or MolDX, in 2011. As part of this program, Palmetto issued a Molecular Test Panel Edit Alert in November 2014 which announced that laboratories performing test panels in affected jurisdictions should start to register each panel, obtain a unique MolDX identifier for each panel, and bill such panels using a single current procedural terminology, or CPT, code and the unique MolDX identifier. Laboratories that perform molecular diagnostic testing and submit claims to Palmetto GBA or Noridian may be affected by the MolDX program, as Noridian is responsible for administering the MolDX program and implementing the MolDX guidelines developed by Palmetto in California. Effective April 1, 2015, Palmetto has announced that it will begin rejecting claims for tests performed as panels and not billed in accordance with the MolDX program. We intend to register each of our IDgenetix test panels and obtain a unique MolDX identifier for test panels if it is required of us by Palmetto or Noridian before April 1, 2015. Although not part of the announcement, it is possible that payments under the test panels may lead to a reduction in payments for our tests, which could have a material adverse financial impact on us.

 

In addition, reimbursement from governmental payors is subject to statutory and regulatory changes, retroactive rate adjustments and administrative rulings, and other policy changes, all of which could materially decrease the range of services for which we are reimbursed or the reimbursement rates paid for IDgenetix testing services. For example, ACA provides that payments under the Medicare Clinical Laboratory Fee Schedule, or CLFS, are to receive a negative 1.75% annual adjustment through 2015 and a productivity adjustment pursuant to the CLFS, further reducing payment rates. Some commercial payors are guided by the CLFS in establishing their reimbursement rates. In February 2012, the Middle Class Tax Relief and Job Creation Act of 2012 was signed into law, which, in part, rebases the CLFS by negative 2%, reducing payment rates in 2013 and thereafter. Because the majority of our revenue is currently derived from the Medicare program and we expect this to continue in the foreseeable future, we are particularly impacted by changes in Medicare reimbursement. We cannot predict whether Medicare and other third-party payor reimbursement rates that mirror Medicare’s will be sufficient to make our tests commercially attractive.

 

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Further, with respect to the CLFS, the Protecting Access to Medicare Act of 2014 will make significant changes to the way that Medicare will pay for clinical laboratory services by moving the clinical laboratory fee schedule away from a system of payments based on historical charges to a market-based payment system. Beginning January 1, 2016, and every three years thereafter (and annually for “advanced diagnostic laboratory tests”), laboratories that receive the majority of their Medicare revenues from payments made under the CLFS or the physician fee schedule will be required to report the payment rates that were paid to the laboratory by commercial health plans, Medicare Advantage plans and Medicaid managed care organizations and the volume of tests for each such payor during the reporting period. Included are any multiple rates during the period, but excluded are capitation or similar payments. Payments rates must be reported net of all discounts and other price concessions. Potentially, low-volume labs and labs on which Medicare makes low expenditures will be excluded from the reporting obligation. CMS will use the reported information to develop uniform national Medicare payment rates, without geographical or other adjustments. These rates will be equal to the volume-weighted median of the reported rates for the tests. These rates will be paid to independent clinical laboratories and to hospitals for their outpatients for tests that are performed after January 1, 2017. However, the new rates are subject to a six-year phase in period that will run from 2017 to 2022. Pursuant to the phase in, rates may not be reduced through the new methodology by more than 10% per test per year in 2017, 2018 and 2019. The maximum reduction is increased to 15% per test per year in 2020, 2021 and 2022. Cumulative payment reductions through the phase-in period could therefore be as much as 75%.

 

These reductions, however, will not initially apply to a “new test” (new or substantially revised Healthcare Common Procedure Coding System, or HCPCS, code after the date of the Act’s enactment that is not an advanced diagnostic laboratory test). Until rates based on reported payor data can be established, rates for new tests will be set by the defined process of “cross-walking” or by a defined process of “gap-filling” where cross-walking is not possible. Another special rule applies to “advanced diagnostic laboratory tests.” These are tests that are offered and furnished only by a single laboratory and not sold for use by a laboratory other than the original developing laboratory (or a successor owner) and which is either an analysis of multiple biomarkers of DNA, RNA, or proteins combined with a unique algorithm to yield a single patient-specific result, a test that “is cleared or approved by the Food and Drug Administration” or a test that meets other criteria established by CMS. Where payment for an advanced diagnostic laboratory test was not made prior to the enactment of the Act under the clinical laboratory fee schedule, payment will be made for three quarters based upon the laboratory’s actual list charge. Then, beginning in January 2017, payment will be made based on the volume-weighted median private payor rates these laboratories are required to report. If the actual list charge substantially exceeds private payor rates, then, when reported, CMS will have the ability to recoup payments in excess of 130% of the weighted median of reported private payor rates that were made during the initial period. We cannot determine at this time the full impact of the new law on our business, financial condition and results of operations.

 

Other Medicare policy changes may include competitive bidding by clinical laboratories for the provision of services, which was the subject of a CMS demonstration project pursuant to the Medicare Prescription Drug, Improvement and Modernization Act of 2003, or MMA. In July 2008, the Medicare Improvements for Patients and Providers Act of 2008 was enacted, which, among other things, repealed the competitive bidding demonstration project for clinical laboratory services. If competitive bidding is implemented in the future, competitive bidding could decrease our reimbursement rates for clinical laboratory tests. Medicare’s coverage and reimbursement policies are often the product of its contractors, such as the Medicare Administrative Contractors, or MACs, who carry out LCDs and pricing. This can result in variable treatment around the country.

 

Finally, some private insurers and other third-party payors link their rates to Medicare’s reimbursement rates, and a reduction in Medicare reimbursement rates for clinical laboratory services could result in a corresponding reduction in the reimbursements we receive from such third-party payors. Any reductions in reimbursement levels for IDgenetix would decrease our revenue and adversely affect our results of operations and financial condition.

 

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Operating as a non-contracting provider with certain payors may adversely affect our results of operations and financial condition, and contracting with those payors may be disadvantageous to us.

 

We are currently considered to be an out-of-network or “non-contracting provider” by a number of third-party payors because we have not entered into a specific contract to provide IDgenetix testing services to their insured patients at specified rates of reimbursement. We were generally subject to reimbursement as a non-contracting provider for approximately 30% of our samples processed and billed for the year ended December 31, 2013 and the nine months ended September 30, 2014. As a non-contracting provider, many payors pay us a smaller percentage of our charges that they recognize to be reasonable, and expect us to collect greater coinsurance or copayments from our patients. Rather than collecting these higher coinsurance and copayment amounts from these patients, when permitted by law to do so, we may instead choose to charge them only the lower coinsurance and copayments amounts that would have applied to them if we had been contracted with their payor, which results in decreased revenues. In instances where we are prohibited by law from treating these patients as if we were in-network, thus requiring these patients to pay higher coinsurance or copayments to us, our customers may decide to reduce or avoid prescribing IDgenetix testing services for such patients, which would adversely affect our results of operations and financial condition.

 

Should any of the third-party payors with whom we are not contracted insist that we enter into a contract for the IDgenetix testing services we provide, the resulting contract may contain pricing and other terms that are materially less favorable to us than the terms under which we currently operate. If revenue from a particular payor grows, there is heightened risk that such a third-party payor will insist that we enter into contractual arrangements that contain such terms. If we refuse to enter into a contract with such a third-party payor, they may refuse to cover and reimburse for IDgenetix testing services, which may lead to a decrease in case volume and a corresponding decrease in our revenues. If we contract with such a third-party payor, although our case volume may increase as a result of the contract, our revenue per case under the contractual agreement and gross margin may decrease. The overall net result of contracting with third-party payors may adversely affect our business, results of operations and financial condition.

 

If the utility of IDgenetix is not supported by peer-reviewed medical publications, the rate of adoption of our test by clinicians and the coverage and reimbursement determinations by third-party payors for IDgenetix testing services may be negatively affected.

 

Healthcare providers typically take a long time to adopt new products, testing practices and clinical treatments, partly because of perceived liability risks and the uncertainty of third-party coverage and reimbursement. It is critical to the success of our sales efforts that we educate a sufficient number of patients, clinicians and administrators about PGx testing, in general, as well as about our IDgenetix tests and our future tests, if any, and demonstrate the clinical benefits of these tests. It is likely that clinicians may not adopt, and third-party payors may not cover or adequately reimburse for, our tests unless they determine, based on published peer-reviewed journal articles and the experience of other clinicians, that our tests provide accurate, reliable and cost-effective information.

 

As the healthcare reimbursement system in the United States evolves to place greater emphasis on comparative effectiveness and outcomes data, we cannot predict whether we will have sufficient data, or whether the data we have will be presented to the satisfaction of any payors seeking such data in the process of determining coverage for diagnostic tests.

 

The administration of clinical and economic utility studies is expensive and demands significant attention from our management team. Data collected from these studies may not be positive or consistent with our existing data, or may not be statistically significant or compelling to the medical community. If the results obtained from our ongoing or future studies are inconsistent with certain results obtained from our previous studies, adoption of diagnostic services would suffer and our business would be harmed.

 

Peer-reviewed publications regarding our tests may be limited by many factors, including delays in the completion of, poor design of, or lack of compelling data from clinical studies that would be the subject of the

 

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article. If our tests or the technology underlying our current test or future tests do not receive sufficient favorable exposure in peer-reviewed publications, the rate of clinician adoption of our test and positive reimbursement coverage decisions for our tests could be negatively affected. The publication of clinical data in peer-reviewed journals is a crucial step in commercializing and obtaining reimbursement for tests such as ours, and our inability to control when, if ever, results are published may delay or limit our ability to derive sufficient revenue from any product that is the subject of a study.

 

Risks Related to This Offering and Ownership of our Common Stock

 

We do not know whether an active, liquid and orderly trading market will develop for our common stock or what the market price of our common stock will be and as a result it may be difficult for you to sell your shares of our common stock.

 

Prior to this offering there has been no public market for shares of our common stock. Although we have applied to list our common stock on the NASDAQ Global Market, or NASDAQ, an active trading market for our shares may never develop or be sustained following this offering. You may not be able to sell your shares quickly or at the market price if trading in shares of our common stock is not active. The initial public offering price for our common stock will be determined through negotiations with the underwriters, and the negotiated price may not be indicative of the market price of the common stock after the offering. As a result of these and other factors, you may be unable to resell your shares of our common stock at or above the initial public offering price. Further, an inactive market may also impair our ability to raise capital by selling shares of our common stock and may impair our ability to enter into strategic partnerships or acquire companies or products by using our shares of common stock as consideration.

 

The price of our stock may be volatile, and you could lose all or part of your investment.

 

The trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control, including limited trading volume. In addition to the factors discussed in this “Risk Factors” section and elsewhere in this prospectus, these factors include:

 

   

our commercial progress in marketing and selling IDgenetix, including sales and revenue trends;

 

   

changes in laws or regulations applicable to IDgenetix;

 

   

adverse developments related to our laboratory facilities;

 

   

increased competition in the diagnostics services industry;

 

   

the failure to obtain and/or maintain adequate reimbursement of IDgenetix, including as a result of Noridian’s draft LCD;

 

   

adverse developments concerning our manufacturers and suppliers;

 

   

our inability to establish future collaborations;

 

   

additions or departures of key scientific or management personnel;

 

   

introduction of new testing services offered by us or our competitors;

 

   

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

 

   

our ability to effectively manage our growth;

 

   

the size and growth, if any, of our targeted markets;

 

   

actual or anticipated variations in quarterly operating results;

 

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our cash position;

 

   

our failure to meet the estimates and projections of the investment community or that we may otherwise provide to the public;

 

   

publication of research reports about us or our industry or positive or negative recommendations or withdrawal of research coverage by securities analysts;

 

   

changes in the market valuations of similar companies;

 

   

overall performance of the equity markets;

 

   

issuances of debt or equity securities;

 

   

sales of our common stock by us or our stockholders in the future;

 

   

trading volume of our common stock;

 

   

changes in accounting practices;

 

   

ineffectiveness of our internal controls;

 

   

disputes or other developments relating to proprietary rights, including our ability to adequately protect our technologies;

 

   

significant lawsuits, including patent or stockholder litigation;

 

   

general political and economic conditions; and

 

   

other events or factors, many of which are beyond our control.

 

In addition, the stock market in general, and diagnostic and biotechnology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of our actual operating performance. If the market price of our common stock after this offering does not exceed the initial public offering price, you may not realize any return on your investment in us and may lose some or all of your investment. In the past, securities class action litigation has often been instituted against companies following periods of volatility in the market price of a company’s securities. This type of litigation, if instituted, could result in substantial costs and a diversion of management’s attention and resources, which would harm our business, operating results or financial condition.

 

We have never paid dividends and we do not intend to pay dividends on our common stock, so any returns on your investment in our common stock will be limited to appreciation in 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. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. Accordingly, if you purchase shares in this offering, realization of a gain on your investment will depend on the appreciation of the price of our common stock, which may never occur. In addition, the LSA also contains a negative covenant which prohibits us from paying dividends without the prior written consent of SVB.

 

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

 

Our executive officers, directors, 5% stockholders and their affiliates owned approximately 86% of our voting stock as of November 30, 2014, and, upon the closing of this offering, that same group will hold

 

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approximately     % of our outstanding voting stock (assuming no exercise of the underwriters’ over-allotment option), based upon the number of shares of our common stock outstanding as of November 30, 2014. Therefore, even after this offering, these stockholders will have the ability to influence us through this ownership position. These stockholders may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders.

 

If you purchase our common stock in this offering, you will incur immediate and substantial dilution in the book value of your shares.

 

The initial public offering price is substantially higher than the net tangible book value per share of our common stock. Investors purchasing common stock in this offering will pay a price per share that substantially exceeds the book value of our tangible assets after subtracting our liabilities. As a result, investors purchasing common stock in this offering will incur immediate dilution of $         per share, based on the initial public offering price of $         per share. Further, investors purchasing common stock in this offering will contribute approximately     % of the total amount invested by stockholders since our inception, but will own only approximately     % of the shares of common stock outstanding after giving effect to this offering.

 

This dilution is due to our investors who purchased shares prior to this offering having paid substantially less when they purchased their shares than the price offered to the public in this offering and the exercise of stock options granted to our employees. To the extent outstanding options or warrants are exercised, there will be further dilution to new investors. As a result of the dilution to investors purchasing shares in this offering, investors may receive significantly less than the purchase price paid in this offering, if anything, in the event of our liquidation. For a further description of the dilution that you will experience immediately after this offering, see the section entitled “Dilution.”

 

We are an emerging growth company, and the reduced reporting 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 Jumpstart Our Business Startups Act of 2012, or the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in this prospectus and our periodic reports and proxy statements and exemptions from the requirements of holding nonbinding advisory votes on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years following the year in which we complete this offering, although circumstances could cause us to lose that status earlier, including if the market value of our common stock held by non-affiliates exceeds $700.0 million as of any June 30 before that time or if we have total annual gross revenue of $1.0 billion or more during any fiscal year before that time, in which cases we would no longer be an emerging growth company as of the following December 31 or, if we issue more than $1.0 billion in non-convertible debt during any three year period before that time, we would cease to be an emerging growth company immediately. Even after we no longer qualify as an emerging growth company, we may still qualify as a “smaller reporting company” which would allow us to take advantage of many of the same exemptions from disclosure requirements including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions, which could result in a less active trading market for our common stock and increased volatility in our stock price.

 

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

 

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

 

After the closing of this offering, we will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Sarbanes-Oxley Act and the rules and regulations of NASDAQ. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal controls over financial reporting. 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 GAAP. Commencing with our fiscal year ending December 31, 2015, we must perform 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 in our Form 10-K filing for that year, as required by Section 404 of the Sarbanes-Oxley Act. This 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. Prior to this offering, we have never been required to test our internal controls within a specified period, and, as a result, we may experience difficulty in meeting these reporting requirements in a timely manner.

 

We are currently in the process of reviewing, documenting and testing our internal control over financial reporting, but we are not currently in compliance with, and we cannot be certain when we will be able to implement the requirements of, Section 404 of the Sarbanes-Oxley Act. For instance, in August 2014, it was determined that we did not maintain effective internal controls over the process for calculating the numerator in the calculation of our net loss per share applicable to common stockholders for the years ended December 31, 2012 and 2013 and for the three months ended March 31, 2013 and 2014. The numerator used to calculate our basic and diluted net loss per share applicable to common stockholders did not properly include the accretion of redeemable convertible preferred stock in accordance with U.S. GAAP. Management identified a lack of sufficient oversight and review to ensure the complete and proper application of U.S. GAAP as it relates to the impact of complex equity transactions on calculating net loss per share applicable to common stockholders. This deficiency in our internal controls was deemed to be a material weakness. A material weakness is a significant deficiency, or a combination of significant deficiencies, in internal control over financial reporting such that it is reasonably possible that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. If one or more material weaknesses persist or if we fail to establish and maintain effective internal control over financial reporting, our ability to accurately report our financial results could be adversely affected. Although remediation efforts are still in progress, we are taking steps to remediate the material weakness in our internal control over financial reporting in 2014, primarily by hiring additional individuals with accounting expertise and, if appropriate, engaging third-party accounting consultants with the appropriate knowledge to supplement our internal and existing external resources in our computation and review processes. These actions are subject to ongoing management review and the oversight of the audit committee of our board of directors.

 

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 are unable to maintain proper and effective internal controls, we may not be able to produce timely and accurate financial statements. 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 the SEC, or other regulatory authorities.

 

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

 

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, which will require, among other things, that we file with the SEC annual, quarterly and current reports with respect to our business and financial condition. In addition, the Sarbanes-Oxley Act, as well as rules subsequently adopted by the SEC and NASDAQ to implement provisions of the Sarbanes-Oxley Act, impose significant requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Further, in July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executive-compensation-related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas. Recent legislation permits emerging growth companies to implement many of these requirements over a longer period and up to five years from the pricing of this offering. We intend to take advantage of this new legislation, but cannot assure you that we will not be required to implement these requirements sooner than planned and thereby incur unexpected expenses. Stockholder activism, the current political environment and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact the manner in which we operate our business in ways we cannot currently anticipate.

 

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

 

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

 

If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market after the lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline. Based on shares of common stock outstanding as of September 30, 2014, upon the closing of this offering we will have outstanding a total of             shares of common stock. Of these shares, only the shares of common stock sold in this offering by us, plus any shares sold upon exercise of the underwriters’ over-allotment option, will be freely tradable without restriction in the public market immediately following this offering. Citigroup Global Markets Inc. and Jefferies LLC, however, may, in their discretion, permit our officers, directors and other stockholders who are subject to these lock-up agreements to sell shares prior to the expiration of the lock-up agreements.

 

We expect that the lock-up agreements pertaining to this offering will expire 180 days from the date of this prospectus. After the lock-up agreements expire, up to an additional             shares of common stock will be eligible for sale in the public market, though such shares held by directors, executive officers and other affiliates and may be subject to volume limitations under Rule 144 under the Securities Act. In addition, shares of common stock that are either subject to outstanding options or reserved for future issuance under our employee benefit plans will become eligible for sale in the public market to the extent permitted by the provisions of various

 

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vesting schedules, the lock-up agreements and Rule 144 and Rule 701 under the Securities Act. If these additional shares of common stock are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline.

 

After this offering, the holders of             shares of our common stock will be entitled to rights with respect to the registration of their shares under the Securities Act, subject to the 180-day lock-up agreements described above. See “Description of Capital Stock—Registration Rights.” 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 to our stockholders and could cause our stock price to fall.

 

We expect that significant additional capital may be needed in the future to continue our planned operations, including conducting clinical trials, commercialization efforts, expanded research and development activities and costs associated with operating a public company. To raise capital, 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, investors may be materially diluted by subsequent sales. Such sales may also result in material dilution to our existing stockholders, and new investors could gain rights, preferences and privileges senior to the holders of our common stock, including shares of common stock sold in this offering.

 

Pursuant to our 2014 equity incentive plan, or the 2014 plan, which will become effective on the business day prior to the public trading date of our common stock, our management is authorized to grant stock options to our employees, directors and consultants. Additionally, the number of shares of our common stock reserved for issuance under our 2014 plan will automatically increase on January 1 of each year, beginning on January 1, 2016 (assuming the 2014 plan becomes effective before such date) and continuing through and including January 1, 2025, by     % of the total number of shares of our capital stock outstanding on December 31 of the preceding calendar year, or a lesser number of shares determined by our board of directors. Unless our board of directors elects not to increase the number of shares available for future grant each year, our stockholders may experience additional dilution, which could cause our stock price to fall.

 

We have broad discretion in the use of the net proceeds from this offering and may not use them effectively.

 

Our management will have broad discretion in the application of the net proceeds from this offering, including for any of the purposes described in the section entitled “Use of Proceeds,” and you will not have the opportunity as part of your investment decision to assess whether the net proceeds will be used appropriately. Because of the number and variability of factors that will determine our use of the net proceeds from this offering, their ultimate use may vary substantially from their currently intended use. Our management might not apply our net proceeds in ways that ultimately increase the value of your investment. We intend to use the net proceeds from this offering as follows: (1) to fund research and development, including clinical studies to demonstrate the utility of our products and support reimbursement efforts, as well as expansion of our IDgenetix testing portfolio; (2) to expand our commercial capabilities in selling and marketing related to our IDgenetix tests; (3) to fund expansion of our facilities and laboratory operations; and (4) the remaining proceeds for working capital and other general corporate purposes.

 

Our expected use of net proceeds from this offering represents our current intentions based upon our present plans and business condition. As of the date of this prospectus, we cannot predict with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering, or the amounts that we will actually spend on the uses set forth above. The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors, including the commercial success of IDgenetix and the costs of our

 

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research and development activities, as well as the amount of cash used in our operations. The costs and timing of research and development activities and the build out of our commercial selling and marketing capabilities, particularly as related to expansion of our IDgenetix product testing portfolio, are highly uncertain, subject to substantial risks and can often change. Depending on the outcome of these activities, our plans and priorities may change, and we may apply the net proceeds from this offering differently than we currently anticipate. For example, in the event we identify other opportunities that we believe are in the best interests of our stockholders, we may use a portion of the net proceeds from this offering for the acquisition of, or investment in, technologies, products or companies that complement our business, although we have no current intentions, commitments or agreements to do so. As a result, our management will have broad discretion in the application of the net proceeds, and investors will be relying on our judgment regarding the application of the net proceeds of this offering. In addition, we might decide to postpone or not pursue expansion of IDgenetix if the net proceeds from this offering and other sources of cash are less than expected.

 

The failure by our management to apply these funds effectively could harm our business. Pending their use, we may invest the net proceeds from this offering in short-term, investment-grade, interest-bearing securities. These investments may not yield a favorable return to our stockholders. If we do not invest or apply the net proceeds from this offering in ways that enhance stockholder value, we may fail to achieve expected financial results, which could cause our stock price to decline.

 

Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control which could limit the market price of our common stock and may prevent or frustrate attempts by our stockholders to replace or remove our current management.

 

Our amended and restated certificate of incorporation and amended and restated bylaws, which are to become effective immediately prior to the closing of this offering, contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions include:

 

   

a board of directors divided into three classes serving staggered three-year terms, such that not all members of the board will be elected at one time;

 

   

a prohibition on stockholder action through written consent, which requires that all stockholder actions be taken at a meeting of our stockholders;

 

   

a requirement that special meetings of stockholders be called only by the chairman of the board of directors, the chief executive officer, the president or by a majority of the total number of authorized directors;

 

   

advance notice requirements for stockholder proposals and nominations for election to our board of directors;

 

   

a requirement that no member of our board of directors may be removed from office by our stockholders except for cause and, in addition to any other vote required by law, upon the approval of not less than two-thirds of all outstanding shares of our voting stock then entitled to vote in the election of directors;

 

   

a requirement of approval of not less than two-thirds of all outstanding shares of our voting stock to amend any bylaws by stockholder action or to amend specific provisions of our certificate of incorporation; and

 

   

the authority of the board of directors to issue preferred stock on terms determined by the board of directors without stockholder approval and which preferred stock may include rights superior to the rights of the holders of common stock.

 

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, which may prohibit certain business combinations with stockholders

 

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owning 15% or more of our outstanding voting stock. These anti-takeover provisions and other provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make it more difficult for stockholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors and could also delay or impede a merger, tender offer or proxy contest involving our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing or cause us to take other corporate actions you desire. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

 

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. Securities and industry analysts do not currently, and may never, publish research on our company. If no securities or industry analysts commence coverage of our company, the trading price for our stock would likely be negatively impacted. In the event securities or industry analysts initiate coverage, if one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price may decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

 

Our independent registered public accounting firm has included an explanatory paragraph relating to our ability to continue as a going concern in its report on our audited financial statements.

 

Our report from our independent registered public accounting firm for the year ended December 31, 2013 includes an explanatory paragraph stating that our recurring losses and negative cash flows from operating activities raise substantial doubt about our ability to continue as a going concern. If we are unable to obtain sufficient funding, our business, prospects, financial condition and results of operations will be materially and adversely affected and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our consolidated financial statements, and it is likely that investors will lose all or a part of their investment. Future reports from our independent registered public accounting firm may also contain statements expressing doubt about our ability to continue as a going concern. If we seek 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.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus, including the sections entitled “Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains 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 prospectus include, but are not limited to, statements about:

 

   

the size and growth potential of the markets for IDgenetix, and our ability to serve those markets;

 

   

the rate and degree of market acceptance of IDgenetix;

 

   

the scalability of our testing platform and processes;

 

   

regulatory developments in the United States and foreign countries;

 

   

our ability to obtain and/or maintain adequate reimbursement of IDgenetix;

 

   

the performance of our third-party contract sales organizations, suppliers and manufacturers;

 

   

the success of competing diagnostic technologies that are or may become available;

 

   

our ability to attract and retain key scientific or management personnel;

 

   

the accuracy of our estimates regarding expenses, future revenues, reimbursement rates, capital requirements and needs for additional financing;

 

   

our ability to obtain funding for our operations;

 

   

our ability to attract collaborators and strategic partnerships; and

 

   

our use of the proceeds from this offering.

 

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 date of this prospectus 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.

 

You should read this prospectus and the documents that we reference in this prospectus and have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of the forward-looking statements in this prospectus by these cautionary 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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USE OF PROCEEDS

 

We estimate that we will receive net proceeds of approximately $         million (or approximately $         million if the underwriters exercise their over-allotment option in full) from the sale of the shares of common stock offered by us in this offering, based on the assumed initial public offering price of $         per share, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by approximately $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

Similarly, a one million share increase (decrease) in the number of shares offered by us, as set forth on the cover of this prospectus, would increase (decrease) the net proceeds to us by $         million, assuming the assumed initial public offering price remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

The principal purposes of this offering are to obtain additional capital to support our operations, to establish a public market for our common stock and to facilitate our future access to the public equity markets. Our estimated use of the net proceeds from this offering are as follows:

 

   

approximately $         million for research and development, including clinical studies to demonstrate the utility of our products and support reimbursement efforts, as well as expansion of our IDgenetix testing portfolio;

 

   

approximately $         million to expand our commercial capabilities in selling and marketing related to our IDgenetix tests;

 

   

approximately $         million for expansion of our facilities and laboratory operations; and

 

   

the remaining proceeds for working capital and other general corporate purposes.

 

We may also use a portion of the remaining net proceeds to in-license, acquire, or invest in complementary businesses, technologies, products or assets. However, we have no current commitments or obligations to do so. We believe that the net proceeds from this offering, together with our existing cash and cash equivalents and anticipated future revenue, will be sufficient to fund our operations through at least the next 12 months.

 

Our expected use of net proceeds from this offering represents our current intentions based upon our present plans and business condition. As of the date of this prospectus, we cannot predict with certainty all of the particular uses for the net proceeds to be received upon the completion of this offering, or the amounts that we will actually spend on the uses set forth above. The amounts and timing of our actual use of the net proceeds will vary depending on numerous factors, including the commercial success of IDgenetix and the costs of our research and development activities, as well as the amount of cash used in our operations. The costs and timing of research and development activities, particularly as related to expansion of our IDgenetix product testing portfolio, and the build out of our commercial selling and marketing capabilities, are highly uncertain, subject to substantial risks and can often change. If one or more of these activities takes longer or costs more to implement than we currently anticipate, we may have to change our expected use of proceeds. For example, if the research and development activities related to expanding our IDgenetix testing portfolio or clinical studies to demonstrate the utility of our products and support reimbursement efforts are less successful than we currently expect, we may have to devote a larger portion of the net proceeds from this offering to research and development activities in order to successfully develop additional IDgenetix tests. In that event, we would have a proportionately smaller amount of proceeds from this offering remaining to allocate to our efforts relating to expanding both our

 

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commercial capabilities and our facilities and laboratory operations. In addition, if the costs associated with the build out of our commercial selling and marketing capabilities are higher than we expect, we will have to spend more of the net proceeds from this offering on these efforts, and will have proportionately less proceeds available to devote to our research and development activities, including with respect to expansion of our IDgenetix product testing portfolio, and expansion of our facilities and laboratory operations. Finally, if the planned expansion of our facilities and laboratory operations cost more than we anticipate, we will have to spend more of the net proceeds of this offering to complete expansion of our facilities and laboratory operations and will have proportionately less proceeds to allocate to research and development activities and build out of our commercial selling and marketing capabilities. Furthermore, our plans and priorities may change, and we may apply the net proceeds from this offering differently than we currently anticipate. For example, in the event we identify other opportunities that we believe are in the best interests of our stockholders, we may use a portion of the net proceeds from this offering for the acquisition of, or investment in, technologies, products or companies that complement our business, although we have no current intentions, commitments or agreements to do so. As a result, our management will have broad discretion in the application of the net proceeds, and investors will be relying on our judgment regarding the application of the net proceeds of this offering. In addition, we might decide to postpone or not pursue expansion of our IDgenetix testing portfolio if the net proceeds from this offering and other sources of cash are less than expected.

 

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

 

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DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings to support our operations and finance the growth and development of our business. We do not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to our dividend policy will be made at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition, capital requirements, contractual restrictions, business prospects and other factors our board of directors may deem relevant. In addition, the terms of our LSA with SVB prohibit us from paying dividends other than in common stock without the prior written consent of SVB.

 

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CAPITALIZATION

 

The following table sets forth our cash and cash equivalents and our capitalization as of September 30, 2014:

 

   

on an actual basis;

 

   

on a pro forma basis, giving effect to (1) the conversion of all our outstanding redeemable convertible preferred stock as of September 30, 2014 into an aggregate of 11,639,977 shares of our common stock immediately prior to the closing of this offering; (2) the effectiveness of our amended and restated certificate of incorporation immediately prior to the closing of this offering; (3) the automatic net exercise of the common stock warrants into              shares of our common stock immediately prior to the closing of this offering, based on the assumed initial public offering price; (4) the reclassification of the preferred stock warrant liability to common stock and additional paid-in capital in connection with the conversion of the warrants to purchase redeemable convertible preferred stock into warrants to purchase common stock; (5) borrowings of $10.0 million subsequent to September 30, 2014 under our credit facility with Silicon Valley Bank, or SVB, in connection with the November 2014 amendment to our loan and security agreement with SVB; and (6) the cancellation of our working capital line of credit with SVB in November 2014; and

 

   

on a pro forma as adjusted basis, reflecting the pro forma adjustments discussed above and giving further effect to the sale by us of              shares of our common stock in this offering at the assumed initial public offering price, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

The pro forma information below is illustrative only and our capitalization following the closing of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes appearing elsewhere in this prospectus.

 

     As of September 30, 2014  
     Actual     Pro Forma      Pro Forma As
Adjusted(1)
 
     (unaudited, in thousands)  

Cash and cash equivalents

   $ 7,458      $         $                
  

 

 

   

 

 

    

 

 

 

Capitalization:

       

Debt, at carrying value, including working capital line of credit

     11,774        

Preferred stock warrant liability

     924        

Redeemable convertible preferred stock:

       

Series A redeemable convertible preferred stock, $0.0001 par value: 3,379 shares authorized and 3,379 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     8,852        

Series B redeemable convertible preferred stock, $0.0001 par value: 7,250 shares authorized and 7,250 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

     8,001        

Stockholders’ equity:

       

Preferred stock, $0.0001 par value: no shares authorized, issued or outstanding, actual; 10,000 shares authorized and no shares issued or outstanding, pro forma and pro forma as adjusted

     —          

Common stock, $0.0001 par value: 21,000 shares authorized and 6,224 shares issued and outstanding, actual; 200,000 shares authorized and 17,864 shares issued and outstanding, pro forma; and 200,000 shares authorized, and              shares issued and outstanding, pro forma as adjusted

     —          

Additional paid-in capital

     —          

Accumulated deficit

     (19,177     
  

 

 

   

 

 

    

 

 

 

Total stockholders’ deficit

     (19,177     

Total capitalization

   $ 10,374      $                    $     
  

 

 

   

 

 

    

 

 

 

 

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

 

The number of shares of common stock shown as issued and outstanding on a pro forma as adjusted basis in the table above is based on the number of shares of our common stock outstanding as of September 30, 2014, and excludes:

 

   

1,158,045 shares of common stock issuable upon the exercise of outstanding stock options as of September 30, 2014, at a weighted-average exercise price of $1.34 per share;

 

   

300,000 shares of common stock issuable upon the exercise of certain outstanding warrants as of September 30, 2014, each with an exercise price of $1.00 per share;

 

   

114,380 shares of common stock issuable upon the exercise of certain outstanding warrants issued in November 2014, each with an exercise price of $3.06 per share;

 

   

             shares of common stock reserved for future issuance under the ESPP, which will become effective upon the execution and delivery of the underwriting agreement for this offering; and

 

   

             shares of common stock reserved for future issuance under the 2014 plan, which will become effective upon the execution and delivery of the underwriting agreement for this offering, plus 878,494 shares of common stock reserved for issuance under the 2008 plan as of September 30, 2014, which shares will be added to the shares reserved under the 2014 plan upon its effectiveness.

 

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DILUTION

 

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

 

Our historical net tangible book value (deficit) as of September 30, 2014, was approximately $(19.2) million, or $(3.08) per share of our common stock. Our historical net tangible book value (deficit) is the amount of our total tangible assets less our liabilities and redeemable convertible preferred stock which is not included within stockholders’ equity (deficit). Historical net tangible book value (deficit) per share is our historical net tangible book value (deficit) divided by the number of shares of common stock outstanding as of September 30, 2014, which includes 3.8 million shares of restricted common stock.

 

Our pro forma net tangible book value (deficit) as of September 30, 2014, was approximately $         million, or $         per share of common stock. Pro forma net tangible book value gives effect to (1) the conversion of all of our outstanding redeemable convertible preferred stock as of September 30, 2014, into an aggregate of 11,639,977 shares of our common stock, which will occur automatically immediately prior to the closing of this offering, (2) the automatic net exercise of the common stock warrants into              shares of our common stock immediately prior to the closing of this offering, based on the assumed initial public offering price, and (3) the reclassification of the preferred stock warrant liability to common stock and additional paid-in capital in connection with the conversion of the warrants to purchase redeemable convertible preferred stock into warrants to purchase common stock.

 

Pro forma as adjusted net tangible book value is our pro forma net tangible book value (deficit), after giving effect to the sale of              shares of our common stock in this offering at the assumed initial public offering price, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. This amount represents an immediate increase in pro forma as adjusted net tangible book value of $         per share to our existing stockholders, and an immediate dilution of $         per share to new investors participating in this offering.

 

The following table illustrates this dilution on a per share basis:

 

Assumed initial public offering price per share

      $                

Historical net tangible book value (deficit) per share as of September 30, 2014

   $ (3.08)      

Pro forma increase in net tangible book value per share as of September 30, 2014 attributable to redeemable convertible preferred stock conversion

     
  

 

 

    

Pro forma net tangible book value (deficit) per share as of September 30, 2014

     

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

     
  

 

 

    

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

     
     

 

 

 

Dilution per share to investors participating in this offering

      $     
     

 

 

 

 

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

 

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(increase) the dilution per share to investors participating in this offering by approximately $        , assuming the assumed initial public offering price remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

If the underwriters exercise their over-allotment option in full, the pro forma as adjusted net tangible book value will increase to approximately $         per share, representing an immediate increase in pro forma as adjusted net tangible book value to existing stockholders of $         per share and an immediate decrease of dilution to investors participating in this offering of approximately $         per share.

 

The following table summarizes, on a pro forma as adjusted basis as of September 30, 2014, the number of shares purchased or to be purchased from us, the total consideration paid or to be paid to us, and the average price per share paid or to be paid to us by existing stockholders and investors participating in this offering at the assumed initial public offering price, before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. As the table below shows, investors participating in this offering will pay an average price per share substantially higher than our existing stockholders paid.

 

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

Existing stockholders before this offering

               $                             $                

Investors participating in this offering

                          
  

 

  

 

 

   

 

 

    

 

 

   

Total

        100   $           100   $     
  

 

  

 

 

   

 

 

    

 

 

   

 

A $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) the total consideration paid by investors participating in this offering and total consideration paid by all stockholders by approximately $         million, and $         million and $        , respectively, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and before deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Similarly, a one million share increase (decrease) in the number of shares offered by us, as set forth on the cover of this prospectus, would increase (decrease) the total consideration paid by investors participating in this offering and total consideration paid by all stockholders by approximately $         million and $         million and $        , respectively, assuming the assumed initial public offering price remains the same, and after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us.

 

If the underwriters exercise their over-allotment option in full, the number of shares of common stock held by existing stockholders will be reduced to     % of the total number of shares of common stock to be outstanding after this offering, and the number of shares of common stock held by investors participating in this offering will be further increased to             , or     % of the total number of shares of common stock to be outstanding after this offering.

 

The foregoing discussion and table excludes:

 

   

1,158,045 shares of common stock issuable upon the exercise of outstanding stock options as of September 30, 2014, at a weighted-average exercise price of $1.34 per share;

 

   

300,000 shares of common stock issuable upon the exercise of certain outstanding warrants as of September 30, 2014, each with an exercise price of $1.00 per share;

 

   

114,380 shares of common stock issuable upon the exercise of certain outstanding warrants issued in November 2014, each with an exercise price of $3.06 per share;

 

   

             shares of common stock reserved for future issuance under the ESPP, which will become effective upon the execution and delivery of the underwriting agreement for this offering; and

 

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             shares of common stock reserved for future issuance under the 2014 plan, which will become effective upon the execution and delivery of the underwriting agreement for this offering, plus 878,494 shares of common stock reserved for issuance under the 2008 plan as of September 30, 2014, which shares will be added to the shares reserved under the 2014 plan upon its effectiveness.

 

Furthermore, we may choose to raise additional capital through the sale of equity or convertible debt securities due to market conditions or strategic considerations even if we believe we have sufficient funds for our current or future operating plans. To the extent any of our outstanding options or warrants are exercised, new options are issued under our equity incentive plans or we issue additional shares of common stock, or other equity or convertible debt securities in the future, there may be further dilution to investors participating in this offering.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

 

The following selected consolidated financial data should be read together with our consolidated financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. We derived the selected consolidated statements of comprehensive loss data for the years ended December 31, 2012 and 2013 from our audited consolidated financial statements and related notes appearing elsewhere in this prospectus. We derived the summary statements of comprehensive loss data for the nine months ended September 30, 2013 and 2014 and consolidated balance sheets data as of September 30, 2014 from our unaudited consolidated financial statements also appearing elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements included in this prospectus and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly state our financial position as of September 30, 2014 and results of operations for the nine months ended September 30, 2013 and 2014. The selected consolidated financial data in this section are not intended to replace our consolidated financial statements and the related notes. Our historical results are not necessarily indicative of the results that may be expected in the future and results of interim periods are not necessarily indicative of the results for the entire year.

 

     Year Ended
December 31,
    Nine Months Ended
September 30,
 
     2012     2013     2013     2014  
                 (unaudited)  
     (in thousands, except per share data)  

Consolidated Statements of Comprehensive Loss Data:

        

Revenue:

        

Diagnostic testing

   $ —        $ 196      $ —        $ 9,067   

Research services and other

     6,915        7,150        4,235        4,542   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     6,915        7,346        4,235        13,609   

Cost of revenue:

        

Diagnostic testing

     —          101        —          1,763   

Research services and other

     4,772        4,663        3,036        3,008   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total cost of revenue

     4,772        4,764        3,036        4,771   

Gross profit

     2,143        2,582        1,199        8,838   

Total operating expenses

     3,737        6,667        4,159        14,163   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from operations

     (1,594     (4,085     (2,960     (5,325

Interest and other income (expense)

     9        27        24        (388

Change in fair value of warrant liability

     —          —          —          (194
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss and comprehensive loss

   $ (1,585   $ (4,058   $ (2,936   $ (5,907

Accretion on redeemable convertible preferred stock

     (585     (1,000     (680     (987
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss applicable to common stockholders — as restated for the years ended December 31, 2012 and 2013

   $ (2,170   $ (5,058   $ (3,616   $ (6,894
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share attributable to common stockholders, basic and diluted — as restated for the years ended December 31, 2012 and 2013(1)

   $ (1.08   $ (2.51   $ (1.80   $ (3.12
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding used in computing net loss per share attributable to common stockholders, basic and diluted(1)

     2,014        2,014        2,014        2,207   
  

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(1)

        
    

 

 

     

 

 

 

Weighted average shares outstanding used in computing pro forma net loss per share attributable to common stockholders, basic and diluted (unaudited)(1)

        
    

 

 

     

 

 

 

 

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

 

     As of December 31,     As of September 30,  
     2012     2013     2014  
                 (unaudited)  
     (in thousands)  

Consolidated Balance Sheet Data:

      

Cash and cash equivalents

   $ 295      $ 2,925      $ 7,458   

Working capital

     (1,235     1,993        2,338   

Total assets

     3,194        8,372        27,274   

Debt, at carrying value, including working capital line of credit

     489        2,591        11,774   

Redeemable convertible preferred stock

     7,697        15,865        16,853   

Accumulated deficit and total stockholders’ deficit

     (7,897     (12,852     (19,177

 

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

 

The following discussion and analysis should be read in conjunction with “Selected Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this prospectus. This discussion and analysis and other parts of this prospectus contain forward-looking statements based upon current beliefs, plans and expectations that involve risks, uncertainties and assumptions, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under “Risk Factors” and elsewhere in this prospectus. You should carefully read the “Risk Factors” section of this prospectus to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements. Please also see the section entitled “Special Note Regarding Forward-Looking Statements.”

 

Overview

 

We are a commercial stage molecular diagnostics company specializing in the field of personalized medicine. IDgenetix, our pharmacogentic, or PGx, testing portfolio, enables personalized therapeutic decisions for patients suffering from some of the most prevalent clinical conditions in the United States, including cardiovascular disease, neuropsychiatric disorders and pain. Our proprietary algorithm-based bioinformatic platform and PGx testing portfolio are intended to serve as a tool to assist healthcare providers in identifying optimal drugs for their patients as well as dosing guidelines based on a patient’s genetic make-up, current prescription regimen and other key factors. IDgenetix is designed to enable healthcare providers to make timely and evidence-based decisions, which we believe can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response.

 

In 2013, the U.S. healthcare system spent in excess of $260 billion on prescription drugs and that amount is expected to exceed $450 billion in 2022. Nearly 50% of the U.S. population, and almost 90% of people 65 years and over (or approximately 36 million patients), take at least one prescription drug and more than 10% of the U.S. population, and almost 40% of people 65 years and over (or approximately 16 million patients), take five or more prescription drugs, which we refer to as polypharmacy. We estimate that the overall potential market opportunity for IDgenetix is greater than 150 million patients in the United States, representing the number of people that take at least one prescription drug, which includes the more than 30 million people who are polypharmacy.

 

We believe there are significant health concerns and unnecessary costs associated with the trial-and-error manner in which physicians prescribe drugs, without prior knowledge of an individual patient’s genetic profile. There are an estimated 100,000 deaths and more than two million serious adverse reactions attributable to prescription drug use in the United States each year, at a cost to the healthcare industry that exceeds $136 billion annually. It has been estimated that genetics can account for up to 95% of variability in drug disposition and effects and as much as 40-60% of adverse drug reactions. We believe IDgenetix can improve clinical outcomes and reduce the overall cost of prescription drugs by enabling better drug selection, earlier favorable results and lower occurrence of adverse events.

 

In October 2013, we commercially launched IDgenetix in the United States. Since launch and through September 30, 2014, we completed IDgenetix tests for more than 13,500 patient samples, of which more than 7,500 samples were completed in the quarter ended September 30, 2014. IDgenetix examines genes involved in both the metabolism and pharmacological activity of numerous drugs. It provides physicians with information on the functionality of critical metabolic enzymes and key biological drug targets, where applicable, for each patient. In addition, our algorithm screens for unfavorable metabolic interactions resulting from multiple prescription drugs, over-the-counter drugs and herbal supplements, and environmental and dietary factors that may significantly alter the metabolism of certain drugs. We currently offer 13 tests in the therapeutic areas of cardiovascular disease, neuropsychiatric disorders and pain, and we are developing additional tests/offerings in the therapeutic areas of neurology and rheumatology.

 

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We designed IDgenetix to provide a comprehensive PGx test offering to best meet the needs of our target customers such as long-term and post-acute care facilities, government facilities, integrated delivery networks, or IDNs, and managed care organizations. These institutional healthcare providers require broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions. These customers often operate under fixed-fee-per-patient or fixed-fee-per-procedure arrangements and are searching for ways to improve clinical outcomes at the lowest possible cost. In addition, IDgenetix addresses the needs of physicians across multiple specialties, such as cardiologists, general practitioners, obstetricians and neurologists.

 

Reimbursement for our IDgenetix testing services comes from third-party payors such as Medicare, Medicaid and other governmental payor programs, hospitals, private insurance plans, managed care organizations and individual patients. Tests performed on patients covered by Medicare represented 59% of all IDgenetix tests for the nine months ended September 30, 2014.

 

We generally bill third-party insurance providers upon generation and delivery of an IDgenetix test result to the ordering physician following completion of a test. Currently, we recognize revenue when tests results are delivered for Medicare patients based on amounts set forth under the Clinical Laboratory Fee Schedule or Medicare local coverage determinations for services provided as defined by the Common Procedural Terminology, or CPT, codes, provided that all revenue recognition criteria are met.

 

While a number of non-Medicare payors have also adopted policies approving IDgenetix tests for reimbursement, for all non-Medicare payors, we recognize revenue on a cash basis, as the fee is not considered fixed and determinable and we cannot reliably estimate the amount that will be ultimately collected. We assume the benefits and risk of collection with the third-party payors. Patients may also have out-of-pocket costs for amounts not covered by their insurance carriers, and we bill the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some third-party payors may not cover the IDgenetix tests as ordered by the physician under their reimbursement policies. Consequently, we pursue reimbursement on a case- by-case basis. We will continue to recognize diagnostic testing revenue upon cash collection for non-Medicare payors until we can reliably estimate the amount that is fixed and determinable and that will be ultimately collected.

 

The rate at which our tests are covered and reimbursed has varied, and is expected to continue to vary, by the third-party payor. We pursue reimbursement on a case-by-case basis. If a reimbursement claim is denied, we generally pursue the appeals process with the particular third-party payor. We continue to pursue adoption of positive coverage policies by other private and Medicaid payors.

 

In addition to IDgenetix, we provide research and development services, primarily in oncology, to numerous biopharmaceutical partners. We use our expertise in next-generation sequencing, or NGS, and our computational biology and information technology capabilities to analyze subject samples from preclinical through clinical development. We are validating a number of companion diagnostic test assays in late stage clinical trials.

 

We have incurred significant losses since our inception, including net losses of $1.6 million and $4.1 million for the years ended December 2012 and 2013, respectively. As of September 30, 2014, our accumulated deficit was $19.2 million and we had $7.5 million in cash and cash equivalents. Substantially all our net losses have resulted from costs incurred in connection with our research and development programs and selling, general and administrative costs to support our operations. We expect to incur additional expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and NASDAQ, additional insurance expenses, investor relations activities and other administrative and professional services. Our net losses may fluctuate significantly from quarter to quarter and year to year.

 

From inception through September 30, 2014, we have financed our operations primarily through private placements of our equity and debt securities, our credit facility and our research and development services agreements. We currently have a credit facility in place with Silicon Valley Bank, or SVB, for up to

 

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$20.0 million, of which we had borrowed $12.4 million as of September 30, 2014. As more fully described below, subsequent to September 30, 2014 we borrowed an additional $10 million in term debt and retired our line of credit. We may not be able to raise additional capital on terms acceptable to us, or at all. Any failure to raise capital as and when needed could have a material adverse effect on our results of operations, financial condition and our ability to execute on our business plan. In its report on our consolidated financial statements for the year ended December 31, 2013, our independent registered public accounting firm included an explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern.

 

Acquisition of IDGenetix, Inc.

 

In May 2013, we completed our acquisition of IDGenetix, Inc. At the date of the acquisition, IDGenetix Inc. consisted of an assembled work force comprised of the three former stockholders who transferred know-how comprised of three algorithms in the conceptualization stage of development as of the date of acquisition.

 

Subsequent to the acquisition date, we have performed research and development activities using the know-how to design and develop molecular diagnostic tests and commercially launched these diagnostics tests in October 2013. Based on our evaluation that the algorithms were in the conceptual phase with only insignificant effort expended in research and development activities to advance the existing knowledge toward the development of these tests through the date of acquisition, we concluded that these research and develop activities did not qualify as an asset. As a result of the acquisition of IDGenetix, Inc., there were no assets to record, and all of IDGenetix, Inc.’s liabilities were paid in full prior to the closing of the merger.

 

In connection with our acquisition of IDGenetix, Inc. in May 2013, we issued, as merger consideration, restricted shares of common stock, or the Merger Consideration Stock Awards, and warrants to purchase common stock, or the Merger Consideration Warrants, to each of Greg Hamilton, Jorge Garces, Ph.D., and Shannon Blalock, Pharm.D., who were, collectively, all of the stockholders of IDGenetix, Inc. at the time of the acquisition, and are now officers of our Company, with the exception of Dr. Blalock who resigned effective November 28, 2014.

 

Silicon Valley Bank Credit Facility

 

In March 2014, we entered into a Second Amended and Restated Loan and Security Agreement, or LSA, with SVB, which allows us to borrow up to $10.0 million under two term loans, or the Initial Loans, of $5.0 million each, and up to an additional $5.0 million under a working capital revolving credit line, based upon eligible accounts receivable. Concurrent with the execution of the LSA, we borrowed $5.0 million under one of the term loans and issued warrants to purchase up to 150,000 shares of our Series B redeemable convertible preferred stock to SVB at an exercise price of $1.00 per share. We borrowed the second $5.0 million in term debt in September 2014 and issued warrants to purchase up to an additional 150,000 shares of our Series B redeemable convertible preferred stock to SVB at an exercise price of $1.00 per share. The Initial Loans bear interest at 8.25% and 8.31%, respectively, and mature on September 1, 2017. The working capital line of credit bore interest at the prime rate plus 1.75% (5% at September 30, 2014). As of September 30, 2014, we had $10.0 million outstanding under the term loans and $2.4 million under the working capital line of credit.

 

In November 2014, we amended the LSA, pursuant to which we borrowed an additional $10.0 million in term debt, or the New Loan. Concurrent with the execution of the amendment, the working capital revolving line of credit, which had been repaid subsequent to September 30, 2014, was cancelled. The New Loan bears an interest rate at the greater of 7.32% above the base rate set forth in the LSA and 8%. Interest-only payments are due monthly until April 1, 2015, at which time the term loan will be payable in 30 equal monthly installments of principal and interest. Concurrent with the execution of the amendment to the LSA, we issued warrants to purchase up to 114,380 shares of our Series B redeemable convertible preferred stock to SVB at an exercise price of $3.06 per share. We must meet minimum required revenue thresholds under the amended LSA and are also obligated to make a final payment of 6.5% of the original principal amount, due on the earliest to occur of (1) September 1, 2017, (2) the acceleration of any term loan under the amended LSA due to an event of default, and (3) the mandatory or voluntary prepayment of the term loan.

 

In December 2014, we entered into a Third Amended and Restated Loan and Security Agreement with SVB. There were no material changes to the parties’ rights or obligations thereunder.

 

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Financial Operations Overview

 

Revenue

 

The following table sets forth the percentage of revenue derived from each our revenue sources:

 

     Year Ended
December 31,
    Nine Months Ended
September 30,
 
         2012             2013             2013             2014      

Diagnostic testing

     —       3     —       67

Research services and other

     100     97     100     33

 

We derive our diagnostic testing revenue from the sale of our IDgenetix tests to physicians and other healthcare providers. We only recently launched our IDgenetix tests. We expect that revenue from diagnostic testing will continue to increase in absolute dollars and as a percentage of our revenue for the remainder of 2014 and beyond.

 

We divide our diagnostic testing market in two categories: (1) institutional healthcare providers and (2) physicians. We designed IDgenetix to provide a comprehensive PGx offering to best meet the needs of our target customers such as long-term and post-acute care facilities, government facilities, IDNs and managed care organizations, which we collectively refer to as institutional healthcare providers. We believe that the institutional healthcare provider market categories will be a significant driver of growth for the company both near- and long-term due to the many types and significant number of potential institutional healthcare providers. In addition, IDgenetix addresses the needs of physicians across multiple specialties.

 

Through September 30, 2014, 83% of our recognized diagnostic testing revenue has been derived from Medicare customers, with the remaining portion derived from private insurance providers or individual patients. We recognize revenue from our Medicare customers when we issue the final IDgenetix test report, provided that all revenue recognition criteria are met. We recognize all revenue from non-Medicare customers when payment is received. We will continue to recognize revenue from non-Medicare customers on a cash-basis until we can establish payment history with these customers and can reliably estimate the amount that will be ultimately collected.

 

The approximate number of IDgenetix tests we processed and billed, and for which we recognized revenue in accordance with our revenue recognition policies discussed above, were as follows:

 

    Year Ended
December 31,
2013
    Three Months Ended
March 31,

2014
    Six Months Ended
June  30,

2014
    Nine Months Ended
September 30,
2014
 

IDgenetix samples processed and billed

    348        1,724        5,778        13,515   

IDgenetix samples for which revenue was recognized

    237        1,241        4,211        9,709   

 

We will continue to make requests for payment from payors and patients and/or appeal payment decisions made by third-party payors. As a result, we may receive payment for a portion of these tests. However, a portion of our requests for payments could be denied or only partially satisfied. If third-party payors agree to pay us for these tests in the future, we will recognize revenue for such tests in the period in which all of our revenue recognition criteria are met. This will continue to affect the comparability of our revenues from period to period. We regularly review to determine if third-party payors meet our revenue recognition criteria and account for the impact of any change on a prospective basis.

 

We derive our research services and other revenue primarily from research and development services, principally in oncology, to numerous biopharmaceutical partners. These services provide a start-to-finish suite of tools focused on molecular biomarker discovery, assay development, assay validation and prospective/retrospective clinical trial testing in support of companion diagnostic development and commercialization. We also derive revenue from licensing fees and fees from third parties for use of our technologies and laboratory services, which we include in research services and other revenue.

 

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Our accounts receivable consists of amounts due from Medicare for our IDgenetix tests and amounts due from our research services and other revenue. We record accounts receivable net of an allowance for doubtful accounts, and are set forth below:

 

     September 30, 2014  
     0-30 Days      31-60 Days      61-90 Days      Over 90     Total  

Medicare

   $ 1,187       $ 196       $ 131       $ 82      $ 1,596   

Research services and other

     1,211         117         463         289        2,080   

Less: allowance for doubtful accounts

     —           —           —           (49     (49
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Accounts receivable, net

   $ 2,398       $ 313       $ 594       $ 322      $ 3,627   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31, 2013  
     0-30 Days      31-60 Days      61-90 Days      Over 90     Total  

Medicare

   $ 125       $ 61       $ —         $ —        $ 186   

Research services and other

     638         1,064         344         289        2,335   

Less: allowance for doubtful accounts

     —           —           —           (58     (58
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Accounts receivable, net

   $ 763       $ 1,125       $ 344       $ 231      $ 2,463   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

Since we report revenue from Medicare based on the contractual rate, as established by the CMS National Laboratory Fee Schedule or Medicare local coverage determinations for services provided as defined by the CPT codes, we do not record a contractual allowance. Since we do not record revenue from non-Medicare payors until cash is collected, there are no accounts receivable from non-Medicare payors.

 

Our days sales outstanding, or DSO, are set forth below:

 

     At September 30, 2014      At December 31, 2013  

Medicare

     27         28   

Research services and other

     133         96   

 

We review our accounts receivable for potential uncollectible accounts on at least a quarterly basis, and record write-offs as deemed necessary on a case-by-case basis. To date, losses from uncollectible accounts have been minimal.

 

Cost of Revenue

 

Our cost of revenue includes the cost of raw materials, supplies, labor for laboratory personnel, equipment and facility expenses associated with performing our research services and processing samples for our IDgenetix tests, in addition to packaging, freight charges and shipping supplies for our IDgenetix tests. We perform all of our research services and IDgenetix tests at our facility located in San Diego, California. Facility expenses include allocated overhead including rent, information technology, equipment depreciation and utilities.

 

We record costs associated with each IDgenetix test when revenue is recognized during the period in which the test is completed and a final report has been issued, regardless of when revenue is recognized for that test. We expect our cost of diagnostic testing revenue to increase in absolute dollars as the number of tests we perform increases. We record the costs associated with our research services and other revenue when such costs are incurred.

 

Our cost of revenue will generally grow in proportion to revenue, however, because a large percentage of our total manufacturing costs are fixed, we also expect that as our IDgenetix test volumes increase we will realize manufacturing efficiencies, and associated increase in gross margin.

 

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Nevertheless, our gross margin could be negatively impacted in the future by several factors, including, but not limited to: (1) excess capacity if actual utilization is not sufficient to cover our committed capacity, particularly as we expand our laboratory facility and our related fixed occupancy costs increase in 2015; (2) idle capacity charges associated with additional downtime for implementing improvements to manufacturing equipment; (3) unplanned downtime caused by equipment failures; or (4) higher-than-anticipated failure rates for our IDgenetix tests or work performed under our research services agreements.

 

Research and Development

 

We expense our research and development costs as incurred. To date, substantially all of our research and development expenses have been incurred for company-sponsored research and development activities. Our research and development costs are comprised primarily of costs incurred in performing research and development activities for continued support and development of our IDgenetix portfolio, including personnel-related costs, contract services, laboratory supplies and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expensed all costs including materials and supplies incurred prior to establishing technological feasibility of our IDgenetix tests in October 2013, as such costs were incurred. We expect research and development expenses to increase in future periods as we incur costs to sponsor or co-sponsor IDgenetix-guided clinical studies as part of our strategy to target institutional healthcare providers, develop additional IDgenetix tests, expand the range of test options available to healthcare providers using IDgenetix and continue to invest in IDgenetix process improvements.

 

We evaluate future test development based upon the clinical utility of PGx testing within a therapeutic area, prescription volume, commercial potential, synergy with our current IDgenetix test offerings and clinical relevance to institutional healthcare providers. As a result of the risks and uncertainties involved in developing new IDgenetix tests, process improvements or technologies, we may not be able to estimate the nature, timing and cost of the efforts necessary to complete each of our major projects.

 

Sales and Marketing

 

Our sales and marketing expenses consist primarily of sales commissions to our distributors and contract sales organizations, personnel-related costs for our customer service and marketing teams, direct marketing expenses, consulting costs, and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expect our sales and marketing expenses to increase in future periods as we grow our outside sales and internal customer service and marketing teams to help drive the adoption of our IDgenetix tests.

 

General and Administrative

 

General and administrative expenses include executive, finance and accounting, regulatory, human resources and legal functions. These expenses consist of personnel-related costs, audit and legal expenses, consulting costs, bad debt expense and allocated overhead, including rent, information technology, equipment depreciation and utilities. We expect to incur additional expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and NASDAQ, additional insurance expenses, investor relations activities and other administrative and professional services.

 

Interest Expense

 

Interest expense consists of interest and borrowing costs on outstanding borrowings.

 

Factors Affecting Our Performance

 

We believe that our future results of operations are dependent upon a number of factors, including the 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” in this prospectus.

 

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The Number of Samples we Receive, Process, and Bill

 

The growth in our business is tied to the number of patient samples we receive, process and bill. We incur costs of collecting and shipping the samples and a portion of the costs of performing tests where we cannot issue a final patient report and bill due to inadequate genetic material in the sample or other test failures. Because we cannot bill for all samples received, the number of patient samples received does not directly correlate to the total number of patient reports issued and billed, and thus potential revenue generated.

 

Continued Adoption of and Reimbursement for IDgenetix

 

We expect we will continue to derive a substantial portion of our revenue from our IDgenetix testing services, which we currently bill on a fee-for-service basis to third-party payors such as Medicare, Medicaid and other governmental payor programs, hospitals, private insurance plans, managed care organizations and individual patients. Additionally, from time to time, third-party payors change processes and reimbursement rates that may affect the amount or timing of payments. These changes may result in uneven cash flow or impact the timing of revenue recognized with these payors.

 

To facilitate increased adoption of IDgenetix, we plan to increase our marketing efforts and to selectively increase our internal and external sales forces in high-volume U.S. geographies. Because some third-party payors consider IDgenetix experimental and investigational, we may not receive payment on tests, and payments may be lower than the amounts that we bill. We are generally not reimbursed for our IDgenetix tests at full list price. Through September 30, 2014, 83% of our recognized diagnostic testing revenue has been derived from Medicare customers based on amounts set forth in the Clinical Laboratory Fee Schedule or Medicare local coverage determinations for services provided as described by existing CPT codes. Reimbursement to healthcare providers, such as specialized diagnostic service providers like us, is subject to continuing change in policies by governmental payors, such as Medicare and Medicaid, private insurers, including managed care organizations, and other private payors, such as hospitals and private medical groups.

 

As a Medicare-participating laboratory based in California, we bill Noridian Healthcare Solutions, or Noridian, the Medicare Administrative Contractor, or MAC, for California, and are subject to Noridian’s local coverage and reimbursement policies. Effective July 2014, Noridian no longer covers and reimburses for CYP1A2 testing, which negatively affects our future revenue and gross margin. This change in coverage decreased our average Medicare reimbursement rate per sample from approximately $1,000 to $1,100 to approximately $720 to $780.

 

In addition, in August 2014, Noridian issued a draft local coverage determination, or LCD, that proposes to revise coverage and impose policy limits related to genetic testing, including testing for the CYP2D6 and CYP2C19 enzymes which are part of our IDgenetix tests. The draft LCD would impact all three therapeutic areas in which we currently offer testing (cardiovascular disease, neuropsychiatric disorders and pain) as well as those therapeutic areas we intend to expand in (neurology and rheumatology). The draft LCD is similar to the LCDs of two other MACs (Palmetto GBA and CGS Administrators) that already restrict coverage of the CYP2D6 and CPY2C19 enzymes to only certain patients with depression who are initiating therapy with one of three specified medications (for CYP2D6) and patients with acute coronary syndrome (ACS) undergoing percutaneous coronary interventions (PCI) who are initiating or reinitiating Plavix therapy (for CPY2C19). Palmetto and CGS currently consider all other clinical indications as investigational at this time. Noridian’s draft LCD, if finalized, would adopt the same coverage criteria. The draft LCD was subject to a 60-day comment period beginning on September 3, 2014 and ending on November 3, 2014. If the proposed LCD as currently drafted is finalized, it would limit coverage of CPY2D6 and CYP2C19 testing, which would impact all three therapeutic areas in which our IDgenetix tests are offered and adversely affect our business. We currently have plans in place that we expect may mitigate some of the expected impacts of this proposed LCD on our business, primarily through re-configuring our IDgenetix tests to harmonize with the LCD in a manner consistent with approaches by other industry providers. With the projected implementation of these plans, and based upon the historical ordering patterns of our customers, we expect that our average Medicare reimbursement per sample will decrease to approximately $600 to $620 if the LCD is implemented as drafted.

 

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We are continuing to take other steps to mitigate this and any future reimbursement risk through:

 

   

continued correspondence with CMS and local MACs to encourage greater alignment between the FDA’s positions on drug warnings related to pharmacogenetics and Medicare’s and MAC’s positions on clinical utility; and

 

   

continued investments in our own clinical studies to establish clinical utility of our IDgenetix tests as a way to establish national or local coverage determinations specific to our IDgenetix tests.

 

However, there can be no assurance that we will be successful in any of these efforts.

 

Palmetto GBA, the current MAC for North Carolina, South Carolina, Virginia and West Virginia and the former MAC for California, developed the Molecular Diagnostic Services Program, or MolDX, in 2011. As part of this program, Palmetto issued a Molecular Test Panel Edit Alert in November 2014 which announced that laboratories performing test panels in affected jurisdictions should start to register each panel, obtain a unique MolDX identifier for each panel, and bill such panels using a single current procedural terminology, or CPT, code and the unique MolDX identifier. Laboratories that perform molecular diagnostic testing and submit claims to Palmetto GBA or Noridian may be affected by the MolDX program, as Noridian is responsible for administering the MolDX program and implementing the MolDX guidelines developed by Palmetto in California. Effective April 1, 2015, Palmetto has announced that it will begin rejecting claims for tests performed as panels and not billed in accordance with the MolDX program. We intend to register each of our IDgenetix test panels and obtain a unique MolDX identifier for test panels if it is required of us by Palmetto or Noridian before April 1, 2015. Although not part of the announcement, it is possible that payments under the test panels may lead to a reduction in payments for our tests, which could have a material adverse financial impact on us.

 

Even with these current and potential developments in Medicare reimbursement, we believe that we have developed our business model to withstand these and future impacts of decreases in reimbursement, primarily based upon the following factors:

 

   

We have designed our cost structure to maintain positive gross margins even with the risk of decreases in reimbursement, supporting our belief that our cost of sales differentiation is a competitive advantage. For the nine months ended September 30, 2014, we generated gross margin of approximately 81% from our diagnostic testing revenues. Even with future expected and potential changes in reimbursement in the near- and long-term, we believe that we will be able to maintain gross margins for our diagnostic testing revenue in the 65% to 70% range; and

 

   

We have elected to launch our business using third-party sales organizations which are paid a commission based primarily upon a percentage of sales, which has allowed us to better absorb the impact of changes in reimbursement. If reimbursement rates decline, so will our sales and marketing costs.

 

Some private insurers and other third-party payors link their rates to Medicare’s reimbursement rates, and a reduction in Medicare reimbursement rates for clinical laboratory services could result in a corresponding reduction in the reimbursements we receive from such third-party payors. Our revenue growth depends on our ability to achieve broader coverage and reimbursement at increased levels from third-party payors and to expand our base of prescribing physicians.

 

We expect our revenue growth will increase as more third-party payors make positive coverage decisions, which should enhance our collections. If we are unable to expand the base of prescribing physicians at an acceptable rate, or if we are not able to execute our strategy for increasing reimbursement, we may not be able to effectively increase our revenue. In addition, any reductions in coverage and reimbursement levels for our IDgenetix testing services would decrease our revenue and adversely affect our results of operations and financial condition.

 

Revenue Recognition

 

We recognize revenue from our Medicare customers when we issue the final IDgenetix test report, provided that all revenue recognition criteria are met. We recognize all revenue from non-Medicare customers when

 

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payment is received. We will continue to recognize revenue from non-Medicare customers on a cash basis until we can establish payment history with these customers and can reliably estimate the amount that will be ultimately collected. Because the timing and amount of cash payments received from payors is difficult to predict, we expect that our revenue will fluctuate significantly in any given quarter.

 

Because we are in the early stages of commercialization of IDgenetix, we have had limited payment and collection history, particularly from our non-medicare customers. Notwithstanding our efforts to obtain payment for our tests, payors may deny our claims, in whole or in part, and we may never receive revenue from previously performed but unpaid tests. Revenue from these tests, if any, may not be equal to the billed amount due to a number of factors, including differences in reimbursement rates, the amounts of patient co-payments, the existence of secondary payors and claims denials.

 

We record the expense for tests in the period in which the test is conducted and recognize revenue for tests in the period in which our revenue recognition criteria are met. Accordingly, any revenue that we receive in respect of previously performed but unpaid IDgenetix tests will favorably impact our liquidity and results of operations in future periods.

 

Increased Adoption by Institutional Healthcare Organizations

 

We recently entered into an agreement for our first pilot study with a managed care organization. We intend to devote significant financial resources and personnel to sponsor or co-sponsor additional clinical studies within other institutional healthcare organizations. The intent of these studies will be to collect clinical data on IDgenetix-guided therapy, as compared to the current standard of care, against defined clinical endpoints, such as number of prescription drugs, hospitalizations and length of stay, and other health assessments. However, we expect that we may have very little control over, or insight into, the conduct of any such clinical studies. Negative, or even mixed, results from any such study or from similar studies undertaken independently by healthcare providers or our competitors could harm our reputation and could have a negative impact on our relationship with the applicable healthcare organization and on our ability to market our services to other healthcare organizations, which could harm our business.

 

Expansion of our IDgenetix Portfolio

 

We believe our future success is dependent upon our ability to successfully market our existing IDgenetix test portfolio to additional healthcare providers within the United States and to develop and commercialize enhanced tests or additional tests aimed at additional therapeutic areas. Our pipeline of new tests is in various states of development and may take more time to commercialize than we currently anticipate. Furthermore, enhancing or developing new tests requires us to anticipate patients’, healthcare providers’ and payors’ needs and emerging technology trends accurately. We may experience research and development, regulatory, marketing and other difficulties that could delay or prevent our introduction of enhanced or new tests.

 

Seasonal Fluctuations

 

Although we only launched our IDgenetix tests in the fourth quarter of 2013 and have not experienced any known impact of seasonality on our business to date, we expect that our business could be subject to fluctuations in volume throughout the year. Like other companies in our field, vacations by physicians and patients could negatively affect our volumes during the summer months and during the end-of-year holidays compared to other times of the year. Our reimbursed rates and cash collections could also be subject to seasonality. Medicare has historically made downward adjustments in its fee schedules at the beginning of the year, which may negatively affect our reimbursement. Additionally, patient deductibles generally reset at the beginning of each year, which means that patients early in the year are responsible for a greater portion of the cost of our tests, and we have lower collection rates from individuals than from Medicare and third-party payors. Later in the year, particularly in the fourth quarter, we expect we could experience better payment results as third-party payors tend to clear pending claims toward year end. This trend could increase our cash collections in the fourth quarter and decrease cash collections for the subsequent first quarter of the succeeding year. The effects, if any, of these seasonal fluctuations in future periods may be obscured by the growth of our business.

 

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Liquidity and Capital Resources

 

We have incurred significant losses since our inception, including net losses of $1.6 million and $4.1 million in the years ended December 2012 and 2013, respectively. As of September 30, 2014, our accumulated deficit was $19.2 million and we had $7.5 million in cash and cash equivalents and $12.4 million in borrowings under our credit facility with SVB. Subsequent to September 30, 2014, we repaid the $2.4 million balance on the working capital line of credit under this credit facility, and in November 2014, we amended the LSA with SVB pursuant to which we borrowed an additional $10.0 million in term debt and the working capital line of credit was cancelled. Although it is difficult to predict future liquidity requirements, we believe that the net proceeds from this offering, together with our existing cash and cash equivalents and anticipated future revenue, will be sufficient to fund our operations through at least the next 12 months.

 

The report of our independent registered public accounting firm on our audited financial statements for the year ended December 31, 2013 includes an explanatory paragraph stating that our recurring losses from operations and negative cash flows from operating activities raise doubt about our ability to continue as a going concern. If we are unable to obtain additional financing on commercially reasonable terms, our business, financial condition and results of operations will be materially adversely affected and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our financial statements. We may obtain additional financing in the future through other equity or debt financings or through collaborations or partnerships with other companies.

 

The following table sets forth a summary of the net cash flow activity for each of the periods set forth below (in thousands):

 

     Year Ended
December 31,
     Nine Months Ended September 30,   
         2012             2013             2013             2014      
                 (unaudited)  

Net cash used in operating activities

   $ (1,535   $ (4,929   $ (2,104   $ (4,280

Net cash used in investing activities

     (164     (1,176     (844     (1,228

Net cash provided by financing activities

     174        8,735        6,378        10,041   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

   $ (1,525   $ 2,630      $ 3,430      $ 4,533   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

Net cash used in our operating activities was $2.1 million for the nine months ended September 30, 2013 as compared to $4.3 million for the same period in 2014. Net cash used in our operating activities was $1.5 million and $4.9 million for the years ended December 31, 2012 and 2013, respectively. The primary use of cash was to fund our net losses in each of these years ended December 31, 2012 and 2013, and for the nine months ended September 30, 2013 and 2014, to advance the development, commercialization and expansion of our IDgenetix test portfolio.

 

Net cash used in our investing activities was $0.8 and $1.2 million for the nine months ended September 30, 2013 and 2014, respectively. During the years ended December 31, 2012 and 2013, our investing activities used cash of $0.2 million and $1.2 million, respectively. Cash used in our investing activities for each of these periods was due to the purchase of property and equipment to support our operations.

 

Net cash provided by our financing activities in the nine months ended September 30, 2013 was $6.4 million, attributed to proceeds from issuance of shareholder notes payable, which were ultimately converted into preferred stock in connection with our Series B preferred stock financing in May 2013. During the nine months ended September 30, 2014 our financing activities provided net cash of $10.0 million, attributed to net proceeds from our credit facility with SVB, offset in part by the repayment of existing equipment loans. Our financing activities in the year ended December 31, 2012 provided net cash of $0.2 million, compared to $8.7 million during the year ended December 31, 2013. Financing activities in 2012 consisted of proceeds from the first closing on our shareholder notes payable. Financing activities in 2013 consisted of the net proceeds from

 

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our issuance of 7.3 million shares of Series B redeemable convertible preferred stock, stockholder notes payable and our bank credit facility.

 

Our future capital requirements are difficult to forecast and will depend on many factors, including:

 

   

fluctuations in our gross margin and negative operating margin;

 

   

our ability to generate sales including the commercial success of IDgenetix testing services;

 

   

fluctuations in working capital;

 

   

the costs to sponsor or co-sponsor IDgenetix-guided clinical studies as part of our strategy to target institutional healthcare providers;

 

   

the costs to expand our sales, marketing and customer service capabilities;

 

   

the costs of product development initiatives, including expanding our IDgenetix test portfolio;

 

   

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

 

   

the extent to which we acquire or invest in new businesses, products or technologies, or expand internationally.

 

Until such time, if ever, as we can generate more substantial revenue, we may be required to finance our cash needs through equity or debt financings or through collaborations or partnerships with other companies. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our common stockholders. If we are unable to raise additional funds through equity, debt financings, or through collaborations or partnerships with other companies when needed, we may be required to delay, limit, reduce or terminate our commercialization and product development efforts.

 

Results of Operations

 

Comparison of the Nine Months Ended September 30, 2013 and 2014

 

     Nine Months Ended
September 30,
    Dollar
Change
    %
Change
 
     2013     2014      
    

(unaudited)

             
     (in thousands)        

Revenue:

        

Diagnostic testing

   $ —        $ 9,067      $ 9,067     

Research services and other

     4,235        4,542        307        7
  

 

 

   

 

 

   

 

 

   

Total revenue

     4,235        13,609        9,374        221

Cost of revenue:

        

Diagnostic testing

     —          1,763        1,763     

Research services and other

     3,036        3,008        (28     (1 )% 
  

 

 

   

 

 

   

 

 

   

Total cost of revenue

     3,036        4,771        1,735        57 %
  

 

 

   

 

 

   

 

 

   

Gross profit

     1,199        8,838        7,639        637 %

Operating expenses:

        

Research and development

     1,134        2,485        1,351        119 %

Sales and marketing

     1,098        5,246        4,148        378 %

General and administrative

     1,927        6,432        4,505        234
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     4,159        14,163        10,004        241 %
  

 

 

   

 

 

   

 

 

   

Loss from operations

     (2,960     (5,325     (2,365     (80 )%

Interest expense and other income, net

     24        (388     (412     (1,717 )%

Loss from change in fair value of warrant liability

     —          (194     (194  
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (2,936   $ (5,907   $ (2,971     101 %
  

 

 

   

 

 

   

 

 

   

 

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Revenue

 

Our revenue is derived from our IDgenetix diagnostic testing, research services and license payments. Our revenue and samples processed were as follows (in thousands):

 

     Nine Months
Ended September 30,
    Change      %
Change
 
     2013     2014       
     (unaudited)               

Revenue:

         

Diagnostic testing

   $ —        $ 9,067      $ 9,067      

Research services and other

     4,235        4,542        307         7
  

 

 

   

 

 

   

 

 

    

Total

   $ 4,235      $ 13,609      $ 9,374         221
  

 

 

   

 

 

   

 

 

    

% of Revenue:

         

Diagnostic testing

         67     

Research services and other

     100     33     
  

 

 

   

 

 

      

Total

     100     100     
  

 

 

   

 

 

      

IDgenetix samples processed:

         

Medicare

     —          7,972        7,972      

Non-Medicare

     —          5,543        5,543      
  

 

 

   

 

 

   

 

 

    

Total

     —          13,515        13,515      
  

 

 

   

 

 

   

 

 

    

IDgenetix samples for which revenue was recognized:

         

Medicare

     —          7,972        7,972      

Non-Medicare

     —          1,737        1,737      
  

 

 

   

 

 

   

 

 

    

Total

     —          9,709        9,709      
  

 

 

   

 

 

   

 

 

    

 

Our diagnostic testing revenue for the nine months ended September 30, 2014 was $9.1 million, attributable to the commercial launch of our IDgenetix test portfolio in October 2013, and represented 67% of our total revenue. We expect that revenue from diagnostic testing will continue to increase in absolute dollars and as a percentage of our revenue for the remainder of 2014 and beyond.

 

We are not dependent upon a single or small number of healthcare providers, which we consider to be the customers for IDgenetix testing, the loss of which would have a material adverse effect on our business. A relatively small number of contract sales organizations and distributors generate a significant percentage of our diagnostic testing revenue. For the nine months ended September 30, 2014, three of our contract sales organizations, PGx Medical, LLC, B&D Medical, LLC and Core Genetics, Inc., generated 35%, 28% and 17% of our diagnostic testing revenue, respectively. In addition, a relatively small number of third-party payors comprises the majority of our IDgenetix test revenue. Medicare comprised 83% of our diagnostic testing revenue for the nine months ended September 30, 2014.

 

Our research services and other revenue increased $0.3 million, or 7%, during the nine months ended September 30, 2014 as compared to the same period in 2013. This increase is primarily due to timing of performing services when compared to the nine months ended September 30, 2013. Our research services and other revenue has historically fluctuated from period to period and likely will continue to fluctuate in the future based upon the timing and composition of funding under existing and future agreements, as well as our partners’ clinical trial and regulatory approval timelines.

 

For the nine months ended September 30, 2013, revenue from two of our customers represented 21% and 14% of our research services and other revenue, respectively. During the nine months ended September 30, 2014, revenue from two customers represented 30% and 11% of research services and other revenue, respectively. In addition, because Noridian is no longer reimbursing for IDgenetix tests covering the CYP1A2 gene, effective as

 

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of July 2014, we expect that our weighted-average reimbursement rate per sample will decrease from approximately $1,000 to $1,100 to approximately $720 to $780 with a further reduction to approximately $600 to $620 if the draft LCD from Noridian becomes effective.

 

Cost of Revenue

 

Our cost of revenue increased $1.7 million, or 57%, during the nine months ended September 30, 2014 as compared to the same period in 2013. This increase is attributable primarily to the commercial launch of our IDgenetix test portfolio in October 2013. We established technological feasibility in October 2013, and materials that were purchased prior to October 2013 were previously expensed to research and development but were consumed in commercial operations in 2013.

 

Our gross profit increased $7.6 million, or 637%, during the nine months ended September 30, 2014 as compared to the same period in 2013, and our gross margin improved from 28% to 65%. This improvement is attributable to both efficiencies in our research services operating costs and sales from our IDgenetix tests, which typically have higher margins than our research services and other revenue.

 

Many of the consumable supplies and reagents used as raw materials in our IDgenetix testing process are procured from a limited number of suppliers, some of which are sole-source. Two suppliers accounted for approximately 54% and 15%, respectively, of our materials purchases for nine months ended September 30, 2014.

 

Research and Development

 

Our research and development expenses increased $1.4 million, or 119%, during the nine months ended September 30, 2014 as compared to the same period in 2013. This increase was primarily due to increased personnel, materials and other costs we incurred to advance the development, commercialization and expansion of our IDgenetix test portfolio.

 

Sales and Marketing

 

Our sales and marketing expenses increased $4.1 million, or 378%, during the nine months ended September 30, 2014 as compared to the same period in 2013. The increase was driven primarily by the following costs associated with the commercialization of our IDgenetix test portfolio:

 

   

sales commissions to our distributors and contract sales organizations;

 

   

personnel-related costs related to the establishment of our customer service and marketing functions; and

 

   

direct marketing expenses and consulting costs.

 

General and Administrative

 

Our general and administrative expenses increased $4.5 million, or 234%, during the nine months ended September 30, 2014 as compared to the same period in 2013. This increase is primarily attributable to costs related to expanding our executive, regulatory, finance and accounting, human resources and legal functions, consisting primarily of personnel-related costs, audit and legal expenses, outside services and consulting costs. We expect to incur additional expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and NASDAQ, additional insurance expenses, investor relations activities and other administrative and professional services.

 

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Comparison of the Years Ended December 31, 2012 and 2013

 

     Year Ended
December 31,
    Change     %
Change
 
   2012     2013      
     (in thousands)        

Revenue:

        

Diagnostic testing

   $ —        $ 196      $ 196     

Research services and other

     6,915        7,150        235        3
  

 

 

   

 

 

   

 

 

   

Total revenue

     6,915        7,346        431        6

Cost of revenue:

        

Diagnostic testing

     —          101        101     

Research services and other

     4,772        4,663        (109     (2 )% 
  

 

 

   

 

 

   

 

 

   

Total cost of revenue

     4,772        4,764        (8 )     0
  

 

 

   

 

 

   

 

 

   

Gross profit

     2,143        2,582        439        20

Operating expenses:

        

Research and development

     777        1,733        956        123

Sales and marketing

     1,555        1,842        287        18

General and administrative

     1,405        3,092        1,687        120
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     3,737        6,667        2,930        78
  

 

 

   

 

 

   

 

 

   

Loss from operations

     (1,594     (4,085     (2,491     156

Interest expense and other income, net

     9        27        18       200
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (1,585   $ (4,058   $ (2,473     156 %
  

 

 

   

 

 

   

 

 

   

 

Revenue

 

Our revenue are derived from our IDgenetix diagnostic testing, research services and license payments. Our revenue and samples processed were as follows (in thousands):

 

     Year Ended
December 31,
    Change      %
Change
 
     2012     2013       

Revenue:

         

Diagnostic testing

   $ —        $ 196      $ 196      

Research services and other

     6,915        7,150        235         3
  

 

 

   

 

 

   

 

 

    

Total

   $ 6,915      $ 7,346      $ 431         6
  

 

 

   

 

 

   

 

 

    

% of Revenue:

         

Diagnostic testing

     —       3     

Research services and other

     100     97     
  

 

 

   

 

 

      

Total

     100     100     
  

 

 

   

 

 

      

IDgenetix samples processed:

         

Medicare

     —          230        230      

Non-Medicare

     —          118        118      
  

 

 

   

 

 

   

 

 

    

Total

     —          348        348      
  

 

 

   

 

 

   

 

 

    

IDgenetix samples for which revenue was recognized:

         

Medicare

     —          230        230      

Non-Medicare

     —          7        7      
  

 

 

   

 

 

   

 

 

    

Total

     —          237        237      
  

 

 

   

 

 

   

 

 

    

 

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Our diagnostic testing revenue for the year ended December 31, 2013 was $0.2 million, attributable to the commercial launch of our IDgenetix test portfolio in October 2013, and represented 3% of our total revenue. We expect that revenue from diagnostic testing will continue to increase in absolute dollars and as a percentage of our revenue for the remainder of 2014 and beyond.

 

For the year ended December 31, 2013, two of our contract sales organizations, PGx Medical, LLC and B&D Medical, LLC, generated 66% and 26% of our diagnostic testing revenue, respectively. Medicare comprised 96% of our diagnostic testing revenue for the year ended December 31, 2013.

 

Our research services and other revenue increased $0.2 million, or 3%, during the year ended December 31, 2013 as compared to the same period in 2012. This increase was primarily attributable to increased volume in research services activity offset by a reduction in license revenue from 2012. Our research services and other revenue has historically fluctuated from period to period and likely will continue to fluctuate in the future based upon the timing and composition of funding under existing and future agreements, as well as our partners’ clinical trial and regulatory approval timelines.

 

For the year ended December 31, 2012, revenue from two customers represented 13% and 10% of our research services and other revenue, respectively. For the year ended December 31, 2013, revenue from three customers represented 22%, 12% and 11% of our research services and other revenue, respectively.

 

Cost of Revenue

 

Our cost of revenue remained relatively flat from 2012 to 2013, even as our revenue levels increased, and our gross profit increased by $0.4 million. Our gross margin increased from 31% to 35%, attributable to higher realization on our research services revenue, and, to a lesser extent, contribution from our IDgenetix tests which we launched commercially in October 2013. We established technological feasibility in October 2013, and materials that were purchased prior to October 2013 were previously expensed to research and development but were consumed in commercial operations in 2013.

 

Two suppliers accounted for approximately 54% and 12%, respectively, of our materials purchases for the year ended December 31, 2013.

 

Research and Development

 

Our research and development expenses increased $1.0 million, or 123%, from 2012 to 2013. This increase was primarily due to increased personnel, materials and other costs we incurred to advance the development, commercialization and expansion of our IDgenetix test portfolio.

 

Sales and Marketing

 

Our sales and marketing expenses increased $0.3 million, or 18%, from 2012 to 2013. We only began to incur expenses related to the commercial sales of IDgenetix in late 2013.

 

General and Administrative

 

Our general and administrative expenses increased $1.7 million, or 120%, from 2012 to 2013. This increase is primarily attributable to costs related to expanding our executive, regulatory, finance and accounting, human resources and legal functions, consisting primarily of personnel-related costs, audit and legal expenses, outside services and consulting costs.

 

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Critical Accounting Policies and Significant Judgments and Estimates

 

Our management’s discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.

 

While our significant accounting policies are more fully described in the notes to our audited consolidated financial statements appearing elsewhere in this prospectus, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our financial statements and understanding and evaluating our reported financial results.

 

Revenue Recognition

 

We recognize revenue when the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.

 

Diagnostic Testing Revenue

 

We generally bill third-party insurance providers upon generation and delivery of an IDgenetix test result to the ordering physician following completion of a test. We recognize revenue upon delivery of the test results to the ordering physician when the above revenue recognition criteria have been met, based upon one or all of the following: (1) We have an established payment history with the payer and collectibility is reasonably assured; (2) we have a contractual arrangement with the payer; or (3) as in the case of Medicare, the payer has published data on approved reimbursement rates for our IDgenetix tests. We recognize revenue for Medicare patients based on amounts allowed by the Center for Medicare and Medicaid Services, or CMS, National Laboratory Fee Schedule or Medicare local coverage determinations for services provided as defined by the CPT codes, provided that all revenue recognition criteria are met. We received our authorized Medicare National Provider Identification number, or NPI, in November 2013.

 

For those tests completed for which the above revenue recognition criteria have not been met at the time the test results are delivered, we recognize revenue on a cash basis, as the fee is not considered fixed and determinable or we cannot reliably estimate the amount that will be ultimately collected. We assume the benefits and risk of collection with the third-party payors. Patients may also have out-of-pocket costs for amounts not covered by their insurance carriers, and we bill the patient directly for these amounts in the form of co-pays and deductibles in accordance with their insurance carrier and health plans. Some payors may not cover the IDgenetix tests as ordered by the physician under their reimbursement policies. Consequently, we pursue reimbursement on a case-by-case basis. We will continue to recognize diagnostic testing revenue upon cash collection for non-Medicare payors until we can reliably estimate the amount that is fixed and determinable and that will be ultimately collected.

 

Research Services and Other Revenue

 

We regularly enter into contracts where revenue is derived from multiple elements including assay development and sample testing services. The delivery of these services is within a short time from the contract

 

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execution date; however, delivery may vary based on the complexity of the deliverable. Revenue recognition for contracts with multiple elements is based on the individuals units of accounting determined to exist in the contract. A delivered item is considered a separate unit of accounting when the delivered item has value to the customer on a stand-alone basis.

 

We allocate revenue at the inception of the agreement to all deliverables based on their relative selling price. The relative selling price for each deliverable is determined using vendor specific objective evidence, or VSOE, of selling price or third-party evidence of selling price if VSOE does not exist. If neither VSOE nor third-party evidence of selling price exists, we use our best estimate of the selling price for the deliverable. We have determined that assay development, assay validation and sample testing each have stand-alone value due to the fact that such services have been sold separately. Revenue for assay development and assay validation services is recognized upon delivery of assay development and assay validation reports to the customer. Revenue for sample testing services is recognized when earned, which is generally at the time the sample testing results data is made available for delivery to the customer or agreed-upon performance conditions are met. Due to the customized nature of each assay development, we have not established a selling price using VSOE or third-party evidence. Given the lack of VSOE and third-party evidence, we rely upon prices set by management. These prices are generally based on an estimate of the amount of time and materials required to perform the services, plus a reasonable profit margin.

 

We also enter into agreements to license certain technology rights on an exclusive or nonexclusive basis in exchange for license fees and/or royalties. When a payment is specifically tied to a separate earnings process, revenue is recognized when the specific performance obligation associated with the payment is completed.

 

Cash received in advance of services being performed is recorded as deferred revenue and recognized as revenue when services are performed over the applicable term of the agreement.

 

Facility Lease

 

During the second quarter of 2014, we negotiated certain landlord/tenant incentives, rent holidays and escalations in the base price of rent payments under an operating lease for our new facility, which we expect to occupy in early 2015. We are accounting for this lease under Accounting Standards Codification, or ASC, 840 “Leases,” pursuant to which we are the accounting owner of the leasehold improvements being constructed on our behalf. For purposes of determining the period over which the incentives are recognized or amortized, the initial term of an operating lease includes the build-out period of leases, where no rent payments are typically due under the terms of the lease. We recognize rent holidays and rent escalations on a straight-line basis over the initial lease term. The landlord/tenant incentives are recorded as an increase to deferred rent in our balance sheets and are amortized on a straight-line basis over the initial lease term. Deferred rent balances are classified as short-term or long-term in our balance sheets based upon the period when reversal of the liability is expected to occur.

 

We amortize leasehold improvements, including amounts funded by landlord/tenant incentives or allowances, for which the related deferred rent is amortized as a reduction of lease expense, over the shorter of their economic lives or the lease term.

 

Stock-Based Compensation

 

Stock-based compensation expense for awards with time-based vesting criteria is recognized as expense on a straight-line basis, net of estimated forfeitures, over the requisite service period, which is generally the vesting period. For awards with performance-based vesting criteria, we assess the probability of the achievement of the performance conditions at the end of each reporting period and recognize the share-based compensation costs when it becomes probable that the performance conditions will be met.

 

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Valuation of Stock Options under the 2008 Equity Incentive Plan

 

We estimate the fair value of stock option awards on the date of grant using assumptions about volatility, expected life of the awards, risk-free interest rate, and dividend yield rate. The expected volatility in this model is based on an analysis of our publicly traded peers. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time awards are granted, based on maturities which approximate the expected life of the options. The expected life of the options granted is estimated using the historical exercise behavior of employees and an analysis of our peers. The expected dividend rate takes into account the absence of any historical payments and our intention to retain all earnings for future operations and expansion.

 

The weighted average assumptions used in the Black-Scholes option pricing model to determine the fair value of the employee stock option grants were as follows:

 

    

Year Ended

December 31,

  

Nine Months Ended

September 30,

     2012    2013    2013    2014
               (unaudited)

Expected volatility

   56.4%    71.5% - 71.8%    71.5%    69.3% - 72%

Dividend yield

   0%    0%    0%    0%

Risk-free interest rate

   0.9% - 1.8%    0.9% - 1.9%    0.9%    1.9 - 2.0%

Expected term in years

   6.1    6.1    6.1    6.0 - 6.1

 

We granted options to purchase an aggregate of 510,250 shares of common stock during the nine months ended September 30, 2014.

 

Valuation of Merger Consideration for Acquisition of IDGenetix, Inc.

 

In connection with our acquisition of IDGenetix, Inc., we issued an aggregate of 3.8 million restricted shares of common stock, or the Merger Consideration Stock Awards, and warrants to purchase 1.9 million shares of common stock, or the Merger Consideration Warrants, to the three stockholders of IDGenetix, Inc., who became our executive officers after the closing of the merger. We collectively refer to the Merger Consideration Stock Awards and the Merger Consideration Warrants as the Merger Consideration. The Merger Consideration is subject to defined service and performance criteria.

 

In accordance with ASC Topic No. 718, “Stock Compensation,” we account for the Merger Consideration as post-combination compensation. Twenty-five percent of the Merger Consideration is recognized on a straight-line basis over the service period. The remaining 75% is subject to the achievement of defined revenue and EBITDA performance conditions for which we estimate the Merger Consideration expected to vest at each reporting period, and we expense the aggregate value (based upon the per share value determined at the valuation date) over the remaining performance period, also through December 31, 2015. Pursuant to the original merger agreement, upon the occurrence of a liquidity event, initially defined to be the sale of our company or substantially all of our assets, all of the Merger Consideration held in escrow will be released. In June 2014, the merger agreement was amended to revise the definition of liquidity event to include the completion on an initial public offering, or IPO. As a result, upon either the sale of our company or an IPO, all of the Merger Consideration held in escrow will be released and all related unrecognized share-based compensation expense will be accelerated at that time.

 

The initial grant date fair value of Merger Consideration Stock Awards and Merger Consideration Warrants was determined to be $0.17 per share and $0.03, respectively, at the close of the merger on May 30, 2013, representing an aggregate fair value of approximately $0.7 million. In accordance with ASC Topic No. 718, we account for the June 2014 amendment to the Merger Agreement as a modification to the Merger Consideration. The modification had no impact on the fair value of the Merger Consideration that was estimated to be probable of vesting as of the modification date. The modification results in incremental stock-based compensation expense of up to $6.1 million for the Merger Consideration that was estimated to be improbable of vesting as of the modification date. The probability of our achievement of the 2015 revenue and EBITDA performance conditions is reassessed each reporting period and cumulative catch-up adjustments of stock-based compensation are recorded as necessary.

 

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As of December 31, 2013 and September 30, 2014, there was approximately $0.6 million and $0.5 million, respectively, of unrecognized stock-based compensation expense related to the Merger Consideration that was deemed probable of vesting upon the modification date. As of September 30, 2014, there was approximately $5.9 million of unrecognized stock-based compensation expense related to the modified Merger Consideration that was deemed improbable of vesting upon the modification date.

 

We determined the fair value of the Merger Consideration using a hybrid method to allocate the equity value of our company to the common shares and warrants based on our capital structure. The assumptions used in these valuation models included: (1) management’s revenue projections; (2) probability and timing of various liquidity event dates; (3) weighted-average cost of capital that included the addition of a company specific risk premium to account for uncertainty associated with us achieving future cash flows; (4) selection of appropriate market comparable transactions and multiples; (5) expected volatility; and (6) risk-free rate.

 

Determination of the Fair Value of Common Stock

 

Because our common stock is not currently publicly traded, our board of directors, with the assistance of management, uses significant judgment to estimate the fair value of our common stock. Following the closing of this offering, the fair value of our common stock will be determined based on the closing price of our common stock on NASDAQ.

 

The following table summarizes by grant date the number of shares of common stock underlying stock options granted from January 1, 2013 through the date of this prospectus, as well as the associated per share exercise price and the estimated fair value per share of our common stock on the grant date:

 

Grant Date

   Number of
Common
Shares
Underlying
Options Granted
     Exercise Price
Per Common
Share
     Assessed Fair
Value Per
Common Share

for Financial
Accounting
Purposes
     Intrinsic
Value per
Share at
Date of
Grant
 

May 1, 2013

     9,500       $ 0.57       $ 0.17       $ —     

December 16, 2013

     459,500       $ 0.36       $ 0.71       $ 0.35   

February 19, 2014

     42,750       $ 0.36       $ 1.86       $ 1.50   

February 24, 2014

     1,500       $ 0.36       $ 1.86       $ 1.50   

June 30, 2014

     255,750       $ 2.31       $ 2.31       $ —     

August 8, 2014

     60,500       $ 2.82       $ 2.82       $ —     

September 29, 2014

     149,750       $ 3.45       $ 3.45       $ —     

November 18, 2014

     828,000       $ 3.45       $ 3.45       $ —     

December 19, 2014

     25,500       $ 4.46       $ 4.46       $ —     

 

We are required to estimate the fair value of the common stock underlying our stock-based awards when performing the fair value calculations using the Black-Scholes option pricing model, or OPM. The fair value of the common stock underlying our stock-based awards was determined on each grant date by our board of directors, with input from management and utilization of an independent third-party valuation consultant. All options to purchase shares of our common stock are intended to be granted with an exercise price per share no less than the fair value per share of our common stock underlying those options on the date of grant, based on the information known to us on the date of grant. In the absence of a public trading market for our common stock, on each grant date, our board of directors considered various objective and subjective factors, along with input from management, to determine the fair value of our common stock, including:

 

   

the prices of our redeemable convertible preferred stock, and the rights, preferences and privileges of our redeemable convertible preferred stock as compared to those of our common stock, including the liquidation preferences of our redeemable convertible preferred stock;

 

   

our results of operations, financial position and achievement of enterprise milestones;

 

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the composition of, and changes to, our management team and board of directors;

 

   

the lack of marketability of our common stock as a private company;

 

   

our stage of development and business strategy and the material risks related to our business and industry;

 

   

external market conditions affecting the life sciences and biotechnology industry sectors;

 

   

the likelihood of achieving a liquidity event for the holders of our common stock, such as an IPO or a sale of our company, given prevailing market conditions; and

 

   

the conclusions of contemporaneous valuations of our common stock by an unrelated valuation specialist

 

In addition to the above factors, as part of its assessment of the fair value of our common stock for purposes of making stock option grants, our board of directors considered appraisals of the value of our common stock as of December 31, 2011, May 31, 2013, September 30, 2013, December 31, 2013, March 31, 2014, June 15, 2014, July 18, 2014, September 29, 2014 and December 15, 2014, which were prepared by an independent third-party valuation consultant using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants, or AICPA, Audit and Accounting Practice Aid Series: Valuation of Privately Held Company Equity Securities Issued as Compensation, or the AICPA Practice Aid. The AICPA Practice Aid prescribes several valuation approaches for setting the value of an enterprise, such as the cost, income and market approaches, and various methodologies for allocating the value of an enterprise to its common stock.

 

For each valuation date through December 31, 2013, we determined the fair value of our common stock by using the OPM method. We adjusted our estimates of fair value between valuation periods based upon changes in overall market conditions, revenue projections, and achievement of milestones. In connection with our preparation of the 2013 audited financial statements, in light of the increase in our enterprise value indicated by the integration of IDgenetix, and successful launch of our diagnostic services, we reassessed the fair value of our common stock during 2013 on a retrospective basis for financial reporting purposes. Our retrospective assessment involved updating the inputs into our valuation model. As a result, we concluded that the fair value of our common stock solely for accounting purposes had increased from $0.36 per share at December 16, 2013 and February 19, 2014 to $0.71 per share.

 

Beginning with the March 31, 2014 valuation, we began to utilize a hybrid method to determine the fair value of our common stock, which incorporated use of both the probability-weighted return methodology, or PWERM, and the OPM due to the increased probability of an IPO or other liquidity event given our recent successful launch of our diagnostic services and its continued market acceptance in early 2014. The PWERM is a scenario-based analysis that estimates the value per share based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to us, as well as the economic and control rights of each share class. In the hybrid method, the OPM is used to estimate the allocation of value within one or more of PWERM scenarios. The hybrid method can be a useful alternative to explicitly modeling all PWERM scenarios in situations when we have transparency into one or more near-term exits but is unsure about what will occur if the current plans fall through. The hybrid model was selected at this time for the reasons described above, including our plans relating to this offering.

 

Under the hybrid method, the OPM was used to allocate the equity value considering the probability that an IPO or other liquidity event does not occur in the near-term. Under this scenario, private transactions in our Series B redeemable convertible preferred stock and a revenue multiple analyses were utilized to determine the fair value of our company. This value was then allocated using an OPM to determine the fair value of our shares under this scenario. The PWERM scenarios in the hybrid method consider multiple exit, or liquidity, events. The estimated time to liquidity was based on the probability weighted time of a liquidity event considering these scenarios.

 

March 2014 Valuation

 

The common stock valuation was $1.86 per share at March 31, 2014, an increase of $1.15 per share from the reassessed fair value as of December 2013. Between December 2013 and March 2014, we continued to see an

 

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increase in market acceptance of our diagnostic services resulting in an increased probability of an IPO or other liquidity event within a shorter time horizon. For our March 31, 2014 valuation, we assessed the time to a liquidity event to have decreased from 2.0 years as of December 31, 2013 to 0.6 – 1.0 years as of March 31, 2014 with our estimates of possible future scenarios being 5% probability of an IPO within 0.5 years, 5% probability of an IPO within 1.0 year, 10% probability of a sale of the company within 1.0 year and 80% probability of staying private.

 

June 2014 Valuation

 

The common stock valuation was $2.31 per share at June 15, 2014, an increase of $0.45 per share from the third-party valuation at March 31, 2014. Between March 31, 2014 and June 15, 2014, we continued to see significant growth of our diagnostic services resulting in our assessment of continued increase in the likelihood of an IPO or other liquidity event. For our June 15, 2014 valuation, we assessed the time to a liquidity event to have decreased from 0.5 – 1.0 years as of March 31, 2014 to 0.38 – 0.79 years as of June 15, 2014 with our estimates of possible future scenarios being 7.5% probability of an IPO within 0.38 years, 7.5% probability of an IPO within 0.79 years, 15% probability of a sale of the company within 0.79 years and 70% probability of staying private.

 

July 2014 Valuation

 

The common stock valuation was $2.82 per share at July 18, 2014, an increase of $0.51 per share from the third-party valuation at June 15, 2014. Between June 15, 2014 and July 18, 2014, we continued to see continued growth of our diagnostic services resulting in our assessment of continued increase in the likelihood of an IPO or other liquidity event. For our July 18, 2014 valuation, we assessed the time to a liquidity event to have decreased from 0.38 – 0.79 years as of June 15, 2014 to 0.29 – 0.70 years as of July 18, 2014 with our estimates of possible future scenarios being 10.0% probability of an IPO within 0.29 years, 10.0% probability of an IPO within 0.70 years, 20% probability of a sale of the company within 0.70 years and 60% probability of staying private.

 

September 2014 Valuation

 

The common stock valuation was $3.45 per share at September 29, 2014. Between July 18, 2014 and September 29, 2014, we continued to see continued growth of our diagnostic services; however, due to unfavorable market conditions and the resulting impact on the market valuations of our peers, we delayed the timing of our proposed IPO. For the September 29, 2014 valuation, we assessed the time to a liquidity event to have increased from 0.29 – 0.70 years as of July 18, 2014 to 0.33 – 0.75 years as of September 30, 2014 with our estimates of possible future scenarios being 35% probability of an IPO within 0.33 years, 15% probability of an IPO within 0.75 years, 10% probability of a sale of the company within 0.75 years and 40% probability of staying private.

 

December 2014 Valuation

 

The common stock valuation was $4.46 per share at December 15, 2014, an increase of $1.01 per share from the third-party valuation at September 29, 2014. Between September 29, 2014 and December 15, 2014, we continued to see significant growth of our diagnostic services resulting in our assessment of continued increase in the likelihood of an IPO or other liquidity event. For our December 15, 2014 valuation, we assessed the time to a liquidity event to have decreased from 0.5 – 1.0 years as of September 29, 2014 to 0.13 – 0.54 years as of December 15, 2014 with our estimates of possible future scenarios being 50% probability of an IPO within 0.13 years, 15% probability of an IPO within 0.54 years, 10% probability of a sale of the company within 0.54 years and 25% probability of staying private.

 

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Significant assumptions for each valuation include:

 

     Common
Stock Value
(1)
     Volatility(2)     Risk-Free
Rate
    Years to
Exit
     Weighted-
Average Cost
of Capital
    Discount for
Lack of
Marketability
 

December 31, 2012

   $ 0.56         72.7     0.36     3.0         25     46.3%   

May 31, 2013

   $ 0.17         60.0     0.41     2.5         30     30.0%   

September 30, 2013

   $ 0.51         61.0     0.33     2.0         30     30.0%   

December 31, 2013

   $ 0.71         70.0     0.38     2.0         30     30.0%   

March 31, 2014(3)

   $ 1.86         70.0     0.29     0.6 to 1.0         30     15.0% to 30.0%   

June 15, 2014(3)

   $ 2.31         67.0     0.28     0.4 to 0.8         30     15.0% to 30.0%   

July 18, 2014(3)

   $ 2.82         69.0     0.31     0.3 to 0.7         30     15.0% to 30.0%   

September 29, 2014(3)

   $ 3.45         71.0     0.36     0.3 to 0.8         30     15.0% to 30.0%   

December 15, 2014(3)

   $ 4.46         67.0     0.18     0.1 to 0.5         30     15.0% to 25.0%   

 

(1)   Common stock value for all periods in 2013 is presented giving effect to the number of shares and warrants issued in connection with our merger with IDGenetics, Inc. to the extent that such shares and warrants are expected to vest pursuant to the service and performance conditions defined in the merger agreement.
(2)   The computation of expected volatility is based on the historical volatility of a representative group of public diagnostics and life sciences companies with similar characteristics.
(3)   Derived by using OPM and PWERM in a hybrid method using multiple scenarios.

 

Warrants Liability

 

We have issued warrants to purchase up to 300,000 shares of our Series B redeemable convertible preferred stock at an exercise price of $1.00 per share. These warrants are classified as liabilities in the accompanying balance sheets, as the terms for redemption of the underlying security are outside our control. The warrants are recorded at fair value using OPM. As of September 30, 2014, these warrants were valued at $3.08 per share. In connection with the first amendment to the LSA in November 2014, we issued warrants to purchase up to 114,380 shares of our Series B redeemable convertible preferred stock to SVB at an exercise price of $3.06 per share. We re-measure the fair value of these warrants at each financial reporting date with any changes in fair value being recognized in other income (expense), a component of other income (expense), in the accompanying statements of operations.

 

We will continue to adjust the liability for changes in fair value until the earlier of the exercise or expiration of the warrants to purchase redeemable convertible preferred stock, conversion of redeemable convertible preferred stock into common stock (including upon completion of this offering), or until holders of the redeemable convertible preferred stock can no longer trigger a deemed liquidation event. Upon the closing of this offering, these warrants will convert into warrants to purchase common stock, and the warrants liability will be adjusted to fair value in the consolidated statements of comprehensive loss with the final fair value reclassified to additional paid-in capital.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements (as defined by applicable regulations of the SEC) that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources. We had no material purchase commitments at December 31, 2013 or September 30, 2014.

 

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Contractual Obligations

 

The following table summarizes our contractual obligations as of December 31, 2013:

 

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

Operating leases(1)

   $ 1,053       $ 276       $ 578       $ 199       $ —     

Principal payment on debt obligation

     1,391         344         1,047         —           —     

Working capital line of credit

     1,200         1,200         —           —           —     

Interest and fees on debt obligation

     120         62         58         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 3,764       $ 1,882       $ 1,683       $ 199       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)   In August 2009, we entered into a sublease agreement with Ajinomoto Althea Technologies, Inc. pursuant to which we sublease approximately 18,500 square feet for our operations in San Diego, California. The lease is subject to charges for common area maintenance and other costs. The sublease had an initial expiration of August 31, 2017, but was amended in April 2014 to expire on April 1, 2015. The sublease provides for escalating rent payments. Rent expense is recorded on a straight line basis over the lease. After giving effect to the amendment in April 2014 which revised the expiration to April 2015, total future annual minimum lease payments at December 31, 2013 under the amended sublease would have been $0.3 million. Rent expense was $0.3 million for each of the years ended December 31, 2012 and 2013 and $0.2 million for the nine months ended September 30, 2014.

 

In March 2014, we entered into the amended LSA with SVB, which allows us to borrow up to $10.0 million under two term loans of $5.0 million each, and up to an additional $5.0 million under a working capital revolving credit line, based upon eligible accounts receivable. Concurrent with the execution of the LSA, we borrowed $5.0 million under one of the term loans, and in September 2014, we borrowed the remaining $5.0 million term loan. Future annual minimum payments under the term loan as of September 30, 2014 are set forth below (in thousands):

 

2014

   $ 201   

2015

     3,544   

2016

     4,450   

2017

     3,338   
  

 

 

 

Total minimum payments

     11,533   

Less amounts representing interest

     (1,533
  

 

 

 

Face value of long term debt

   $ 10,000   
  

 

 

 

 

In April 2014, we signed a lease agreement for 69,808 square feet of new office and laboratory space in San Diego for a term of 84 months, commencing upon completion of tenant improvements, which is expected in early 2015. Upon lease commencement, rent will be approximately $213,000 per month (reduced to approximately $106,500 pursuant to a partial rent abatement), which includes both base rent and tenant improvement allowances. The rent will be increased by 3% on each annual anniversary of the first day of the first full month during the lease term. The lease agreement allows for an 18-month partial abatement period starting with the first month of the lease, during which time the monthly rent shall be reduced by 50%. The lease provides us with two consecutive options to extend the term of the lease for five years each, which may be exercised with no more than 12 months and no less than nine months prior written notice. In the event we choose to extend the term of the lease, the minimum monthly rent payable for the additional term will be determined according to the then-prevailing market rate. We plan to relocate all of our operations to this new facility in 2015. In addition to the new lease, we entered into an agreement with the landlord to occupy approximately 7,500 square feet of temporary office space adjacent to the site of the new building, free of charge, until we take occupancy of the new space.

 

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Future annual minimum lease payments under the new lease are set forth below (in thousands):

 

2014

   $ —     

2015

     2,555   

2016

     2,631   

2017

     2,714   

2018

     2,790   

Thereafter

     8,880   
  

 

 

 
   $ 19,570   
  

 

 

 

 

Related Party Transactions

 

For a description of our related party transactions, see “Certain Relationships and Related Person Transactions.”

 

JOBS Act

 

In April 2012, the JumpStart Our Business Startups Act of 2012, or the JOBS Act, was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an “emerging growth company.” As an “emerging growth company,” we are electing not to take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 107 of the JOBS Act provides that our decision not to take advantage of the extended transition period is irrevocable. In addition, we are in the process of evaluating the benefits of relying on the other exemptions and reduced reporting requirements provided by the JOBS Act. Subject to certain conditions set forth in the JOBS Act, if as an “emerging growth company” we choose to rely on such exemptions, we may not be required to, among other things, (1) provide an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404, (2) provide all of the compensation disclosure that may be required of non-emerging growth public companies under the Dodd-Frank Wall Street Reform and Consumer Protection Act, (3) comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis), and (4) disclose certain executive compensation-related items such as the correlation between executive compensation and performance and comparisons of the Chief Executive Officer’s compensation to median employee compensation. These exemptions will apply for a period of five years following the completion of our initial public offering or until we no longer meet the requirements of being an “emerging growth company,” whichever is earlier.

 

Recently Issued Accounting Pronouncements

 

In November 2014, the Financial Accounting Standards Board, or FASB, issued guidance codified in Accounting Standards Update, or ASU, 2014-16, “Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force).” The ASU clarifies how current guidance should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of a host contract. The ASU is effective for fiscal years and interim periods beginning after December 15, 2015. We are currently in the process of evaluating the impact of adoption of this standard on our consolidated financial statements.

 

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In August 2014, the FASB issued ASU 2014-15 (Subtopic 205-40): “Presentation of Financial Statements – Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.” The guidance requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable). Management will be required to make this evaluation for both annual and interim reporting periods and will have to make certain disclosures if it concludes that substantial doubt exists or when its plans alleviate substantial doubt about the entity’s ability to continue as a going concern. Substantial doubt exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or available to be issued). The term probable is used consistently with its use in ASC Topic 450, Contingencies. The guidance is effective for annual periods ending after December 15, 2016 and for interim reporting periods starting in the first quarter 2017, with early adoption permitted. We are currently evaluating the impact of this guidance and expect to adopt the standard for the annual reporting period ended December 31, 2016.

 

In May 2014, the FASB and the International Accounting Standards Board, or IASB, jointly issued ASU No. 2014-09, “Revenue from Contracts from Customers,” which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition.” ASU 2014-09 is a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current authoritative guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The standard is effective for public entities for annual and interim periods beginning after December 15, 2016. There is a one-year deferral for nonpublic companies, but some companies that consider themselves private may have to follow the public company effective date if they meet certain requirements. Early adoption is not permitted under GAAP, but nonpublic companies may adopt the new standard as of the public entity effective date. We are currently evaluating the financial statement impact of the new revenue recognition standard.

 

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists,” a new accounting standard update on the financial statement presentation of unrecognized tax benefits. The new guidance provides that a liability related to an unrecognized tax benefit would be presented as a reduction of a deferred tax asset for a net operating loss carryforward, a similar tax loss or a tax credit carryforward if such settlement is required or expected in the event the uncertain tax position is disallowed. The new guidance became effective for the Company on January 1, 2014 and it should be applied prospectively to unrecognized tax benefits that exist at the effective date with retrospective application permitted. We are currently assessing the impact of this new guidance.

 

In February 2013, the FASB issued ASU 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” new disclosure guidance related to the presentation of the Statement of Comprehensive Income. This guidance requires the disclosure of the effect of significant amounts reclassified from each component of accumulated other comprehensive income based on its source and the income statement line items affected by the reclassification. We adopted this accounting standard for the accounting year ended December 31, 2013. The adoption did not have any impact on our financial position or results of operations.

 

Quantitative and Qualitative Disclosures about Market Risk

 

Interest Rate Risk

 

Our cash and cash equivalents as of September 30, 2014 consist of cash deposits at a financial institutions. We are exposed to market risk related to fluctuations in interest rates and market prices. Our primary exposures

 

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to market risk are the rate at which we can borrow capital and interest income sensitivity, both of which are affected by changes in the general level of U.S. interest rates. However, because our existing long-term debt bears interest at a fixed rate and we are not required to make any future borrowings, a sudden change in market interest rates would not be expected to have a material impact on our financial condition and/or results of operation.

 

Effects of Inflation

 

We do not believe that inflation and changing prices had a significant impact on our results of operations for any periods discussed above.

 

Internal Control Over Financial Reporting

 

Pursuant to Section 404(a) of the Sarbanes-Oxley Act, commencing the year following our first annual report required to be filed with the SEC, our management will be required to report on the effectiveness of our internal control over financial reporting. To comply with the requirements of being a reporting company under the Exchange Act, we may need to upgrade our systems, including information technology, implement additional financial and management controls, reporting systems and procedures, and hire additional accounting and finance staff.

 

In August 2014, it was determined that we did not maintain effective internal controls over the process for calculating the numerator in the calculation of our net loss per share applicable to common stockholders for the years ended December 31, 2012 and 2013 and for the three months ended March 31, 2013 and 2014. The numerator used to calculate our basic and diluted net loss per share applicable to common stockholders did not properly include the accretion of redeemable convertible preferred stock, in accordance with U.S. GAAP. Management identified a lack of sufficient oversight and review to ensure the complete and proper application of U.S. GAAP as it relates to the impact of complex equity transactions on calculating net loss per share applicable to common stockholders. This deficiency in our internal controls was deemed to be a material weakness. A material weakness is a significant deficiency, or a combination of significant deficiencies, in internal control over financial reporting such that it is reasonably possible that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. If one or more material weaknesses persist or if we fail to establish and maintain effective internal control over financial reporting, our ability to accurately report our financial results could be adversely affected. Although remediation efforts are still in progress, we are taking steps to remediate the material weakness in our internal control over financial reporting, primarily by hiring additional individuals with accounting expertise and, if appropriate, engaging third-party accounting consultants with the appropriate knowledge to supplement our internal and existing external resources in our computation and review processes. These actions are subject to ongoing management review and the oversight of the audit committee of our board of directors.

 

We will be required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting for the year following our first annual report required to be filed with the SEC. This assessment will need to include disclosure of any material weaknesses identified by management over our internal control over financial reporting. However, our independent registered public accounting firm will not be required to report on the effectiveness of our internal control over financial reporting pursuant to Section 404(b) until we are no longer an emerging growth company. We are in the very early stages of compiling the system and processing documentation necessary to perform the evaluation needed to comply with Section 404. We may not be able to complete our evaluation, testing or any required remediation in a timely manner. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are designed and operating effectively, which could result in a loss of investor confidence in the accuracy and completeness of our financial reports. This could cause the price of our common stock to decline, and we may be subject to investigation or sanctions by the SEC.

 

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BUSINESS

 

Overview

 

We are a commercial stage molecular diagnostics company specializing in the field of personalized medicine. IDgenetix, our pharmacogenetic, or PGx, testing portfolio, enables personalized therapeutic decisions for patients suffering from some of the most prevalent clinical conditions in the United States, including cardiovascular disease, neuropsychiatric disorders and pain. Our proprietary algorithm-based bioinformatic platform and PGx testing portfolio are intended to serve as a tool to assist healthcare providers in identifying optimal drugs for their patients as well as dosing guidelines based on a patient’s genetic make-up, current prescription regimen and other key factors. IDgenetix is designed to enable healthcare providers to make timely and evidence-based decisions, which we believe can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response.

 

In 2013, the U.S. healthcare system spent in excess of $260 billion on prescription drugs and that amount is expected to exceed $450 billion in 2022. Nearly 50% of the U.S. population, and almost 90% of people 65 years and over (or approximately 36 million patients), take at least one prescription drug and more than 10% of the U.S. population, and almost 40% of people 65 years and over (or approximately 16 million patients), take five or more prescription drugs, which we refer to as polypharmacy. We estimate that the overall potential market opportunity for IDgenetix is greater than 150 million patients in the United States, representing the number of people that take at least one prescription drug, which includes the more than 30 million people who are polypharmacy.

 

We believe there are significant health concerns and unnecessary costs associated with the trial-and-error manner in which physicians prescribe drugs, without prior knowledge of an individual patient’s genetic profile. There are an estimated 100,000 deaths and more than two million serious adverse reactions attributable to prescription drug use in the United States each year, at a cost to the healthcare industry that exceeds $136 billion annually. It has been estimated that genetics can account for up to 95% of variability in drug disposition and effects and as much as 40-60% of adverse drug reactions. We believe IDgenetix can improve clinical outcomes and reduce the overall cost of prescription drugs by enabling better drug selection, earlier favorable results, and lower occurrence of adverse events.

 

In October 2013, we commercially launched IDgenetix in the United States. Since launch and through September 30, 2014, we completed IDgenetix tests for more than 13,500 patient samples, of which more than 7,500 samples were completed in the quarter ended September 30, 2014. IDgenetix examines genes involved in both the metabolism and pharmacological activity of numerous drugs. It provides physicians with information on the functionality of critical metabolic enzymes and key biological drug targets, where applicable, for each patient. In addition, our algorithm screens for unfavorable metabolic interactions resulting from multiple prescription drugs, over-the-counter drugs and herbal supplements, and environmental and dietary factors that may significantly alter the metabolism of certain drugs. We currently offer 13 tests in the therapeutic areas of cardiovascular disease, neuropsychiatric disorders and pain, and we are developing additional tests/offerings in the therapeutic areas of neurology and rheumatology.

 

We designed IDgenetix to provide a comprehensive PGx test offering to best meet the needs of our target customers such as long-term and post-acute care facilities, government facilities, integrated delivery networks, or IDNs, and managed care organizations. These institutional healthcare providers require broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions. These customers often operate under fixed-fee-per-patient or fixed-fee-per-procedure arrangements and are searching for ways to improve clinical outcomes at the lowest possible cost. In addition, IDgenetix addresses the needs of physicians across multiple specialties, such as cardiologists, general practitioners, obstetricians and neurologists.

 

In addition to IDgenetix, we provide research and development services, primarily in oncology, to numerous biopharmaceutical partners. We use our expertise in next-generation sequencing, or NGS, and our computational

 

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biology and information technology capabilities to analyze subject samples from preclinical through clinical development. These services provide a start-to-finish suite of tools focused on molecular biomarker discovery, assay development, assay validation and prospective and retrospective clinical trial testing in support of companion diagnostic development and commercialization.

 

Our capabilities have enabled our partners to:

 

   

accelerate clinical development timelines and increase the likelihood of patient response by prospectively analyzing specimens to identify patients with certain genomic alterations for enrollment in clinical trials for targeted therapeutics;

 

   

understand complex combinations of genomic alterations to facilitate development of companion diagnostic tests that may be necessary to bring a targeted therapeutic to market;

 

   

create opportunities for drug combination studies or new target discovery by identifying mechanisms of primary and acquired resistance; and

 

   

inform improvements to clinical trial design by contributing to the understanding of why some clinical studies have not met their primary endpoints.

 

To date, we have provided these services under paid agreements to several major pharmaceutical companies, many of which are the leaders in developing targeted therapies, including Amgen, Bayer Health Care, Bristol-Myers Squibb, Glaxo Smith Kline, and Novartis. We are currently validating a number of companion diagnostic test assays in late stage clinical trials. We also derive revenue from licensing fees and fees from third parties for use of our technologies and laboratory services.

 

We believe that IDgenetix will have commercial success due to the following factors:

 

Significant market need for personalized, genetic based information in treating patients.    There is a significant need to address the current trial-and-error method of prescribing drugs and reduce healthcare costs due to drug-related adverse events and over-prescribing practices. We believe the use of IDgenetix can address both physician and patient needs as well as the financial burden of the current trial-and-error method of prescribing drugs. Government agencies also acknowledge the importance of PGx. For example, the U.S. Food and Drug Administration, or FDA, has required, for certain drugs, the incorporation of PGx information into drug labeling and currently recommends genetic testing for patients taking a subset of these drugs. Additionally, the National Institutes of Health, or NIH, has established the Clinical Pharmacogenetics Implementation Consortium, or CPIC, guidelines intended to assist healthcare providers in translating laboratory genetic test results into actionable prescribing decisions for specific drugs.

 

Broad test portfolio that comprehensively identifies information that will enable decisions to improve patient outcomes.    IDgenetix tests are designed to evaluate genes encoding critical metabolic enzymes and key biological drug targets, where applicable, for which clinical data exists. IDgenetix examines clinically significant gene duplication and deletion events and covers more than 85 genetic mutations in 19 different genes, which we believe is the most comprehensive offering on the market today. We continue to enhance IDgenetix by updating our proprietary algorithm as well as evaluating additional genes to incorporate into our tests. We believe this is a competitive advantage as institutional healthcare providers require broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions.

 

Speed and ease of use for routine clinical practice.    The IDgenetix process, from order initiation and sample acquisition through report delivery and availability of our genetic counseling team, enables healthcare providers to obtain and interpret the information we provide in a convenient and simple manner. Patient samples are easily collected via a cheek swab and sent to our laboratory for analysis. Once received, our proprietary laboratory workflow and bioinformatic algorithm enable us to detect, interpret and report clinically relevant

 

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information to healthcare providers, generally within 48 hours of sample receipt, which we believe is an industry-leading turnaround time. Our concise, easy-to-interpret reports and analysis provide healthcare providers with actionable information on therapeutic options regarding drugs and dosing for their patients, based upon the complex genetic, pharmacological and environmental analysis performed by our algorithm.

 

Healthcare cost reduction.    We provide healthcare providers a tool that enables them to make decisions regarding treatment that may result in the elimination, replacement, supplementation or revision of dosing regimens for prescribed drugs, fewer adverse events and faster therapeutic response. We believe this can reduce overall treatment costs, a particular concern for healthcare providers operating under fixed-fee-per-patient or fixed-fee-per-procedure arrangements who are searching for ways to improve clinical outcomes at the lowest possible cost. For example, the results from a 2012 study (TRITON-TIMI 38) of PGx-guided therapy in patients with acute coronary syndrome showed that one excess cardiovascular event was avoided for every 23 or 30 patients depending upon therapeutic regimen. In addition, a PGx-guided therapy would allow for approximately 70% of the patient population to be prescribed the less-expensive generic drug. Based on this study, we estimate that PGx-guided therapy has the potential to result in $1,454 annual savings per patient.

 

Clinical studies supporting the use of PGx testing.    While there have not been any IDgenetix-specific studies to date, there are more than 5,000 published studies on the use of PGx testing in a clinical setting. For example, there have been several publications linking the CYP2C19 gene to the use of clopidogrel (marketed by Bristol-Myers Squibb under the name Plavix) anticoagulant therapy, including meta-analysis studies totaling more than 150,000 patients. We believe that further studies, including studies that are specific to IDgenetix, will increase awareness and drive adoption of PGx testing, and help establish PGx testing as a standard of care in drug selection.

 

Our Industry

 

PGx Testing Overview

 

Pharmacogenetics is the study of how the actions of, and reactions to, drugs vary with a patient’s genetic composition. According to articles published in numerous publications, including Nature (Evans WE, Relling MV. 2004. Moving towards individualized medicine with pharmacogenetics; Nature 429: 464-68) and The New England Journal of Medicine (Evans WE, McLeod HL. 2003. Pharmacogenomics—drug disposition, drug targets and side effects; N. Engl J. Med 348: 538-49 and Weinshilboum R. 2004. Inheritance and drug response; N. Engl. J. Med. 348: 529-37), it has been estimated that genetics can account for up to 95% of variability in drug disposition and effects. Genetics can influence both the pharmacokinetics, or the body’s impact on a drug, and pharmacodynamics, or a drug’s impact on the body, of a patient’s drug response. The safety and efficacy profile of drugs is often measured across a general population. However, genetic variation between individuals can lead to critical differences in the way they respond to the same drug. PGx testing involves the analysis of specific genes within an individual in order to help determine the suitability of a drug for that individual, thus potentially mitigating the risk and cost of ineffective therapeutic outcomes and adverse drug events.

 

Clinical observations regarding differences in drug response have been made since the 1950s. Since then the identification of specific genes that influence drugs’ pharmacokinetics and pharmacodynamics have increased the clinical relevance of PGx testing. Over the past several years, there has been increased awareness around the variability of response to prescription drugs and the utility of PGx testing. This has resulted in recent momentum supporting PGx testing, namely in the inclusion of PGx information in certain drug labeling and CPIC clinical guidelines specific to PGx.

 

The FDA has introduced specific language in drug labels in reference to genetic testing for situations in which a drug can cause serious undesirable effects compared to the potential benefit from the drug. PGx drug labels may warn against a serious adverse reaction that can be prevented, reduced in frequency or reduced in severity by genetic evaluation of a patient and proper use of the drug. Since 2004, the FDA has issued more than 130 drug labels referencing PGx testing, including numerous black box warning labels related to genetic biomarkers, and the identification of individuals as slow or rapid metabolizers of specific drugs.

 

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In 2009, the NIH established CPIC to address some of the barriers to implementation of PGx tests into clinical practice. CPIC provides guidelines intended to assist healthcare providers to translate laboratory genetic test results into actionable prescribing decisions for specific drugs. A key assumption underlying the CPIC guidelines is that high-throughput and pre-emptive (pre-prescription) PGx testing will become more widespread and that doctors will have patients’ genetic information available even if they have not explicitly ordered a test with a specific drug in mind. Since inception, CPIC has issued multiple clinical guidelines for specific drugs across many therapeutic areas including statins, anti-depressants, anti-coagulants and analgesics.

 

Overall Market Opportunity

 

According to the CDC, from 2007 to 2010, 48.5% of the U.S. population was on at least one prescription drug and 10.6% was on five or more prescription drugs. In the United States, 89.7% of people 65 years and over were on at least one prescription drug and 39.7% were on five or more prescription drugs. This population is projected to increase to more than 88 million people by 2015, according to the U.S. Census Bureau. According to the National Center for Health Statistics, institutional healthcare providers, such as long-term and post-acute care facilities, government facilities, IDNs and managed care organizations, tend to have a higher proportion of patients that are 65 years and over or are on multiple prescription drugs. As such, we believe institutional healthcare providers represent a key market opportunity for IDgenetix testing.

 

In 2013, the U.S. healthcare system spent in excess of $260 billion on prescription drugs and that amount is expected to exceed $450 billion by 2022, according to the Centers for Medicare and Medicaid Services, or CMS. In addition to increased spending on prescriptions, there are an estimated 100,000 deaths and more than two million serious adverse reactions attributable to prescription drug use in the United States each year, at a cost to the healthcare industry that exceeds $136 billion annually, according to the Center for Education and Research on Therapeutics.

 

We estimate that the overall potential market opportunity for IDgenetix is greater than 150 million patients in the United States, representing the number of people that take at least one prescription drug. Our initial primary focus is reaching patient populations that could significantly benefit from IDgenetix testing, including the more than 30 million patients who are on five or more prescription drugs, for whom there is elevated risk and cost related to overmedication and resulting adverse events. We believe that a majority of those patients are associated with institutional healthcare providers and that IDgenetix has the potential to significantly reduce prescription drug utilization, treatment failures and adverse events in a multitude of treatment settings for these patients and their healthcare providers. We believe that patients new to drug therapy, currently failing drug therapy or taking multiple prescriptions concurrently can all benefit from IDgenetix testing.

 

Our Market Focus

 

We divide our market in two categories: (1) institutional healthcare providers and (2) physicians. We designed IDgenetix to provide a comprehensive PGx offering to best meet the needs of our target customers such as long-term and post-acute care facilities, government facilities, IDNs and managed care organizations, which we collectively refer to as institutional healthcare providers. In addition, IDgenetix addresses the needs of physicians across multiple specialities, such as cardiologists, general practitioners, obstetricians and neurologists.

 

Institutional Healthcare Providers

 

Institutional healthcare providers may benefit from broad PGx testing capabilities to manage a large and diverse patient population, with patients often suffering from multiple clinical conditions. These customers often operate under fixed-fee-per-patient or fixed-fee-per-procedure arrangements and are searching for ways to improve clinical outcomes at the lowest possible cost. In recent years, more healthcare dollars are being managed by institutions as many IDNs and healthcare systems are purchasing independent physician practices and/or healthcare services. We believe this trend will continue. Currently, we have more than 10 agreements with institutional healthcare providers for our IDgenetix testing services, all of which are in the early stages of implementation.

 

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Long-Term and Post-Acute Care Facilities

 

Long-term care facilities include a range of institutional providers that primarily provide services for older adults or adults with functional limitations. These can include adult day service centers, home health agencies, hospices, nursing homes and assisted living facilities. Post-acute care facilities typically furnish care after an inpatient hospital stay, and provide services that sometimes overlap with long-term care. These can include skilled nursing facilities, inpatient rehabilitation facilities and long-term care hospitals.

 

According to the National Center for Health Statistics, in 2012 there were approximately 58,500 state-regulated or Medicare-certified long-term and post-acute care facilities in the United States covering approximately eight million patients. This equates to an average of approximately 130 patients per facility. The 2011 IMS Health Annual Prescription Audit reported that long-term care facilities dispensed more than 300 million prescriptions in 2011. A significant number of patients in these facilities rely on Medicare and Medicaid. We believe this market category represents a significant area of growth for IDgenetix based upon the prevalence of polypharmacy in their patient populations, the large number of prescriptions, and institutional focus on cost containment or reduction. Much of the long-term and post-acute care industry is characterized by large organizations that manage multiple facilities. According to our research, the ten largest nursing facility management companies operate more than 2,000 facilities, representing a patient capacity of more than 250,000. By marketing to such organizations, we believe we will drive adoption of our IDgenetix tests through concentrated patient populations that would benefit most from our services. For example, we have nine contracts with nursing homes in Mississippi.

 

Government Facilities

 

U.S. government healthcare facilities provide care for various patient populations including veterans, prisoners and military personnel. The Veterans Health Administration, or VA, is the largest U.S. integrated healthcare system, consisting of more than 150 medical centers, and more than 1,200 outpatient clinics and veterans’ centers, together serving more than eight million patients each year. In addition, the Military Health System, the Department of Defense’s, or DOD, unit that provides healthcare services, has a $50 billion annual budget and serves almost 10 million beneficiaries, including active duty personnel and their families and retirees and their families in approximately 60 hospitals and 200 clinics at facilities across the nation and around the world. According to the U.S. Government Accountability Office, together the VA and DOD spent $11.8 billion in 2012 to purchase drugs on behalf of about 18.5 million beneficiaries. U.S. state and federal correctional facilities serve approximately 1.6 million prisoners, and the State of California, as one example, spent approximately $144.5 million in 2012 for prescription drugs for its nearly 133,000 inmates, according to a report published by the California Legislative Analyst’s Office. While decisions regarding PGx test ordering are currently handled on a hospital-by-hospital basis, if PGx testing becomes the standard of care, we expect that government entities will enter into large-scale arrangements for these services. By targeting government healthcare facilities, we believe we will be able to take advantage of the access to their large patient populations in order to accelerate the growth and adoption of IDgenetix. In 2014, the Walter Reed National Military Medical Center initiated use of our IDgenetix testing services.

 

Integrated Delivery Networks

 

An IDN is a network of facilities and providers that work together to offer a continuum of care to a specific geographic area or market. There are more than 500 IDNs in the United States, including more than 200,000 group practice organizations, which are a type of IDN. The concept was developed in the 1980s and has since evolved to address common concerns, such as fixed-fee arrangements, excess capacity, decreased margins and complaints from patients regarding healthcare access. IDNs include many types of associations across the continuum of care. For example, one network could include a short- and long-term care hospital, healthcare management program, home health agency and hospice services. Multi-hospital systems can be considered limited IDNs, since different entities are joining together to provide care. We believe accessing IDNs will further enable us to broaden the reach and adoption of IDgenetix. We recently entered into an agreement with a subsidiary of Universal Health Services, Inc., or UHS, a hospital management company covering 25 acute care

 

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hospitals, 195 behavior health facilities and three surgery centers, to initiate a pilot roll-out of IDgenetix testing among different specialties at its Aiken Regional Medical Center in South Carolina. We also recently entered into an agreement with a nationally-ranked medical center within a large healthcare system in the southeastern United States to perform IDgenetix testing. This medical center is staffed by more than 390 physicians and specialists across numerous areas of clinical expertise. While we market our IDgenetix service across several specialties within this healthcare system, the initial focus of IDgenetix testing will be for patients undergoing neurosurgery in an effort to optimize post-operative pain management and reduce both costs and length of stay following surgery.

 

Managed Care Organizations

 

Managed care organizations are either a health plan coordinating care or a healthcare delivery system consisting of affiliated or owned hospitals, physicians and others which provide a wide range of coordinated health services. An increasing amount of healthcare in the United States is administered through managed care organizations. We estimate that the top ten managed care organizations in the United States have more than 140 million subscribers, each with individual subscriber populations ranging from 3.8 million to 36.5 million. By targeting managed care organizations, we believe we will accelerate the growth and adoption of IDgenetix by securing high-volume customers serving large populations of patients that would benefit from our services. In June 2014, we entered into an agreement for our first pilot study with a large managed care organization covering more than 2.5 million lives, pursuant to which we have agreed to conduct a prospective study to evaluate patient outcomes in approximately 300 nursing home patients following IDgenetix testing.

 

Physicians

 

In addition to our institutional efforts, we also target individual physicians across many specialties such as cardiologists, general practitioners, obstetricians and neurologists. While institutional healthcare providers are our main selling focus, we believe expansion of our physician-office-based sales force will enhance our growth, increase the number of institutional referrals and expand the footprint of our brand within the U.S. market.

 

Our Strategy

 

Our goal is to become the premier provider of PGx testing services to institutional healthcare providers and physicians across the United States. To achieve this objective, we intend to:

 

Target large institutions where polypharmacy is a significant cost driver.    Institutional healthcare providers, such as long-term and post-acute care facilities, government facilities, IDNs and managed care organizations, tend to have a higher proportion of patients that are 65 years and over and others who are taking multiple prescription drugs. Polypharmacy, particularly in a fixed-fee setting, is a significant cost reduction opportunity. IDgenetix may address polypharmacy by enabling healthcare providers to make timely and evidence-based decisions, which we believe can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response. As such, we believe institutional healthcare providers represent the largest opportunity for IDgenetix.

 

Highlight our value proposition and clinical utility through clinical studies.    We intend to continue to sponsor or co-sponsor IDgenetix-guided clinical studies within institutional healthcare organizations to analyze the impact of the use of IDgenetix by physicians on defined clinical endpoints such as the number of prescription drugs, hospitalizations and length of stay, and other health assessments. In June 2014, we entered into an agreement for our first pilot study with a large managed care organization covering more than 2.5 million lives, pursuant to which we have agreed to conduct a prospective study to evaluate patient outcomes in approximately 300 nursing home patients following IDgenetix testing. In September 2014, we entered into an agreement for a second pilot study to be conducted at an acute care facility run by UHS. The results from these studies and future studies could drive increased adoption of IDgenetix and provide important feedback for our future product development efforts.

 

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Differentiate our IDgenetix offering through superior customer service.    As part of our IDgenetix customer service department, we provide physicians with access to individuals with doctorate degrees in pharmacy (Pharm.D.), certified genetic counselors and additional customer service support personnel at no additional charge. Our customer service department has the capability to address a range of inquiries, from routine questions to complex patient cases, with the healthcare providers. We believe this differentiated service offering increases the quality of care to patients, thereby facilitating adoption of our IDgenetix tests by institutional healthcare providers and physicians.

 

Leverage operational efficiency.    Our automated and efficient testing platform enables us to maintain a low-cost, scalable laboratory operation. We plan to continue optimizing our testing platform to maximize throughput, increase efficiency and maintain or reduce our costs across all aspects of testing, including sample collection, sample processing, DNA extraction, polymerase chain reaction, or PCR, analysis and data analysis. As our sample volume increases, we expect our average cost per sample to decrease.

 

Expand the IDgenetix portfolio and offerings.    We recently expanded our IDgenetix tests from 16 to 19 genes, and, in the near term, expect to expand our tests from three to five therapeutic areas. We plan to pursue continued expansion of IDgenetix and enhance our bioinformatic algorithm, with the intent to continually increase the clinical utility of our services. Because we currently test more than 85 genetic mutations in 19 different genes that are most commonly associated with drug metabolism, we are able to add additional tests at an accelerated pace, with limited additional cost. By expanding our portfolio, we believe that we will drive additional demand from our customer base and drive increased adoption from new customers. We also plan to develop additional information technology applications in the areas of database services and patient and physician communication.

 

Our Solution

 

IDgenetix assists institutional healthcare providers and physicians in their efforts to make optimal therapeutic decisions for their patients. Our IDgenetix tests are laboratory developed tests, or LDTs, which provide reliable and actionable information about a patient’s likelihood of having an adverse event or a therapeutic response to a drug based on each patient’s unique genetic make-up and other important patient-specific healthcare information. IDgenetix incorporates a proprietary bioinformatic algorithm containing more than 2,500 drug names that enables a tailored and personalized approach to the selection and dosing of drugs for many of the most highly prescribed therapeutic areas such as cardiovascular disease, neuropsychiatric disorders and pain. This evidence-based approach can eliminate the current trial-and-error prescribing practices that may produce a higher rate of adverse events and treatment failures. We believe that the information IDgenetix provides can reduce the overall cost of patient care by reducing adverse events, optimizing patients’ overall therapeutic regimen and helping to achieve a faster therapeutic response. We operate and analyze patient samples at our CAP-accredited and CLIA-certified molecular diagnostics laboratory located in San Diego, California.

 

Our Testing Platform

 

Our IDgenetix product testing platform, which includes proprietary technology, methods and computational algorithms, incorporates three core areas: pharmacokinetics, pharmacodynamics and bioinformatic algorithmic screening. In order to provide a truly personalized approach to therapeutic selection and dosing, it is important to analyze each of these areas because a drug’s effect is often related to its concentration at the site of action and all three areas play a role in this process. Pharmacokinetics is the study of the process by which a drug is absorbed, distributed, metabolized and excreted in the body, or more simply, how the body processes a drug. Analysis of genes encoding key enzymes involved in the pharmacokinetics of drugs is an important component of PGx testing. Analysis of genes encoding proteins involved in pharmacodynamics, the study of the biochemical and physiological effects of drugs on the body, determines if a genetic mutation at the site of action could, where applicable, impact the therapeutic effect of that drug. Our proprietary bioinformatic algorithm incorporates these genetic analyses with key external factors, including drug-drug interactions, over-the-counter drugs and herbal

 

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supplements, and environmental and dietary factors to identify if these factors alter a patient’s response to a drug or group of drugs. It is through this holistic approach that we are able to provide personalized therapeutic options for a specific patient.

 

Pharmacokinetics.    Treatment failures due to differences in drug metabolism, or the body’s process of altering a drug into an inactive chemical substance or, in the case of pro-drugs, an active chemical substance, may be avoided, in certain cases, by determining a patient’s metabolic phenotype, or activity of their liver enzymes. Metabolic phenotypes are categorized as follows:

 

   

Ultra-Rapid Metabolizers typically carry multiple copies of the same gene and have elevated enzyme activity and may need increased drug dosing or decreased drug dosing, in the case of pro-drugs, in order to offset the higher rate of metabolism.

 

   

Extensive Metabolizers (normal metabolizers) carry two functional genes and have normal enzyme activity. Standard drug dosing is appropriate for extensive metabolizers.

 

   

Intermediate Metabolizers have decreased functional enzymes and a reduced capacity to metabolize drugs and therefore may require modified drug doses.

 

   

Poor Metabolizers have a severely reduced or no capacity to metabolize drugs. Poor metabolizers are at-risk for side effects due to toxic drug accumulation and may require alternative therapeutic options.

 

More than 50% of the population in the United States have gene mutations that alter the rate at which they metabolize drugs.

 

IDgenetix involves the analysis of key genes that determine a patient’s metabolic phenotype. This determines how much drug is available to produce the desired therapeutic effect or unfavorable adverse response. An individual patient’s response to certain drugs is influenced by genetic variations in the enzymes responsible for drug metabolism.

 

For example, the family of cytochrome P450 genes, or CYP genes, encode enzymes responsible for approximately 80% of the first phase of drug metabolism. Genetic variation of these genes alone is estimated to influence 20-25% of all drug metabolism. Variations in drug metabolism can cause life-threatening toxicities in certain patients or reduce a drug’s effectiveness in other patients. Clinically significant genetic alterations in the CYP genes can result in decreased or increased enzyme activity. Knowing a patient’s metabolic phenotype and its impact on drug metabolism can inform treatment decisions, with the potential to increase drug efficacy and reduce the risk of adverse events. The IDgenetix product testing portfolio covers six clinically significant CYP genes.

 

Pharmacodynamics.    Obtaining therapeutic benefit from a drug is also dependent upon the integrity of its biological target, such as local metabolizing enzymes and key enzyme-linked receptor and transporter proteins in the human body. IDgenetix enables us to analyze genes, where the biological target has been identified, that influence how effective these key proteins will be at regulating biological processes targeted by certain drugs. This determines how likely each drug is to produce its desired therapeutic effect.

 

Bioinformatic Algorithmic Screening.    Our proprietary bioinformatic algorithm enables us to screen for unfavorable metabolic interactions that alter which drugs are optimal for each patient to ensure physicians receive accurate and clinically relevant information. This algorithm incorporates genetic markers, known drug-drug interactions, over-the-counter drugs, herbal supplements and environmental and dietary factors. This algorithm also incorporates CPIC guidelines, more than 5,000 peer-reviewed publications and approximately 5,000 drug labels containing metabolic or other information, with more than 130 drug labels referencing PGx testing (but not IDgenetix, specifically), including numerous black box warning labels related to genetic biomarkers. The algorithm is dynamic and is updated quarterly with new FDA-approved drugs, additional black box warnings or label changes, recently published clinically significant peer-reviewed publications and new CPIC guidelines. We have a formal review team that includes geneticists, Pharm.D.s and lab specialists, that

 

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determines the appropriate updates each quarter. IDgenetix provides the healthcare provider with a simple report categorizing the FDA-approved therapies that are best suited for the individual patient by disease condition.

 

Our Process

 

IDgenetix is a customer-centric testing process that is designed to be simple. The healthcare professional’s activities can be completed within minutes and are easily incorporated into clinical practice (shown in Figure 1). For example, a healthcare professional can swab a patient on Monday and get a result via a secure web-portal, fax or email by Wednesday. The ease of use provides healthcare providers flexibility in report delivery, including viewing results on their tablets and mobile devices, test ordering and process tracking.

 

To facilitate the process, we provide a single-use package to the healthcare provider that includes a test requisition form and cheek swabs. First, the healthcare provider collects a cheek swab sample from the patient and fills out a test requisition form. Second, the sample and test requisition form are shipped via overnight courier to our laboratory for testing. Third, we perform a thorough and expansive genetic analysis of the sample and subsequently generate clinical results using our proprietary bioinformatic algorithm. Fourth, we return simple, easy-to-read, actionable laboratory results to the healthcare provider, generally within 48 hours of sample receipt, which we believe is an industry-leading turnaround time.

 

Healthcare providers are responsible for communicating test results to patients and incorporating the provided test information into the patient’s overall care. Our certified genetic counselors and Pharm.D.s are available to answer questions regarding the results, including assistance with complex patient case management.

 

Our web-portal allows the healthcare provider to order tests, monitor test status and review results online. The web-portal also stores all of the activity for each individual healthcare provider, including tests ordered and all patient results. Since each report is delivered and stored electronically as a PDF file, healthcare providers are able to “drag and drop” the results into their organization’s electronic medical records system. We seek to maintain our web-portal in compliance with the Health Insurance Portability and Accountability Act of 1996, or HIPAA.

 

Figure 1: Our IDgenetix Customer-Centric Process

 

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Our Internal Process

 

IDgenetix is a complex, high-throughput molecular test that involves pre-analytical, analytical and post-analytical steps carried out in a strictly controlled laboratory environment, each of which is critical to delivering a high quality result. Our testing process was designed to maximize throughput, efficiency and quality, and is easily scalable to serve the needs of our growing customer base. We currently operate an approximately 10,000 square foot CAP-accredited, CLIA-certified laboratory that can accommodate up to 100,000 patient samples per year, and we expect to move to a new facility that can accommodate up to 500,000 patient samples per year in 2015. Our laboratory utilizes fully automated, custom configured workflow to minimize manual handling of test samples. This allows us to operate our laboratory with fewer personnel and maintain a smaller laboratory space, resulting in cost savings and lower overhead. Each automated step is directed by our laboratory information management system, which ensures that samples are efficiently moved from one step to the next in the laboratory process per our procedures. Bar-coding is further utilized throughout the process to ensure chain of custody and integrity of results. Each batch of patient samples undergoes a rigorous evaluation of multiple quality metrics before results are released. In addition, there is continuous monitoring of laboratory performance metrics to ensure our laboratory is performing as expected. We specifically designed our automated process to be modular, in order to allow us to quickly scale up to meet anticipated higher test volumes.

 

We are able to manage our costs across all aspects of testing, including sample collection, sample processing, DNA extraction, PCR analysis and data analysis. Because we utilize commercially available off-the-shelf hardware and consumables in proprietary configurations, as our sample volume increases we expect to be able to scale to meet demand and expect our average cost per sample to decrease. We believe our highly efficient laboratory workflow provides a competitive advantage as we are able to analyze more genes and genetic mutations than any other competitor that we are aware of at a cost effective rate. Our proprietary workflow will allow us to continue to add genes and genetic mutation analysis in the future while having a minimal impact to our cost profile. All incoming reagents are carefully inspected and tested to ensure the highest level of performance quality, and proprietary pre-characterized controls are processed with every batch of patient samples analyzed. Additionally, our process is technology agnostic, and as future technologies such as NGS become more cost effective we can integrate them as appropriate.

 

Our IDgenetix Reports and Analysis

 

Patient Reports

 

Our proprietary bioinformatic algorithm computes complex genetic and environmental factors and produces a simple, easy to read, evidence-based report that is actionable for use by healthcare providers (shown in Figure 2).

 

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Figure 2: Example of Patient Report

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The “Pharmacogenetic Testing Based Treatment Guidance” section of the report lists the FDA-approved drugs that can be used as directed and the FDA-approved drugs that should be used with caution or with increased monitoring and dosing guidance, where applicable, due to the patient’s unique genetic profile and other factors incorporated in our algorithm. The “Laboratory Results & Pharmacogenetic Test Analysis” section of the report provides the patient’s genetic results and corresponding metabolic phenotype, where applicable. We include other relevant information for the healthcare provider in the “Summary and Comments” section of the report.

 

Polypharmacy Analysis

 

In addition to patient reports, we offer a polypharmacy analysis for certain institutional healthcare provider customers (shown in Figure 3) that allows physicians to identify potentially harmful interactions and possibly avoid adverse events through elimination of drugs or selection of more appropriate drugs.

 

Figure 3: Example of Polypharmacy Analysis

 

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