htgm-10k_20171231.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

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

For the fiscal year ended December 31, 2017

OR

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

FOR THE TRANSITION PERIOD FROM                      TO

Commission File Number 001-37369

 

HTG Molecular Diagnostics, Inc.

(Exact name of Registrant as specified in its Charter)

 

 

Delaware

 

86-0912294

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

3430 E. Global LoopTucson, AZ

 

85706

(Address of principal executive offices)

 

(Zip Code)

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

 

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

 

Title of each class

 

Name of each exchange on which registered

Common Stock, par value $0.001 per share

 

The Nasdaq Capital Market

 

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

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

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

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

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

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

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

 (Do not check if a small reporting company)

  

Smaller reporting company

 

 

 

 

 

 

 

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if he registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

 

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, based on the closing price of the shares of common stock on The Nasdaq Capital Market on June 30, 2017, was $30,213,142.

The number of shares of Registrant’s Common Stock outstanding as of March 16, 2018 was 28,355,800.

 

 

 


 

Table of Contents

 

 

 

Page

PART I

 

 

Item 1.

Business

2

Item 1A.

Risk Factors

28

Item 1B.

Unresolved Staff Comments

57

Item 2.

Properties

57

Item 3.

Legal Proceedings

57

Item 4.

Mine Safety Disclosures

57

 

 

 

PART II

 

 

Item 5.

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

58

Item 6.

Selected Financial Data

58

Item 7.

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

59

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

69

Item 8.

Financial Statements and Supplementary Data

69

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

70

Item 9A.

Controls and Procedures

70

Item 9B.

Other Information

70

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

71

Item 11.

Executive Compensation

79

Item 12.

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

91

Item 13.

Certain Relationships and Related Transactions, and Director Independence

93

Item 14.

Principal Accounting Fees and Services

96

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

97

Item 16.

Form 10-K Summary

101

 

 

 

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PART I

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

Forward-Looking Statements

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

 

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

 

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

 

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

 

the activities anticipated to be performed by us and third parties under development projects and programs, and the expected benefits and outcomes of such projects and programs;

 

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

 

the regulatory regime for our products, domestically and internationally;

 

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

 

our intellectual property position;

 

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

 

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

 

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

 

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

 

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

These forward-looking statements reflect our management’s beliefs and views with respect to future events and are based on estimates and assumptions as of the filing date of this Annual Report and are subject to risks and uncertainties. We discuss many of these risks in greater detail under “Risk Factors.” Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Annual Report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

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Item 1. Business.

Overview

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

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

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

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

We currently have two primary sources of revenue: revenue from research use only (“RUO”) profiling for biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for companion diagnostic development programs for biopharmaceutical companies. RUO profiling revenue includes customer purchases of our HTG EdgeSeq instrument and integrated RUO assay kits, and the use of our HTG EdgeSeq instruments and RUO assay kits to process samples on the customer’s behalf in our VERI/O laboratory. Collaborative development services revenue relates to services performed primarily for biopharmaceutical companies pursuant to our Master Assay Development, Commercialization and Manufacturing Agreement (the “Governing Agreement”) with QIAGEN Manchester Limited (“QML”), a wholly owned subsidiary of QIAGEN N.V. Under the Governing Agreement, whereby our HTG EdgeSeq proprietary technology is utilized to develop, seek regulatory approval for and commercialize clinical diagnostic assays for biopharmaceutical drug candidates and corresponding therapeutics.

Our assay offerings that are currently sold for research use only include the following:

 

HTG EdgeSeq Oncology Biomarker Panel;

 

HTG EdgeSeq Immuno-Oncology Assay;

 

HTG EdgeSeq DLBCL Cell of Origin Assay;

 

HTG EdgeSeq PATH Assay;

 

HTG EdgeSeq miRNA Whole-Transcriptome Assay; and

 

HTG EdgeSeq EGFR, KRAS and BRAF Mutation Assay (VERI/O lab service offering exclusively).

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In addition, we have obtained CE-marking for two of our assay offerings in Europe, making the following assay products available for diagnostic use in Europe:

 

HTG EdgeSeq ALKPlus Assay EU; and

 

HTG EdgeSeq DBLCL Cell of Origin Assay EU.

We continue work on our pre-market approval (“PMA”) submission for our HTG EdgeSeq ALKPlus Assay in the United States. We also have a focused development pipeline of new profiling products, which includes planned panels for translational research, drug development, and molecular diagnostics with initial focus in immuno-oncology. Our HTG EdgeSeq EGFR, KRAS and BRAF Mutation Assay is our first commercially available application based on the next generation of our HTG EdgeSeq chemistry.

Our HTG EdgeSeq assays are automated on our HTG EdgeSeq platform, which may also be referred to as an “instrument” or “processor” and which, together with the assay, is a fully integrated system.

Customers can obtain the advantages of our proprietary technology by engaging our VERI/O laboratory for pre-clinical and clinical research-related services, including drug development and translational research. Our services include processing samples for molecular profiling data and designing custom research or investigational profiling assays. We also perform collaborative development services for biopharmaceutical company customers, primarily through the Governing Agreement with QML.

We believe the value propositions of our products and services are gaining significant recognition. In 2016, we entered into an RUO services agreement with Bristol-Myers Squibb Company (“BMS”) and a collaborative development services agreement with Merck KGaA, Darmstadt, Germany (“Merck KGaA”). In June 2017, we entered into our first statement of work (“SOW One”) under the Governing Agreement relating to a companion diagnostic program for a biopharmaceutical partner, and subsequently entered into two additional statements of work in October 2017 (“SOW Two”) and January 2018 (“SOW Three”), relating to companion diagnostic programs for two additional biopharmaceutical company customers. In December 2017, we entered into a separate RUO services agreement for development and manufacturing of RUO assays supporting biomarker research programs with Merck KGaA. These programs represent just a few of the over 30 individual project programs with biopharmaceutical companies employing our proprietary technology in their clinical research and drug development programs as of December 31, 2017.

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

Our Strategy

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

 

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

 

Increase and strengthen companion diagnostics collaborations with biopharmaceutical companies. We believe collaborations with biopharmaceutical companies with late-stage drug development programs will lead to us generating companion diagnostic consumables revenue. As of December 31, 2017, we had 37 active development programs across 9 leading biopharmaceutical companies which are incorporating companion diagnostics in their drug development programs. Through our Governing Agreement with QML, we have initiated companion diagnostic collaborative development services for three biopharmaceutical company programs to date, in addition to our existing arrangement with Merck KGaA from 2016. We intend to continue to leverage our VERI/O laboratory services business to enable nimble response to emerging biopharmaceutical molecular profiling requirements.

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

 

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

 

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

 

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

Our Market

Development of Molecular Profiling

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

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

We estimate that the global cancer profiling market was approximately $30.0 billion in 2017. Based on published industry reports, this market is projected to achieve a value of $87.1 billion by 2023, with a compound annual growth rate of approximately 19.0% between 2017 and 2023. According to these reports, the increase in demand for cancer and tumor profiling products is mainly driven by an increasing number of new cancer cases in an aging population, rising utility of biomarkers in tumor profiling, rising availability of funding for cancer research and increasing demand for next generation sequencing for cancer profiling. Our initial diagnostic products target the pathology related diagnostic markets where we can transition existing testing methods to NGS-based workflows. The companion diagnostic market is currently estimated at $2.6 billion and growing approximately 20% annually. We believe that the acceleration of investment into immunotherapy drugs will also be a catalyst for future companion diagnostics for combination therapies where gene expression classification is expected to be important.

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

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

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

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

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

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

When a molecular biomarker panel is used for selection of patients in a Phase 2 or Phase 3 clinical trial to demonstrate safety and efficacy of a new drug, the drug and biomarker test are often submitted to the applicable regulatory agency for approval together. In the United States, upon U.S. Food and Drug Administration (“FDA”) approval of the biomarker test, or companion diagnostic, the patient must be tested with the companion diagnostic prior to treatment with the drug. Companion diagnostic tests have a clear clinical utility which generally supports favorable reimbursement decisions. We believe there are over 900 active oncology drug development programs, most of which have molecular biomarker strategies, creating a significant opportunity for molecular diagnostic companies with the right molecular profiling solutions.

Complexities and Challenges of Molecular Profiling Today

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

Insufficient Sample Availability

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

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

Slow Turnaround Times

In many cases, turnaround times for comprehensive profiling of a patient’s sample(s) are several weeks due to the logistical time to route samples to various laboratory departments and to distant specialized labs. Several technologies for sample characterization have been used and introduced over the years to determine the status of various molecular characteristics for a sample. These characteristics include RNA and protein expression levels, and/or the presence or absence of DNA mutations, such as single-point mutations and gene fusions and rearrangements, which mutations can be detected in genomic DNA or expressed RNA and protein. A single tumor specimen from a cancer patient is often profiled for multiple molecular characteristics where each characteristic is measured using a different platform. These platforms are utilized in separate laboratory departments or institutions with different technicians and clinicians, requiring that the sample and data be split into multiple workflows. This also requires even more sample consumption.

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

Implications of Workflow Inefficiencies on Data Quality and Integration

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

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

Our Solution

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

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

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Our Technology

HTG EdgeSeq Chemistry

Our HTG EdgeSeq chemistry is shown schematically in the following figure. Specifically, DNA nuclease protection probes, or DNA protection probes, which include a target-specific region flanked by universal wing sequences are hybridized to targeted RNAs. Target RNA can be both soluble and cross-linked in the biological matrix. Universal DNA wingmen probes are hybridized to the wings to prevent S1 nuclease digestion. S1 nuclease is added to remove single-stranded nucleic acids, including unhybridized DNA protection probes and RNA. Following S1 nuclease treatment, the only remaining DNA protection probes in the reaction are those hybridized to targeted RNA and wingmen probes to form a hybridized complex. This produces an approximately 1:1 ratio of DNA protection probes to the RNA targeted in the sample. Alkaline hydrolysis of the hybridized complexes releases the DNA protection probes from such complexes. The released DNA protection probes are ready for quantitation. DNA protection probes are labeled with sequencing adaptors and tags in a thermocycler. The labeled DNA protection probes are concentrated, pooled, and ready for sequencing using standard NGS protocols. Data from the NGS instrument is processed and reported by the parser software provided with the HTG EdgeSeq system.

 

Key Advantages of our HTG EdgeSeq Chemistry

 

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

 

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

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

 

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

 

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

HTG Instrument Platform

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

 

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

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

In addition to direct sales of our systems, we utilize several alternative arrangements to sell our systems. Our platform can be purchased directly by our customers, who also then purchase HTG EdgeSeq assays and other consumables from us on an as-needed basis. In some instances, we provide our instruments free of charge on a limited basis to facilitate customer evaluation. We also may choose to install instruments for our customers at no cost, in exchange for an agreement to purchase assays and other consumables from us at a stated price over the term of the agreement, or allow customers to rent our instrument for a monthly fee. As of

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December 31, 2017, we had an installed base of 44 instruments (consisting of 31 systems sold, two covered under reagent rental agreements, six evaluation units and five systems with key opinion leaders) and an additional three instruments installed at third party sites in support of companion diagnostic collaboration projects.

Current Commercial Panels Offered on the HTG EdgeSeq Platform

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

 

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

 

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

 

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

 

HTG EdgeSeq PATH Assay. The HTG EdgeSeq PATH Assay has been designed for retrospective gene expression profiling (“GEP”) to compliment traditional immunohistochemistry (“IHC”) testing by allowing investigators to assess mRNA expression of 470 targets when tissue availability is limited. The assay enables a wide variety of applications, including pre-screening of samples to guide subsequent testing and development of novel gene signatures.

 

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

 

HTG EdgeSeq DLBCL Cell of Origin Assay EU. The HTG EdgeSeq DLBCL Cell of Origin Assay EU is an in vitro diagnostic (“IVD”) assay that uses GEP to determine the cell of origin (“COO”) subtype of DLBCL tumors from FFPE tissue section. The gene expression data are assessed by a classification algorithm and the tumor samples are determined to be of the ABC, GCB or unclassified subtype. This product has obtained CE-marking in Europe where it is available for diagnostic use. It is not for sale in North America.

 

HTG EdgeSeq ALKPlus Assay EU. The HTG EdgeSeq ALKPlus Assay EU is an IVD NGS-based assay sold in the EU intended to measure and analyze mRNA ALK gene fusion events in FFPE lung tumor specimens from patients previously diagnosed with NSCLC. This product has also obtained CE-marking in Europe where it is available for diagnostic use. It is not for sale in North America.

 

HTG EdgeSeq EGFR, KRAS and BRAF Mutation Assay (VERI/O lab service offering exclusively). The HTG EdgeSeq EGFR, KRAS, and BRAF Mutation Assay is an RUO assay currently available exclusively as a VERI/O laboratory service and detects 23 mutations in EGFR, KRAS and BRAF from a 5 µm section of FFPE tissue. Retrospective analysis of the tumor’s mutational status may help researchers understand the tumor response to targeted therapy. This assay is extraction-free and can be used with small samples such as a needle core biopsy.

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Opportunities for Comprehensive Molecular Profiling in Diagnostics

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

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

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

We are currently developing our HTG EdgeSeq ALKPlus Assay (“ALKPlus Assay”) as our first clinical diagnostic test for the U.S. market. This test panel is in clinical study phase and three of the four PMA modules have been submitted to the FDA. We completed the CE marking of the HTG EdgeSeq ALKPlus Assay EU in Europe in March 2017, and currently expect to obtain FDA pre-market approval for the ALKPlus Assay in mid-2018 though prioritization of other diagnostic programs for customers may cause this expected timeline to be adjusted. The intended use for the ALKPlus Assay, if approved by the FDA, will be as a companion diagnostic for crizotinib therapy for ALK positive NSCLC cases. Information on the ROS1, RET, NTRK1 and HER2 gene rearrangements included in the ALKPlus Assay panel will be provided with RUO status. After obtaining the appropriate exemption(s), we believe the ROS1, RET, NTRK1 and HER2 gene rearrangements detected with the ALKPlus Assay could also be used for investigational use only (“IUO”) for certain late-stage drug development trials, and, as appropriate, receive FDA approval in the future.

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

We are leveraging our platform to develop comprehensive molecular profiling panels across an increasing set of molecular applications, with initial focus in immuno-oncology and next generation pathology. In conjunction with our biopharmaceutical collaborators, we plan to develop novel RNA-based gene panels and possibly classifiers that can provide information about inflammation signatures and the molecular classification of tumors. Separately, we also plan to develop novel RNA-based gene panels designed for expanded applications in immune health monitoring and prescreening, detection of hyper-progression and predicting patient response to combination therapies. We believe that we will need to develop, refine and implement new panel protocols and make changes or adjustments to our chemistry and software to optimize these planned applications and panels for use with our HTG EdgeSeq system. We expect this to require substantial effort from our research scientists and the use of various laboratory equipment, supplies and materials, which together represent the most significant costs that we expect to incur in connection with the development of these applications and profiling panels.

Serving the decentralized markets with Project JANUS

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

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Research and Development

We have committed, and expect to commit, significant resources to developing new technologies and products, improving product performance and reliability and reducing costs. We have assembled an experienced research and development team with the scientific, engineering, software and process talent that we believe is required to successfully grow our business. As of December 31, 2017, our research and development team consisted of 30 employees across the disciplines of research and development scientist, platform development and bioinformatics.

Our development team is responsible for clinical assay development services being performed for biopharmaceutical company customers in accordance with our Governing Agreement with QML. We believe these programs have the potential to generate future revenue through the sale of HTG EdgeSeq instruments and test kit annuities associated with a successfully approved clinical diagnostic as the related drug gains adoption. Our research efforts are currently focused on the expansion of our technology into new immune-oncology applications as well as other applications in solid and liquid biopsies, while working to continuously improve assay performance and probe design.

Sales and Marketing

We distribute our instruments and consumables via direct sales in the United States and Europe and also through distributors in parts of Europe and other countries. As of December 31, 2017, our U.S. sales and marketing organization consisted of 23 employees including 12 in direct sales or sales management, five in sales support and six in marketing. In addition to our direct sales team in the United States, as of December 31, 2017, we had five direct sales and support employees in Europe and distribution agreements in several additional countries. This sales model provides us with direct sales coverage in the United Kingdom, France, Germany, Switzerland, Belgium and the Nordic countries, with distributors in Spain, Portugal, Italy and Israel.

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

Our top two customers accounted for 54% and 8% of our revenue for the year ended December 31, 2017, compared with 29% and 12% for the year ended December 31, 2016. QML was our largest customer for the year ended December 31, 2017 with approximately $7.9 million of collaborative development services revenue recognized for work performed for two precision diagnostic programs under our Governing Agreement.

Manufacturing and Suppliers

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

Instruments

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

Consumables

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

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Segment and Geographic Information

Financial information about segments and geographic information is incorporated herein by reference to Note 1, Description of Business, to our financial statements included in Part II in this Annual Report on Form 10-K.

Competition

We have categorized known competition into:

 

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

 

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

 

Decentralized CLIA labs developing LDTs locally such as major cancer centers.

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

 

cost of capital equipment;

 

cost of consumables and supplies;

 

reputation among customers;

 

innovation in product offerings;

 

flexibility and ease-of-use;

 

accuracy and reproducibility of results; and

 

compatibility with existing laboratory processes, tools and methods.

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

 

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

 

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

 

availability of coverage and adequate reimbursement for testing services; and

 

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

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

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

 

Greater name and brand recognition, financial and human resources;

 

Broader product lines;

 

Larger sales forces and more established distributor networks;

 

Substantial intellectual property portfolios;

 

Larger and more established customer bases and relationships; and

 

Better established, larger scale and lower cost manufacturing capabilities.

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Intellectual Property

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

Patents and Patent Applications

As of December 31, 2017, our patent portfolio included 13 patent families that, collectively, consisted of 11 issued U.S. patents, 34 granted foreign patents (variously in Australia, Canada, China, Japan, France, Germany, Italy, Spain, and United Kingdom), and 22 patent applications pending in the United States and foreign jurisdictions. This portfolio is directed to our nuclease-protection-based technologies, other nucleic-acid detection methods, and to methods for subtyping lung cancer and DLBCL and distinguishing indeterminate nevi from melanoma. Our patent portfolio will help us maintain an exclusive position in key areas of our business, including targeted nuclease-protection based sequencing, and DLBCL cell-of-origin applications of our technology. In addition, this portfolio may provide out‑licensing opportunities, such as, for methods of detecting melanoma or subtyping lung cancer. There were 10 granted patents, including one U.S. patent, directed to our novel HTG EdgeSeq methods in the portfolio as of December 31, 2017. The HTG EdgeSeq method patents will expire in April 2032. The portfolio also included two Patent Cooperation Treaty (PCT) applications as of December 31, 2017, one for our direct-target sequencing (V2) HTG EdgeSeq methods and one for our DLBCL subtyping methods.

Trade Secrets

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

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

Agreements with Third Parties

Asset Purchase Agreement with NuvoGen Research, LLC

We entered an asset purchase agreement dated January 9, 2001, as amended in November 2003, September 2004, November 2012 and February 2014, with NuvoGen Research, LLC (“NuvoGen”) to acquire certain intellectual property from NuvoGen. The acquired technology generally relates to our former array-based nuclease protection panels. Pursuant to the terms of the agreement, in exchange for the acquired technology, we initially paid NuvoGen 5,587 shares of our common stock, fixed payments of $740,000 over the first two years of the agreement and, thereafter, agreed to pay NuvoGen the greater of $400,000 per year or 6% of our annual revenue, until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15,000,000. Pursuant to the latest amendment to the agreement, we paid NuvoGen annual fixed fees of $800,000 and $543,750, in quarterly installments, for the years ended December 31, 2017 and 2016, respectively. Although the amendment allowed for the deferral of any accrued revenue-based payments through December 31, 2017, no revenue-based payments were deferred, and revenue-based payments of $85,574 and $0 were payable as of December 31, 2017 and 2016, respectively, for the amount by which 6% of revenue exceeded the applicable fixed fee. Beginning in 2018, we are obligated to pay the greater of $400,000 or 6% of sales. As of that date and continuing until the remaining obligation has been paid in full, interest on the remaining unpaid obligation will accrue and compound annually at a rate of 2.5% per year. Accrued interest on this unpaid obligation is payable on the date that the remaining obligation is paid in full.

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

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

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

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

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

We may prepay all, but not less than all, of the loaned amount plus accrued and unpaid interest thereon through the prepayment date with 15 days’ notice to Oxford. In accordance with the August 2015 amendment, we will be obligated to pay a prepayment fee equal to 1% of the principal amount repaid if the loan is repaid prior to the September 1, 2018 maturity date. We are not entitled to reborrow any amounts of principal once such principal has been repaid. The agreement was again amended in June 2016 to modify the definitions of permitted indebtedness and permitted liens to provide for an increased maximum amount of permitted indebtedness, authorize a new category of permitted indebtedness and authorize a new category of permitted liens.

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

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

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

Warrants granted to each of the Lenders in connection with Growth Term Loan A are exercisable until August 22, 2024 and were automatically converted to warrants for common stock upon completion of our initial public offering in May 2015. In connection with the funding of Growth Term Loan B, in March 2016, we issued Oxford an additional common stock warrant exercisable for 45,307 shares of common stock at an exercise price of $2.759 per share, and the warrant previously issued to SVB automatically became exercisable for an additional 5,317 shares of common stock at an exercise price of $23.51 per share in accordance with the Growth Term Loan.

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Development and Component Supply Agreement with Illumina, Inc.

In June 2017, we entered into an Amended and Restated Development and Component Supply Agreement with Illumina, Inc. (“Illumina”), effective May 31, 2017 (the “Restated Agreement”), which amended and restated our IVD Test Development and Component Supply Agreement originally entered into with Illumina in October 2014 (the “Original Agreement”). The Restated Agreement provides for the development and worldwide commercialization by the Company of nuclease-protection-based RNA or DNA profiling tests (“IVD test kits”) for use with Illumina’s MiSeqDx sequencer in the field of diagnostic oncology testing in humans (the “Field”).

Under the Restated Agreement, the parties have agreed to continue activities under the first development plan which was entered into pursuant to the Original Agreement relating to our HTG EdgeSeq ALKPlus Assay. In addition, we may, at our discretion, submit additional development plans for IVD test kits in the Field to Illumina for its approval, not to be unreasonably withheld.

Under each development plan, Illumina will provide specified regulatory support and rights, and develop and deliver to us an executable version of custom software, which, when deployed on Illumina’s MiSeqDx sequencer, would enable sequencing by the end-user of the subject IVD test kit probe library. Illumina retains ownership of the custom software, subject to our right to use the custom software in connection with the commercialization of IVD test kits. In addition to fees paid in 2015 under the Original Agreement, we are required to pay Illumina up to $0.6 million in the aggregate upon achievement of specified regulatory milestones relating to the IVD test kits, though none of these regulatory milestones have been reached through December 31, 2017. We have also agreed to pay Illumina a single digit percentage royalty on net sales of any IVD test kits that we commercialize pursuant to the Restated Agreement.

We submitted two additional development plans for IVD test kits to Illumina in the second and fourth quarters of 2017. Following receipt of the custom software module for the first of these test kits, we paid Illumina $50,000, which is included in our statements of operations for the year ended December 31, 2017. No payments were made to Illumina during the year ended December 31, 2016 under this agreement. Ongoing research and development costs for development plans under the Restated Agreement have been expensed as incurred.

Absent earlier termination, the Restated Agreement will expire in May 2027; however, Illumina is no longer obligated to notify us of changes in its products that may affect our IVD test kits after May 31, 2023. We may terminate the Restated Agreement at any time upon 90 days’ written notice and may terminate any development plan under the Restated Agreement upon 30 days’ prior written notice. Illumina may terminate the Restated Agreement upon 30 days’ prior written notice if we undergo certain changes of control, subject to a transition period of up to 12 months for then-ongoing development plans. Either party may terminate the Restated Agreement upon the other party’s material breach of the Restated Agreement that remains uncured for 30 days, or upon the other party’s bankruptcy.

Authorization, Supply and Regulatory Authorization Agreement with Life Technologies Corporation

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

Pursuant to the agreement, we have agreed to obtain our requirements for certain components to be used in the development of HTG Assays from LTC. In March 2016, we purchased approximately $250,000 of LTC products and equipment in accordance with this agreement. LTC has agreed to provide support in our efforts to obtain regulatory approval of the HTG Assays. We are required to pay LTC a milestone payment in the mid-six figure dollar range upon certain regulatory achievements for each HTG Assay. In addition, we have agreed to pay LTC a single digit percentage royalty on net sales of HTG Assays that we commercialize pursuant to the agreement. No milestone or royalty payments have been accrued or made pursuant to this agreement as of December 31, 2017.

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

Bristol-Myers Squibb Company Agreement

In May 2016, we entered into a Collaboration Agreement with BMS for the development of custom RUO assays for BMS based on our HTG EdgeSeq technology. Following development of each custom RUO assay, at BMS’s request, we may also perform sample processing services using such custom RUO assay(s) and/or supply the custom RUO assay(s) to BMS or its third-party subcontractors.

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Additional development related to immuno-oncology research may be undertaken pursuant to the Collaboration Agreement in accordance with a mutually acceptable work plan, which is incorporated by written amendment.

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

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

Merck KGaA Agreements

Master CDx Agreement

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

The Project has three stages aligned with timelines and outcomes of M7583 development. The timing of our development activities and payments may be affected by the M7583 development timing and activities which is controlled by Merck KGaA. During stages 1 and 2, we have agreed to perform specified DLBCL Assay development activities. In stage 3, we have agreed to seek to obtain applicable regulatory approvals on the DLBCL Assay and make it commercially available in the United States and certain other jurisdictions.

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

Merck KGaA may terminate the Project or any other project agreement by providing three months’ prior written notice, at which point Merck KGaA will be required to reimburse us for certain costs incurred during the termination period, and we will be required to reimburse Merck KGaA for any costs that have been prepaid without being incurred prior to termination. Further, either party may also terminate the agreement or a project agreement upon the other party’s material breach that remains uncured for 60 or 45 days, respectively, or upon the other party’s bankruptcy.

Master Collaboration Agreement

In December 2017, we entered into a Master Collaboration Agreement for translational research programs with Merck KGaA. The Master Collaboration Agreement complements the Master CDx Agreement with Merck KGaA and includes a statement of work with EMD Serono, the U.S. biopharmaceutical affiliate of Merck KGaA.

Under the first statement of work, we plan to develop and manufacture a custom profiling assay to support biomarker research for six indications within Merck KGaA’s drug development pipeline. The assay is expected to be kitted for use on HTG EdgeSeq instruments acquired by Merck KGaA and/or their contract research organization partners.

QIAGEN Agreements

Governing Agreement

In November 2016, we entered the Governing Agreement with QML. The Governing Agreement creates a framework for the companies to combine their technological and commercial strengths to offer biopharmaceutical companies a complete NGS-based solution for the development, manufacture and commercialization of companion diagnostic assays. Under the Governing Agreement, the parties jointly seek companion diagnostic programs with biopharmaceutical companies, QML enters into sponsor project agreements with interested biopharmaceutical companies for specified projects, and we and QML enter into statements of work, that set forth the rights and obligations of each party with respect to each project.

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

We and QML share net profits under each statement of work, at a percentage that primarily depends on which company’s intellectual property forms the basis for the particular assay under the applicable statement of work. Each statement of work provides additional financial terms for the corresponding project, which terms depend on the respective development and/or commercialization activities of the parties.

The Governing Agreement has a five-year term. However, either party may terminate the Governing Agreement upon (i) the other party’s uncured material breach, bankruptcy or insolvency, (ii) specified events affecting all statements of work, or (iii) a change of control by either party, except neither party will have such change of control termination right to the extent the Governing Agreement relates to SOW One, SOW Two or SOW Three (each defined below). In the event a party terminates the Governing Agreement for its own change of control, a $2.0 million termination payment will be payable to the non-terminating party.

Stock Purchase Agreement

Pursuant to a stock purchase agreement, entered concurrent with the Governing Agreement, QIAGEN North American Holdings, Inc. (“QNAH”) another wholly owned subsidiary of QIAGEN N.V., purchased 833,333 shares of our common stock on November 17, 2016 at $2.40 per share, for a total purchase price of $2.0 million. The purchase price for the shares of common stock purchased by QNAH on November 17, 2016 reflected the parties’ agreement as to the fair market value of the shares as of the closing. However, the portion of the purchase price per share that exceeded the most recently reported closing price of our common stock, or $175,000 in the aggregate, was attributed to the Governing Agreement and recorded as deferred revenue to be recognized on a straight-line basis over the Governing Agreement’s five-year term. No additional shares of our common stock were purchased by QNAH in the second tranche closing allowed for in this agreement and QNAH had no further obligation to purchase our common stock under the stock purchase agreement as of December 31, 2017.

Statement of Work No. One

In June 2017, we entered into the first statement of work (“SOW One”) under the Governing Agreement with QML. SOW One addresses the initial activities to be performed by us and QML in support of the development and potential commercialization of a NGS-based companion diagnostic assay that is the subject of a sponsor project agreement between QML and a biopharmaceutical company (“Pharma One”). The parties expect development activities for the assay to be the subject of more than one work plan under the sponsor project agreement and a corresponding number of statements of work under the Governing Agreement.

QML pays us a monthly fee for development work performed by us and our subcontractors. We also will share any net profits resulting from performance of the development work as determined pursuant to the Governing Agreement. Such profit sharing payment(s) is deemed to be fixed or determinable upon completion of SOW One deliverables, acceptance of corresponding deliverables by Pharma One, and the mutual agreement by QML and us on the calculation of net profit.

SOW One will expire when all activities and deliverables have been completed by the respective responsible party and all payments from QML to us have been delivered, including any required profit sharing, unless terminated earlier in accordance with the terms of the Governing Agreement.

Contemporaneous with entry into SOW One, the Governing Agreement was amended to provide that neither party may terminate SOW One or the Governing Agreement to the extent it relates to SOW One in the event of a change of control.

Statement of Work No. Two

In October 2017, we entered into SOW Two under the Governing Agreement with QML. SOW Two was made effective as of June 2, 2017 (“Onset Date”). SOW Two addresses development activities conducted by us and QML since the Onset Date and those expected to be further conducted by parties in connection with a sponsor project agreement between QML and BMS (the “BMS/QML SPA”).

The development work performed and expected to be performed by us and QML under SOW Two (“Initial Phase Work”) is expected to form the basis of a multi-stage project leading to the potential development and commercialization of a companion diagnostic assay in support of one or more of BMS’s therapeutic development and commercialization programs. SOW Two will expire upon completion of the Initial Phase Work and receipt by us of all amounts due for such work, which we believe will occur in mid-2018 barring any unexpected project delays. QML will pay us mid-single digit millions of dollars for the Initial Phase Work

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performed by us under SOW Two. In addition, we will share in any net profits (as determined under the Governing Agreement) generated by the Initial Phase Work with QML on an approximately quarterly basis throughout the term of SOW Two.

SOW Two also provides that, notwithstanding anything in the Governing Agreement to the contrary, neither party shall have the right to terminate SOW Two or the Governing Agreement to the extent it relates to SOW Two upon a change of control of either party.Concurrently with SOW Two, as a condition to BMS’s approval of SOW Two, we entered into a Supplement Agreement with QML and BMS, made effective as of the Onset Date. The Supplement Agreement establishes certain rights and obligations of the parties with regard to confidential information and other intellectual property needed to perform, and/or produced as a result of, the Initial Phase Work. We will receive sole ownership of certain improvements (as specified in the Supplement Agreement) that may be produced as a result of the Initial Phase Work, and have agreed to grant certain royalty-free, non-exclusive license rights to our technology in the event of a project delay caused by us and to certain patent rights we may obtain as a result of the Initial Phase Work. In addition, we will have joint ownership of certain other results of the Initial Phase Work, and royalty-free, non-exclusive license rights to BMS- or QML-owned (solely or jointly) patents resulting from the Initial Phase Work. The Supplement Agreement will expire or terminate upon expiration or termination of the BMS/QML SPA, which is expected to be approximately coextensive with the term of SOW Two.

Statement of Work No. Three

In January 2018, we entered into SOW Three under the Governing Agreement with QML. SOW Three relates to development activities for a NGS-based clinical-trial assay (“SOW Three Project”) in connection with a sponsor project agreement between QML and a pharmaceutical company (“Pharma Three”). If successfully completed, SOW Three Project is expected to lead to subsequent assay development activities and the potential commercialization of a companion diagnostic assay for a corresponding Pharma Three drug.

QML has agreed to pay us low, single-digit millions of dollars in development fees for the SOW Three Project, which is expected to be completed in the second quarter of 2018. In addition, we and QML will share any net profits (as determined under the Governing Agreement) generated by the SOW Three Project on an approximately quarterly basis over the term of SOW Three.

Under the terms of SOW Three, we have agreed to assign our rights in certain SOW Three Project‑related intellectual property (“Project IP”) predominantly related to Pharma Three’s drug candidate(s) to QML for ultimate assignment to Pharma Three in accordance with the project agreement. Improvements to the respective background intellectual property of the parties generally will be owned solely by the respective party. Otherwise, Project IP will be jointly owned among us, QML and Pharma Three.

Pursuant to the terms of SOW Three, if Pharma Three terminates the project agreement or the SOW Three Project due to our uncured material breach of SOW Three, we will be required to negotiate in good faith with Pharma Three a non‑exclusive, royalty‑bearing license to certain of our intellectual property as reasonably necessary for Pharma Three to research, develop, and commercialize an in vitro diagnostic assay meeting the same specifications as in SOW Three.

Neither we nor QML have the right to terminate SOW Three or the Governing Agreement to the extent it relates to SOW Three upon a change of control of either party. In addition, if Pharma Three terminates the project agreement or the SOW Three Project for an uncured material breach that is directly caused by our or QML, then, for the non‑breaching party, the exclusivity obligation of the Governing Agreement will terminate solely with respect to the development for Pharma Three and/or its affiliates of an in vitro diagnostic assay meeting the same specifications as in SOW Three.

SOW Three expires upon completion of the SOW Three Project and receipt by us of all amounts due for such work.

QNAH Convertible Note Agreement

In October 2017, we issued a subordinated convertible promissory note (the “QNAH Convertible Note”) to QNAH in the principal amount of $3.0 million against receipt of cash proceeds equal to such principal amount. The QNAH Convertible Note bears simple interest at the rate of 3.0% per annum and matures on October 26, 2020. Our indebtedness under the QNAH Convertible Note is expressly subordinated in right of payment to the prior repayment in full of our indebtedness under our Growth Term Loan. QNAH may elect to convert all or any portion of the outstanding principal balance of the QNAH Convertible Note and all unpaid accrued interest thereon at any time prior to the maturity date into shares of our common stock at a conversion price of $3.984 per share.

Third-Party Coverage and Reimbursement

Clinical laboratories will acquire our instrumentation through a capital purchase, capital lease or reagent purchasing agreement. These laboratories will offer their customers a menu of testing services using our IVD test kits or their LDTs, which they may develop

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using components they purchase from us, or a combination of both. Our customers will generate revenue for these testing services by collecting payments from third-party payors, including public and private payors, as well as patient co-payments.

United States

In the United States, molecular testing laboratories have multiple options for reimbursement coding, but we expect that the primary codes used will be the Genomic Sequencing Procedure codes. We are also monitoring the Protecting Access to Medicare Act implementation as well as the recent National Coverage Determination for NGS testing by the Centers for Medicare and Medicaid Services (“CMS”).

Genomic Sequencing Procedures.

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

 

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

 

Gene rearrangements in solid tumors and hematolymphoid neoplasms;

 

Mutations in solid tumors and hematolymphoid neoplasms.

Payments for Tier 1 and Tier 2 Molecular Pathology Procedures and GSPs may be sought from both public and private payors. Claims for Medicare coverage are processed by private Medicare Administrative Contractors (“MACs”) such as Novitas and Cahaba, and coverage for specific test codes are specified in Local Coverage Determinations (“LCDs”) issued by individual MACs or National Coverage Determinations (“NCDs”) which apply to all MACs. Private payors issue their own coverage determinations that are largely reflective of the CMS LCDs and NCDs. HTG closely monitors trends in coverage through interactions with customers, industry associations such as the College of American Pathologists (“CAP”) and the Association for Molecular Pathology (“AMP”) and industry consultants; these trends are key considerations in our product development plans.

Our customers may use our products, if approved, and subject to regulatory limitations, to offer testing services that provide an analysis of 5‑50 genes as well as 51 or more genes. In October 2014, CMS released its preliminary determinations regarding the method for determining 2015 payment rates for new codes under the clinical laboratory fee schedule. CMS recommended that payment rates for GSPs be determined through a process known as gapfill rather than by crosswalking to allow CMS and its contractors to gather information about the manner in which the tests are performed and the resources necessary to provide them, so that ultimately CMS can set an appropriate payment rate for these tests. In the gapfill process, the local MACs determine the appropriate fee schedule amounts in the first year, and CMS calculates a national payment rate based on the median of these local fee schedule amounts in the second year. On September 22, 2017, gapfill pricing for CPTs 81445 and 81450 for the assessment of 5-50 genes in solid and liquid tumors, respectively, were set at $598 and $760, respectively, and remains the same as of December 31, 2017. CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors was set at $2,920.

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

Outside the United States

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

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

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

Government Regulation – Medical Device Regulations

United States

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

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

Device Classification

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

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

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

 

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

 

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

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

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

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

The PMA Process

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

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

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

Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If the PMA application is determined to be sufficiently complete, the FDA will accept the application for filing and begin the review. The FDA, by statute and by regulation, has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant’s response to deficiencies communicated by the FDA. The FDA considers a PMA or PMA supplement to have been voluntarily withdrawn if an applicant fails to respond to an FDA request for information (e.g. major deficiency letter) within a total of 360 days. Before approving or denying a PMA, an FDA advisory panel may be convened to review the PMA and provide the FDA with the committee’s recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. This advisory panel may also involve a public meeting if FDA determines public input is required. Prior to approval of a PMA, the FDA may conduct a bioresearch monitoring inspection of the clinical study data and clinical study sites, and a QSR inspection of the manufacturing facility and processes. Overall, the FDA review of a PMA application generally takes between one and three years, but may take significantly longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:

 

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

 

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

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

 

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

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

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

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

Post-Approval Requirements

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

 

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

 

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

 

labeling regulations and unique device identification requirements;

 

advertising and promotion requirements;

 

restrictions on sale, distribution or use of a device;

 

PMA annual reporting requirements;

 

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

 

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

 

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

 

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

 

an order of repair, replacement or refund;

 

device tracking requirements; and

 

post-approval study and post market surveillance requirements.

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

Research Use Only

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

European Union

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

 

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

 

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

 

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

On May 26, 2017, the EU released a new regulatory framework, the In Vitro Diagnostic Medical Device Regulation (“IVDR”) which is expected to replace IVDD. Our products in the EU will have to comply with the IVDR requirements after May 26, 2022. Until that time, our products must continue to meet the requirements of IVDD for commercialization in the EU.

Other International

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

Government Regulation – Fraud and Abuse and Other Healthcare Regulation

We may be subject to various federal and state healthcare laws, including, but not limited to, anti-kickback laws. Penalties for violations of these healthcare laws include, but are not limited to, criminal, civil and/or administrative penalties, damages, fines, disgorgement, individual imprisonment, possible exclusion from Medicare, Medicaid and other federal healthcare programs, additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws and the curtailment or restructuring of operations.

Federal Anti-Kickback Statute

The Federal Anti-Kickback Statute prohibits persons or entities from knowingly and willfully soliciting, offering, receiving or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, or for the purchasing, leasing, ordering, or arranging for or recommending, any good, facility, service or item for which payment may be made in whole or in part under federal

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healthcare programs, such as the Medicare and Medicaid programs. The Federal Anti-Kickback Statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. The term “remuneration” expressly includes kickbacks, bribes, or rebates and has been broadly interpreted to include anything of value, including for example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payments, ownership interests and providing anything at less than its fair market value.

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

Federal Civil False Claims Act

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

Federal Physician Self-Referral Prohibition

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

Federal Civil Monetary Penalties Statute

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

Health Insurance Portability and Accountability Act of 1996

The Federal Health Insurance Portability and Accountability Act (“HIPAA”) created several additional federal crimes, including healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private third-party payors. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services.

In addition, HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act (“HITECH”) and their implementing regulations established uniform standards for certain covered entities, which are certain healthcare providers, health plans and healthcare clearinghouses, as well as their business associates that perform services for them that involve the creation, use, maintenance or disclosure of, individually identifiable health information, governing the conduct of specified electronic

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healthcare transactions and protecting the security and privacy of protected health information. Among other things, HITECH also created four new tiers of civil monetary penalties and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce federal HIPAA laws and seek attorneys’ fees and costs associated with pursuing federal civil actions. The EU has established its own data security and privacy legal framework, including but not limited to Directive 95/46/EC (“Data Protection Directive”). The Data Protection Directive will be replaced starting in May 2018 with the recently adopted European General Data Protection Regulation (“GDPR”), which contains new provisions specifically directed at the processing of health information, higher sanctions and extra-territoriality measures intended to bring non-EU companies under the regulation. Over time we may expand our business operations to include additional operations in the EU. With such expansion, we would be subject to increased governmental regulation, including the GDPR, in the EU countries in which we operate.

The Federal Physician Payments Sunshine Act

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

State Law Equivalents

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

Healthcare Reform

In March 2010, President Obama enacted the ACA, which is substantially changing healthcare financing and delivery by both governmental and private insurers, and is significantly impacting the medical device industry. The ACA’s provisions of importance to our business include, but are not limited to, a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, which became effective January 1, 2013. However, the Consolidated Appropriations Act of 2016, signed into law in December 2015, includes a two-year moratorium on the medical device excise tax that applies between January 1, 2016 and December 31, 2017. Further, on January 22, 2018, President Trump signed a continuing resolution on appropriations for fiscal year 2018, the 2018 Appropriations Resolution, that extended the moratorium on the medical device excise tax through December 31, 2019. Absent further legislative action, the tax will be automatically reinstated for medical device sales beginning January 1, 2020.

Since its enactment in 2010, there have been judicial and Congressional challenges to certain aspects of the ACA. Since January 2017, President Trump has signed two Executive Orders and other directives designed to delay the implementation of certain provision of the ACA and otherwise circumvent some of the requirements for health insurance mandated by the ACA. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the ACA. While Congress has not passed comprehensive repeal legislation, two bills affecting the implementation of certain taxes under the ACA have been signed into law. The 2017 U.S. Tax Cuts and Jobs Act (the “2017 Tax Act”) includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the ACA on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”. Additionally, the 2018 Appropriations Resolution delays the implementation of certain ACA-mandated fees, including, without limitation, the medical device excise tax.

In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following the passage of other legislative amendments, including the Bipartisan Budget Act of 2018, will stay in effect through 2027 unless additional Congressional action is taken. On January 2, 2013, President Obama signed into law the

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American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

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

The Foreign Corrupt Practices Act

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

Employees

Our ability to retain current talent and recruit new employees into our Company is a critical factor in our continued growth and performance improvement. We continue to initiate programs to promote our organizational culture and to identify the best possible new talent as the organization grows and new positions are made available. As of December 31, 2017, we had 94 full-time and four part-time employees, of which 12 are employed in administration, 22 in manufacturing and operations, 30 in research and development, six in regulatory and quality affairs, and 28 in sales and marketing. We had five employees in Europe as of December 31, 2017, all others were in the United States. We believe that our success will depend, in part, on our ability to attract and retain qualified personnel. We have never experienced a work stoppage due to labor difficulties and believe that our relations with our employees are good. None of our U.S. employees are represented by labor unions. Collective bargaining is established by law in France. We and our French employees have agreed to the terms of the applicable collective bargaining agreements.

Corporate Information

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

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

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012. We will remain an emerging growth company until the earlier of (1) December 31, 2020, (2) the last day of the fiscal year (a) in which we have total annual gross revenue of at least $1.07 billion, or (b) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeded $700.0 million as of the prior June 30th, and (3) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period. We refer to the Jumpstart Our Business Startups Act of 2012 in this Annual Report on Form 10-K as the “JOBS Act,” and references to “emerging growth company” have the meaning associated with it in the JOBS Act.

We are also a “smaller reporting company” as defined in the Securities Exchange Act of 1934 (the “Exchange Act”) and have elected to take advantage of certain of the scaled disclosures available to smaller reporting companies.

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Item 1A. Risk Factors.

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

Risks Related to our Business and Strategy

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

We have incurred losses since our inception and expect to incur losses in the future. We incurred net losses of $19.0 million and $26.0 million for the years ended December 31, 2017 and 2016, respectively. As of December 31, 2017, we had an accumulated deficit of $134.6 million. We expect that our losses will continue for the foreseeable future as we will be required to invest significant additional funds to support product development, including development of our next generation instrument platforms, development of our new HTG EdgeSeq panels, including our initial U.S. IVD assay, development of assays pursuant to our Governing Agreement with QML, and the commercialization of our HTG EdgeSeq system and proprietary consumables. We also expect that our selling, general and administrative expenses will continue to increase due to the additional costs associated with market development activities and expanding our staff to sell and support our products and services. Our ability to achieve or, if achieved, sustain profitability is based on numerous factors, many of which are beyond our control, including the market acceptance of our products and services, competitive product development and our market penetration and margins. We may never be able to generate sufficient revenue to achieve or, if achieved, sustain profitability.

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

We have limited experience marketing and selling our products. Our HTG Edge system was introduced for sale in the life sciences research market in the third quarter of 2013. Our HTG EdgeSeq chemistry was introduced for sale in the life sciences research market in the third quarter of 2014. Our dedicated HTG EdgeSeq system was introduced for sale in the life sciences research market in the fourth quarter of 2015 and has been our primary product focus since 2016. Our VERI/O service laboratory was announced in June 2016. We currently market our products through our own sales force in the United States and Europe, and have distributors in parts of Europe and the Middle East. In the future, we intend to expand our sales and support team in the United States, continue to build a direct sales and support team in Europe and establish additional distributor and/or third party contract sales team relationships in other parts of the world. However, we may not be able to market and sell our products effectively. Our sales of life science research products and potential future diagnostic products will depend in large part on our ability to successfully increase the scope of our marketing efforts and establish and maintain a sales force commensurate with our then applicable markets. Because we have limited experience in marketing and selling our products in the life science research market and in marketing and selling our products in the diagnostic market, our ability to forecast demand, the infrastructure required to support such demand and the sales cycle to customers is unproven. If we do not build an efficient and effective sales force and distributor relationships targeting these markets, our business and operating results will be adversely affected.

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

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

The FDA regulates diagnostic kits sold and distributed through interstate commerce in the United States as medical devices. Unless an exemption applies, generally, before a new medical device may be sold or distributed in the United States, or may be marketed for a new use in the United States, the medical device must receive either FDA clearance of a 510(k) pre-market notification or pre-market approval. Thus, before we can market or distribute our profiling panels, including our mRNA and miRNA panels, as IVD kits for use by clinical testing laboratories in the United States, we must first obtain pre-market clearance or pre-market approval from the FDA. Even if or when we apply for clearance or approval from the FDA for any of our products, the process can be lengthy and unpredictable. We are working collaboratively with multiple biopharmaceutical companies to clinically validate our

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HTG EdgeSeq DLBCL Cell of Origin Assay, which we believe can classify DLBCL as either ABC or GCB subtype. We expect to submit the DLBCL assay for U.S. regulatory clearances or approvals at some future time if and when our work with the biopharmaceutical companies reaches an appropriate stage. We initiated a modular PMA submission process to obtain FDA approval of our HTG EdgeSeq ALKPlus Assay to detect certain gene fusions in lung cancer in 2016. We cannot provide any assurances that our clinical studies or collaborative development services with biopharmaceutical companies will be completed or, if completed, have the desired outcomes or that we will meet the regulatory clearance or approval timelines for either product. Further, even if we complete the requisite clinical validations and submit or complete submission of an application, we may not receive FDA clearance or approval for the commercial use of our tests on a timely basis, or at all. If we are unable to obtain regulatory clearance or approval, or if clinical diagnostic laboratories do not accept our cleared or approved tests, our ability to grow our business could be compromised.

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

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

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

 

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

 

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

 

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

 

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

 

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

 

delays in obtaining suitable patient samples for use in a clinical study.

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

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

We are currently focused on selling our HTG EdgeSeq system and profiling panels within the life sciences research market. We plan to develop panels for many different disease states including companion diagnostics to determine the proper course of treatment for those diseases. We may experience reluctance, or refusal, on the part of physicians to order, and third-party payors to cover and provide adequate reimbursement for, our panels if the results of our research and clinical studies, and our sales and marketing activities relating to communication of these results, do not convey to physicians, third-party payors and patients that the HTG EdgeSeq system and related profiling panels provide equivalent or better diagnostic information than other available technologies and methodologies. We believe our panels represent an emerging methodology in diagnosing disease states, and we may have to overcome resistance among physicians to adopting it for the marketing of our products to be successful. Even if we are able to obtain regulatory approval from the FDA, the use of our panels may not become the standard diagnostic tool for those diseases on which we plan to focus our efforts.

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In addition, a key component of our strategy is to develop diagnostic tools in conjunction with biopharmaceutical companies’ drug development programs, to help assess the proper course of treatment for specific diseases. Even if we are successful in developing those diagnostic tools and receive regulatory approval, we still may not be successful in marketing those diagnostic tests. Furthermore, the decision to advance an underlying drug candidate through clinical trials and ultimately to commercialization is in the discretion of biopharmaceutical companies with which we collaborate. Our biopharmaceutical partners may take certain actions that could negatively impact the utility and marketability of our diagnostic tests. For example, our biopharmaceutical partners could:

 

determine not to actively pursue the development or commercialization of an applicable drug candidate, including due to the failure to demonstrate sufficient efficacy, the occurrence of safety or tolerability issues, or any number of other reasons;

 

fail to obtain necessary regulatory approval of an applicable drug candidate;

 

obtain regulatory approval for a drug candidate in a manner that neither requires nor recommends the use of a companion diagnostic test prior to its use; or

 

choose alternative diagnostic tests to market with their products instead of ours.

To the extent that we develop diagnostic assays for a biopharmaceutical company in collaboration with QML under our Governing Agreement and related statements of work, we may not have responsibility for some or all aspects of developing, marketing or commercializing any resulting diagnostic tests. In addition to this biopharmaceutical partner risk, QML may take certain actions that could negatively impact the development, utility and marketability of the applicable diagnostic tests. For example, QML could fail to satisfy or fall behind in its obligations to us or to the biopharmaceutical partner, which may delay development, regulatory approvals, market development and/or commercialization of an applicable companion diagnostic test.

Any of these events could limit our diagnostic test sales and revenues and have a material adverse effect on our business, operating results and financial condition.

We are dependent on our Governing Agreement with QML, and poor performance under the agreement or the termination of the agreement could negatively impact our business.

A key strategic focus of our business is to enter into collaborative development agreements with biopharmaceutical companies for the development, manufacture and commercialization of companion diagnostic assays for use with their drug development programs. In particular, we are focused on oncology-based collaborations.

In November 2016, we entered into a Governing Agreement with QML. Under the Governing Agreement, we and QML jointly seek collaborative development agreements with biopharmaceutical companies for the development, manufacture and potential commercialization of companion diagnostic assays. QML contracts with interested biopharmaceutical companies for specified projects, and we and QML enter into statements of work for each project. Our relationship with QML under the Governing Agreement is exclusive for NGS-based diagnostic assays (or certain related research assays) in the oncology field, subject to the achievement of certain performance targets. We expect that revenues under the Governing Agreement will constitute a significant portion of our revenues over at least the next few years.

We have limited or no control over the amount and timing of resources that QML will dedicate to activities under the Governing Agreement, and we are subject to a number of other risks associated with our dependence on the Governing Agreement, including:

 

There could be disagreements regarding the Governing Agreement, the initiation or conduct of activities under statements of work for specified projects, the achievement of milestone or other payments, the ownership of intellectual property, or research and development, regulatory, commercialization or other strategy. These disagreements might delay or terminate the development, manufacture or commercialization of companion diagnostic assays, delay or eliminate potential payments under the Governing Agreement or increase our costs under or outside of the Governing Agreement;

 

QML may not allocate adequate resources or otherwise support the development of collaborations with biopharmaceutical companies, including if they no longer view our Governing Agreement as in their best financial or other interests; and

 

QML may not perform as expected, including with regard to making any required payments, or performing its development or other obligations under a statement of work or under the contract with the applicable biopharmaceutical company customer and the Governing Agreement or applicable statement of work may not provide adequate protection for us or may not be effectively enforced.

In addition, we and QML have the right to terminate the Governing Agreement in certain circumstances. If the Governing Agreement is terminated early, we may not be able to find another company to assist us with the development, manufacture and commercialization of companion diagnostic assays for biopharmaceutical companies should we wish to do so. If we fail maintain a

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successful relationship with QML under the Governing Agreement, our development, manufacture and commercialization of companion diagnostic assays may be delayed, scaled back, or otherwise may not occur, and our anticipated revenue from the Governing Agreement could be severely limited or eliminated. In addition, we may be unable to enter into new collaborative arrangements with biopharmaceutical companies or, if necessary, modify our existing arrangements on acceptable terms. Any of these could have a material adverse effect on our business, results of operations and financial condition.

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

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

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

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

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

We are planning to expand our product offerings in the fields of detecting expressed gene rearrangements (e.g., gene fusions and/or insertions) and genomic or expressed DNA mutations. We believe we have successfully demonstrated that our technology is able to detect certain expressed gene rearrangements with our HTG EdgeSeq ALKPlus Assay EU now available in Europe, and genomic DNA mutations with our HTG EdgeSeq EGFR, KRAS and BRAF Mutation Assay service offering. Nevertheless, there are other potential applications for the foregoing technologies and opportunity for additional technology developments, such as detection of expressed DNA mutations, methods to detect mutation load and microsatellite instability and multiparameter testing methods, that we consider when planning our product pipeline. We believe we have successfully demonstrated proof of concept for detection of express DNA mutations but to date our work in this area has only been on relatively few applications or may not have the specificity required for certain applications. We cannot guarantee that we will be able to successfully develop additional applications or new technologies on a commercial scale. If we are unsuccessful at developing additional applications involving gene rearrangements or genomic DNA mutations, or developing technology to detect expressed DNA mutations, mutation load and microsatellite instability or developing multiparameter testing methods we may be limited in the breadth of additional products we can offer in the future, which could impact our future revenues and profits.

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We have initiated development of a new version of our HTG EdgeSeq system that will target the lower-volume throughput lab market. This development program, which we refer to as Project JANUS, is expected to increase our addressable market by enabling efficient molecular profiling of smaller quantity batches of samples. This program involves the development of new chemistry that is not currently compatible with our existing HTG EdgeSeq platform. In the third quarter of 2016, we suspended the development of the Project JANUS program. If we are unable to resume or successfully develop this new version of our HTG EdgeSeq system and in the market window we anticipate, automation of our new chemistry could be delayed and our addressable market could be limited, which could harm our business, results of operations and financial condition.

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

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

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

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

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

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

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

 

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

 

attract and retain sufficient numbers of talented employees;

 

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

 

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

 

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

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

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

Our current customer base is primarily composed of biopharmaceutical companies (including those contracted by QML pursuant to our Governing Agreement), academic institutions and molecular labs that perform analyses using or directly or indirectly obtain services based on our HTG EdgeSeq system and consumables for research use only, which means that the products or data from services may not be used for clinical diagnostic purposes. In July 2016, we obtained CE marking in Europe for our HTG EdgeSeq system and HTG EdgeSeq DLBCL Cell of Origin Assay EU. In March 2017, we obtained CE marking in Europe for our HTG EdgeSeq ALKPlus Assay EU. These products may now be used by customers for diagnostic purposes in Europe. Currently, we do not intend to and, where applicable, do not have appropriate licenses or permits to conduct diagnostic testing services. Our success will depend, in part, upon our ability to increase our market penetration among our customer bases and to expand our market by developing and marketing new clinical diagnostic tests and RUO applications (whether product or service), and to introduce diagnostic products into clinical laboratories in the United States and other jurisdictions after obtaining the requisite regulatory clearances or approvals. We may not be able to successfully complete development of or commercialize any of our planned future tests and applications. To achieve these goals, we will need to conduct substantial research and development, conduct clinical validation studies, expend significant funds, expand and scale-up our research, development, service and manufacturing processes and facilities, expand the number of projects under our Governing Agreement, expand and train our sales force; and seek and obtain regulatory clearance or approvals of our new tests and applications, as required by applicable regulations. Additionally, we must demonstrate to laboratory directors, physicians and third-party payors that our current and any future diagnostic products are effective in obtaining clinically relevant information that can inform treatment decisions, and that our HTG EdgeSeq system and related panels can enable an equivalent or superior approach than other available technology. Furthermore, we expect that a combination of increasing the installed base of our HTG EdgeSeq systems, expanding the number of projects under our Governing Agreement, and entering into additional service and custom RUO assay development agreements with biopharmaceutical customers will drive increased demand for our relatively high margin panels. If we are not able to successfully increase our installed base and biopharmaceutical customer relationships, then sales of our products and services, and our margins for these revenue items may not meet expectations. Attracting new customers and introducing new products and services requires substantial time and expense. Any failure to expand our existing customer base, or launch new products, including diagnostic products or services, would adversely affect our ability to improve our operating results.

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

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

Numerous other factors, many of which are outside our control, may cause or contribute to significant fluctuations in our quarterly and annual operating results. For example, QML and another customer accounted for 54% and 8% of our revenue, respectively, for the year ended December 31, 2017, and QML and another customer accounted for 66% and 11% of our accounts receivable balance, respectively, as of December 31, 2017. If orders from our top customers or the number of collaboration projects with QML are reduced or discontinued, our revenue in future periods may materially decrease. Fluctuations in our operating results may make financial planning and forecasting difficult. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. Factors that may contribute to fluctuations in our operating results include many of the risks described under the caption “Risk Factors – Risks Related to Our Business and Strategy” of this report. In addition, one or more of such factors may cause our revenue or operating expenses in one period to be disproportionately higher or lower relative to the others. Our products involve a significant capital commitment from our customers or may depend on customer studies that have variable or indefinite timelines and accordingly, involve a lengthy sales cycle. We may expend significant effort in attempting to make a particular sale, which may be deferred by the customer or never occur. Also, activities performed under our Governing Agreement involve significant resource commitments by us and depend on QML activities over which we have limited control and on biopharmaceutical customer activities and studies that have variable or indefinite timelines and outcomes. We may expend significant effort in attempting to meet our development obligations under the Governing Agreement, the respective payments for which may occur in a different period. Accordingly, comparing our operating results on a period-to-period basis may not be meaningful, and investors should not rely on our past results as an indication of our future performance. If such fluctuations occur or if our operating results deviate from our expectations or the expectations of investors or securities analysts, our stock price may be adversely affected.

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

Our sales process involves numerous interactions with multiple individuals within any given organization, and often includes in-depth analysis by potential customers of our products (where in some instances we will provide a demonstration unit for their use and evaluation), performance of proof-of-principle studies, preparation of extensive documentation and a lengthy review process. As a result of these factors, the capital investment required in purchasing our instruments and the budget cycles of our customers, the time

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from initial contact with a customer to our receipt of a purchase order can vary significantly and be up to 12 months or longer. Given the length and uncertainty of our sales cycle, we have in the past experienced, and likely will in the future experience, fluctuations in our product and product-related services revenue on a period-to-period basis. In addition, any failure to meet customer expectations could result in customers choosing to retain their existing systems or service providers or to purchase systems or services other than ours. The revenue that we expect to earn from our collaborative development services are also subject to an extended, variable timeline based on each project agreement, which will likely result in fluctuations in our collaborative development services revenue on a period-to-period basis as well.

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

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

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

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

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

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

Other arrangements might include a research agreement whereby an academic collaborator agrees to provide biological samples in exchange for the use of an HTG EdgeSeq system at no cost in furtherance of the collaborator’s professional goals and/or the educational or research objectives of an applicable institution.

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

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

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

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

A key component of our strategy is the development of companion diagnostic products designed to determine the appropriate patient population for administration of a particular therapeutic to more successfully treat a variety of illnesses. We have an exclusive arrangement with QML to develop certain companion diagnostic products for biopharmaceutical companies under our Governing Agreement. Otherwise, we may choose to independently develop companion diagnostic products with or without a biopharmaceutical partner. Successfully developing a companion diagnostic product depends both on regulatory approval for administration of the therapeutic, as well as regulatory approval of the diagnostic product. Even if we are successful in developing products that would be useful as companion diagnostic products, and potentially receive regulatory approval for such products, the biopharmaceutical companies that develop the corresponding therapeutics may ultimately be unsuccessful in obtaining regulatory approval for any such therapeutic, or, even if successful, select a competing technology to use in their regulatory submission instead of ours. The development, especially the independent development, of companion diagnostic products requires a significant investment of working capital which may not result in any future income. This could require us to raise additional funds which could dilute our current investors, or could impact our ability to continue our operations in the future.

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

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

 

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

 

macroeconomic conditions and the political climate;

 

changes in the regulatory environment;

 

differences in budgetary cycles;

 

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

 

market acceptance of relatively new technologies, such as ours.

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

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

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

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

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

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

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

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

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

 

greater name and brand recognition, financial and human resources;

 

broader product lines;

 

larger sales forces and more established distributor networks;

 

substantial intellectual property portfolios;

 

larger and more established customer bases and relationships; and

 

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

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

 

cost of capital equipment;

 

cost of consumables and supplies;

 

reputation among customers;

 

innovation in product offerings;

 

flexibility and ease-of-use;

 

accuracy and reproducibility of results; and

 

compatibility with existing laboratory processes, tools and methods.

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

 

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

 

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

 

availability of coverage and adequate reimbursement for testing services; and

 

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

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

We are dependent on a single third-party supplier for a certain subcomponent of our systems and the loss of this supplier could harm our business.

We currently rely on a single supplier to supply a subcomponent used in our HTG EdgeSeq processors. While we periodically forecast our needs for this subcomponent, our contract with this supplier, which may be a standard purchase order, does not commit them to carry inventory or make available any particular quantities, and the supplier may give other customers’ needs higher priority than ours and we may not be able to obtain adequate supplies in a timely manner or on commercially reasonable terms. If we were to lose this supplier, we may not be able to identify or enter into agreements with alternative suppliers on a timely basis on acceptable terms, or at all. If we should encounter delays or difficulties in securing the quality and quantity of subcomponent we require for our processors, our supply chain would be interrupted which would adversely affect our sales. A loss of this supplier could significantly delay the delivery of our HTG EdgeSeq processor, which in turn would materially affect our ability to generate revenue. If any of these events occur, our business and operating results could be materially harmed.

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

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

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

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

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

We manufacture our consumable products and our HTG EdgeSeq system and perform our RUO profiling and collaborative development services in our Tucson, Arizona facilities. In addition, our Tucson facilities are the center for order processing, receipt of

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

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

During the year ended December 31, 2017, approximately 67% of our revenue was generated from our Governing Agreement with QML, who is located outside of the United States, compared with 16% for the year ended December 31, 2016. We expect that a percentage of our future revenue will continue to come from international sources, driven in part by activities conducted pursuant to our Governing Agreement, and we expect to expand our overseas operations and develop opportunities in additional areas. Engaging in international business involves a number of difficulties and risks, including:

 

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

 

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

 

export and import restrictions;

 

various reimbursement, pricing and insurance regimes;

 

laws and business practices favoring local companies;

 

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

 

political and economic instability;

 

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

 

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

 

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

 

increased financial accounting and reporting burdens and complexities; and

 

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

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

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

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

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

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

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

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

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

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

We may need to raise additional capital to fund our operations in the future. If we are unsuccessful in attracting new capital, we may not be able to continue operations or may be forced to sell assets to do so. Alternatively, capital may not be available to us on favorable terms, or if at all. If available, financing terms may lead to significant dilution of our stockholders’ equity.

We are not profitable and have had negative cash flow from operations since our inception. To fund our operations and develop and commercialize our products, we have relied primarily on equity and debt financings and revenue generated from the sale of our HTG EdgeSeq systems, proprietary consumables, related services and collaborative arrangements with biopharmaceutical company customers. We currently anticipate that our cash and cash equivalents, including funds generated in our January 2018 public offering, will be sufficient to enable us to fund our operations for at least the next 12 months. We may need to obtain additional funds or refinance our existing Growth Term Loan to finance our operations in the future if our estimates of the amount of cash necessary to fund our operations and development and commercialization activities prove to be wrong, and we could spend our available financial resources much faster than we currently expect. Additional capital may not be available at such times or amounts as needed by us. Even if capital is available, it might be available only on unfavorable terms. Any additional equity or convertible debt financing into which we enter could be dilutive to our existing stockholders. Any future debt financing into which we enter may impose covenants upon us that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, we may need to relinquish rights to our technologies or our products, or grant licenses on terms that are not favorable to us. If access to sufficient capital is not available as and when needed, our business will be materially impaired and we may be required to cease operations, curtail one or more product development or commercialization programs, or significantly reduce expenses, sell assets, seek a merger or joint venture partner, file for protection from creditors or liquidate all of our assets. Any of these factors could harm our operating results.

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

In August 2014, we entered into a $16.0 million Growth Term Loan agreement with Oxford Finance LLC and Silicon Valley Bank, who we collectively refer to as our senior lenders. Under the terms of the Growth Term Loan, the senior lenders initially provided us with a term loan of $11.0 million. In March 2016, we borrowed the remaining $5.0 million pursuant to the term loan agreement. The loan is secured by a lien covering substantially all of our assets, excluding patents, trademarks and other intellectual property rights (except for rights to payments related to the sale, licensing or disposition of such intellectual property rights) and certain other specified property. The interest-only payment period expired in April 2016, and we are currently required to make monthly principal and interest payments through September 2018. As of December 31, 2017, we had $5.8 million outstanding under the Growth Term Loan, all of which is scheduled to become due and payable over the nine months following such date. Payments under the Growth Term Loan will result in a reduction in our working capital. If we default under the Growth Term Loan, our senior lenders could foreclose on our assets, including substantially all of our cash, which is held in accounts with our senior lenders.

Pursuant to the terms of an asset purchase agreement with NuvoGen, we agreed to annually pay NuvoGen the greater of $400,000 or 6% of our yearly revenue until the total aggregate cash compensation paid to NuvoGen under the agreement equals $15.0 million. To date, we have paid NuvoGen approximately $7.0 million. Payments to NuvoGen will result in a reduction in our working capital as we continue to make payments on this obligation.

Pursuant to the terms of the $3.0 million QNAH Convertible Note that we issued in October 2017, we will be required to repay the entire outstanding principal amount of the note and unpaid accrued interest thereon in October 2020, subject to the terms of a subordination agreement between QNAH and our senior lenders, provided QNAH may, at its election, convert all or any portion of the outstanding principal balance of the note and unpaid accrued interest at any time prior to the maturity date into shares of our common stock at a conversion price of $3.984 per share. Repayment of this note and unpaid accrued interest thereon at maturity would result in a reduction in our working capital, which could be significant depending on our cash position on the maturity date.

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

 

dispose of assets;

 

complete mergers or acquisitions;

 

incur indebtedness;

 

encumber assets;

 

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

 

make specified investments;

 

change certain key management personnel; and

 

engage in transactions with our affiliates.

These restrictions could inhibit our ability to pursue our business strategies. If we default under our obligations under the Growth Term Loan, the senior lenders could proceed against the collateral granted to them to secure our indebtedness or declare all obligation under the Growth Term Loan to be due and payable. In certain circumstances, procedures by the senior lenders could result in a loss by us of all of our equipment and inventory, which are included in the collateral granted to the senior lenders. In addition, upon any distribution of assets pursuant to any liquidation, insolvency, dissolution, reorganization or similar proceeding, the holders of secured indebtedness will be entitled to receive payment in full from the proceeds of the collateral securing our secured indebtedness before the holders of other indebtedness or our common stock will be entitled to receive any distribution with respect thereto.

We may incur additional indebtedness in the future. The debt instruments governing such indebtedness may contain provisions that are as, or more, restrictive than the provisions governing our existing indebtedness under the Growth Term Loan.

The enactment of U.S. tax reform in 2017 resulted in changes in the U.S. taxation of domestic and international business activities which could materially impact our future financial position and results of operations.

The 2017 Tax Act, which was signed into law on December 22, 2017, significantly revises the Internal Revenue Code of 1986, as amended (the “IRC”). The newly enacted federal income tax law, among other things, contains significant changes to corporate taxation, including a reduction of the federal statutory rates from a top marginal rate of 35% to a flat rate of 21%, limitation of the tax deduction for interest expense to 30% of adjusted earnings (except for certain small businesses), limitation of the deduction for net operating losses to 80% of current year taxable income, elimination of net operating loss carrybacks, one time taxation of offshore earnings at reduced rates regardless of whether they are repatriated, elimination of U.S. tax on foreign earnings (subject to certain

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important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifying or repealing many business deductions and credits. Notwithstanding the reduction in the corporate income tax rate, the overall impact of the new federal tax law is uncertain and our business and financial condition could be adversely affected. It is also unknown if and to what extent various states will conform to the newly enacted federal tax law. The impact of this tax reform on holders of our common stock is likewise uncertain and could be adverse. We urge you to consult with a legal and/or tax advisor with respect to this legislation and the potential consequences of investing in our common stock.

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

As of December 31, 2017, we had federal net operating loss carryforwards (“NOLs”) to offset future taxable income of approximately $122.0 million, which will begin to expire in 2021 if not utilized. A lack of future taxable income would adversely affect our ability to utilize these NOLs. In addition, under Section 382 of the IRC, a corporation that undergoes an “ownership change” (generally defined as a greater than 50% change, by value, in its equity ownership over a three-year period) is subject to limitations on its ability to utilize its NOLs to offset future taxable income. We believe we may have already experienced one or more ownership changes and may in the future experience one or more additional ownership changes, and thus, our ability to utilize pre-ownership change NOLs and other pre-ownership change tax attributes to offset post-ownership change income may be limited. Such limitations may cause a portion of our NOL and credit carryforwards to expire. In addition, future changes in our stock ownership, including as a result of future financings, as well as changes that may be outside of our control, could result in ownership changes under Section 382 of the Code. Our NOLs may also be impaired under similar provisions of state law. We have recorded a full valuation allowance related to our NOLs and other deferred tax assets due to the uncertainty of the ultimate realization of the future benefits of those assets.

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

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

 

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

 

unanticipated liabilities related to acquired companies;

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Our business requires manipulating, analyzing and storing large amounts of data. In addition, we rely on an enterprise software system to operate and manage our business. We also maintain personally identifiable information about our employees. Our business therefore depends on the continuous, effective, reliable and secure operation of our computer hardware, software, networks, Internet servers and related infrastructure. To the extent that our hardware and software malfunction or access to our data by internal personnel is interrupted, our business could suffer. The integrity and protection of our employee and company data is critical to our business and employees have a high expectation that we will adequately protect their personal information. The regulatory environment governing information, security and privacy laws is increasingly demanding and continues to evolve. Maintaining compliance with applicable security and privacy regulations may increase our operating costs. Although our computer and communications software are protected through physical and software safeguards, it is still vulnerable to natural or man-made hazards, such as fire, storm, flood, power loss, wind damage, telecommunications failures, physical or software break-ins, software viruses and similar events. These events could lead to the unauthorized access, disclosure and use of non-public information. The techniques used by criminal elements to attack computer systems are sophisticated, change frequently and may originate from less regulated and remote areas of the world. As a result, we may not be able to address these techniques proactively or implement adequate preventative measures. If our computer systems are compromised, we could be subject to fines, damages, litigation and enforcement actions, and we could lose trade secrets, the occurrence of which could harm our business. In addition, any sustained disruption in internet access provided by other companies could harm our business.

Risks Related to Government Regulation and Diagnostic Product Reimbursement

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

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

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

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

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

Before we begin to label and market our products for use as clinical diagnostics in the United States, including as companion diagnostics, unless an exemption applies, we will be required to obtain either 510(k) clearance or PMA from the FDA. In addition, we may be required to seek FDA clearance for any changes or modifications to our products that could significantly affect their safety or effectiveness, or would constitute a change in intended use. The 510(k) clearance processes can be expensive, time-consuming and uncertain. In addition to the time required to conduct clinical studies, if necessary, it generally takes from four to twelve months from submission of an application to obtain 510(k) clearance; however, it may take longer and 510(k) clearance may never be obtained.

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Even if the FDA accepts a 510(k) submission for filing, the FDA may request additional information or clinical studies during its review. Our ability to obtain additional regulatory clearances for new products and indications may be significantly delayed or may never be obtained. In addition, we may be required to obtain PMAs for new products or product modifications. The requirements of the more rigorous PMA process could delay product introductions and increase the costs associated with FDA compliance. As with all IVD products, the FDA reserves the right to redefine the regulatory path at the time of submission or during the review process, and could require a more burdensome approach. Even if we were to obtain regulatory approval or clearance, it may not be for the uses we believe are important or commercially attractive, in which case we would not be permitted to market our product for those uses.

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

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

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

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

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

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

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

We plan to develop, obtain regulatory approval for and sell clinical diagnostics products for a number of different indications. Successful commercialization of our clinical diagnostic products depends, in large part, on the availability of coverage and adequate reimbursement for testing services using our diagnostic products from third-party payors, including government insurance plans, managed care organizations and private insurance plans. There is significant uncertainty surrounding third-party coverage and reimbursement for the use of tests that incorporate new technology, such as the HTG EdgeSeq system and related applications and assays. Reimbursement rates have the potential to fluctuate depending on the region in which the testing is provided, the type of facility or treatment center at which the testing is done, and the third-party payor responsible for payment. If our customers are unable to obtain positive coverage decisions from third-party payors approving reimbursement for our tests at adequate levels, the commercial success of our products would be compromised and our revenue would be significantly limited. Even if we do obtain favorable reimbursement for our tests, third-party payors may withdraw their coverage policies, review and adjust the rate of reimbursement, require co-payments from patients or stop paying for our tests, which would reduce revenue for testing services based on our technology and demand for our diagnostic products.

The American Medical Association Current Procedural Terminology (“CPT”) Editorial Panel created new CPT codes that could be used by our customers to report testing for certain large-scale multianalyte GSPs, including our diagnostic products, if approved. Effective January 1, 2015, these codes allow for uniform reporting of broad genomic testing panels using technology similar to ours. While these codes standardize reporting for these tests, coverage and payment rates for GSPs remain uncertain and we cannot guarantee that coverage and/or reimbursement for these tests will be provided in the amounts we expect, or at all. Initially, industry associations recommended that payment rates for GSPs be cross-walked to existing codes on the clinical laboratory fee schedule. On October 27, 2014, CMS issued preliminary determinations for 29 new molecular pathology codes, including the GSPs, of gapfill rather than crosswalking as recommended by the Association for Molecular Pathology. This means that local private MACs, such as Palmetto, Novidian, Novitas and Cahaba, were instructed to determine the appropriate fee schedule amounts in the first year, and CMS calculated a national payment rate based on the median of those local fee schedule amounts in the second year. This process may make it more difficult for our customers to obtain coverage and adequate reimbursement for testing services using our diagnostic products. We cannot assure that CMS and other third-party payors will establish reimbursement rates sufficient to cover the costs incurred by our customers in using our clinical diagnostic products, if approved. On September 22, 2017, gapfill pricing was set for three CPT codes which our customers may potentially utilize to obtain reimbursement, subject to regulatory limitations, for the use of our products. CPTs 81445 and 81450, for the assessment of 5-50 genes in solid and liquid tumors, respectively, were set at $598 and $760, respectively, and remains the same as of December 31, 2017. Additionally, CPT 81455 for the assessment of 51 or more genes in solid and liquid tumors was set at $2,920.

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

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

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

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

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

 

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

 

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

 

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

 

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

 

HIPAA, as amended by HITECH, and their respective implementing regulations, which impose requirements on certain covered healthcare providers, health plans, and healthcare clearinghouses as well as their respective business associates that perform services for them that involve the use, maintenance, or disclosure of individually identifiable health information, relating to the privacy, security and transmission of individually identifiable health information. In addition, the EU has established its own data security and privacy legal framework, including but not limited to Directive 95/46/EC (“Data Protection Directive”). The Data Protection Directive will be replaced starting in May 2018 with the recently adopted European General Data Protection Regulation (“GDPR”), which contains new provisions specifically directed at the processing of health information, higher sanctions and extra-territoriality measures intended to bring non-EU companies under the regulation. Over time we may expand our business operations to include additional operations in the EU. With such expansion, we would be subject to increased governmental regulation, including the GDPR, in the EU countries in which we operate.

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

 

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

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

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

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

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

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

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

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disgorgement, individual imprisonment, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional reporting requirements and/or oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws, and curtailment of our operations. Any of these actions or investigations could result in substantial costs to us, including legal fees, and divert the attention of management from operating our business.

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

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

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

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

Other significant measures contained in the ACA include, for example, coordination and promotion of research on comparative clinical effectiveness of different technologies and procedures, initiatives to revise Medicare payment methodologies, such as bundling of payments across the continuum of care by providers and physicians, and initiatives to promote quality indicators in payment methodologies. Further, the ACA includes a deductible 2.3% excise tax on any entity that manufactures or imports medical devices offered for sale in the United States, with limited exceptions, which became effective January 1, 2013. However, the Consolidated Appropriations Act of 2016, signed into law in December 2015, includes a two-year moratorium on the medical device excise tax through December 31, 2017. Further, on January 22, 2018, President Trump signed a continuing resolution on appropriations for fiscal year 2018 (the “2018 Appropriations Resolution”) that extended the moratorium on the medical device excise tax through December 31, 2019. Absent further legislative action, the tax will be automatically reinstated for medical device sales beginning January 1, 2020. The ACA also includes significant new fraud and abuse measures, including required disclosures of financial arrangements with physician customers, lower thresholds for violations and increasing potential penalties for such violations. However, the future of the ACA is uncertain. There have been judicial and Congressional challenges to certain aspects of the ACA. As a result, there have been delays in the implementation of, and action taken to repeal or replace, certain aspects of the ACA. Since January 2017, President Trump has signed two Executive Orders and other directives designed to delay the implementation of certain provisions of the ACA or otherwise circumvent some of the requirements for health insurance mandated by the ACA. Concurrently, Congress has considered legislation that would repeal or repeal and replace all or part of the ACA. While Congress has not passed comprehensive repeal legislation, two bills affecting the implementation of certain taxes under the ACA have been signed into law. The 2017 Tax Act includes a provision repealing, effective January 1, 2019, the tax-based shared responsibility payment imposed by the ACA on certain individuals who fail to maintain qualifying health coverage for all or part of a year that is commonly referred to as the “individual mandate”. Additionally, the 2018 Appropriations Resolution delays the implementation of certain ACA-mandated fees, including, without limitation, the medical device excise tax. Congress may consider additional legislation to repeal or repeal and replace other elements of the ACA. We continue to evaluate the effect that the ACA and its possible repeal and replacement has on our business.

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In addition, other legislative changes have been proposed and adopted since the ACA was enacted. On August 2, 2011, then-President Obama signed into law the Budget Control Act of 2011, which, among other things, created the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes reductions to Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013, and, following the passage of other legislative amendments, including the Bipartisan Budget Act of 2018, will stay in effect through 2027 unless additional Congressional action is taken. On January 2, 2013, then-President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.

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

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

Risks Related to Intellectual Property

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

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

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

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

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

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

As we move into new markets and applications for our products, incumbent participants in such markets may assert their patents and other proprietary rights against us as a means of slowing our entry into such markets or as a means to extract substantial license and royalty payments from us. Our competitors and others may now and in the future have significantly larger and more mature patent portfolios than we currently have. In addition, future litigation may involve patent holding companies or other adverse patent owners who have no relevant product revenue and against whom our own patents may provide little or no deterrence or protection. Therefore, our commercial success may depend in part on our non-infringement of the patents or proprietary rights of third parties. Numerous significant intellectual property issues have been litigated, and will likely continue to be litigated, between existing and new participants in our existing and targeted markets and competitors may assert that our products infringe their intellectual property rights as part of a business strategy to impede our successful entry into those markets. We have not conducted comprehensive freedom-to-operate searches to determine whether the commercialization of our products or other business activities would infringe patents issued to third parties. Third parties may assert that we are employing their proprietary technology without authorization. In addition, our competitors and others may have patents or may in the future obtain patents and claim that use of our products infringes these patents. We could incur substantial costs and divert the attention of our management and technical personnel in defending against any of these claims. Parties making claims against us may be able to obtain injunctive or other relief, which could block our ability to develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of

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infringement against us, we may be required to pay damages and obtain one or more licenses from third parties, or be prohibited from selling certain products. We may not be able to obtain these licenses at a reasonable cost, if at all. We could therefore incur substantial costs related to royalty payments for licenses obtained from third parties, which could negatively affect our gross margins. In addition, we could encounter delays in product introductions while we attempt to develop alternative methods or products to avoid infringing third-party patents or proprietary rights. Defense of any lawsuit or failure to obtain any of these licenses on favorable terms could prevent us from commercializing products, and the prohibition of sale of any of our products could materially affect our ability to grow and gain market acceptance for our products.

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

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

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

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

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

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

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

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

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

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

Risks Related to Being a Public Company

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

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

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

Changes or modifications in financial accounting standards, including those related to revenue recognition, may harm our results of operations.

From time to time, the Financial Accounting Standards Board (“FASB”), either alone or jointly with other organizations, promulgates new accounting principles that could have an adverse impact on our financial position, results of operations or reported cash flows. For example, in May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), and subsequently issued implementation guides (collectively, the “New Revenue Standard”). The New Revenue Standard supersedes nearly all existing revenue recognition guidance under GAAP and became effective for us beginning January 1, 2018. We have finalized our assessment of the impact of the New Revenue Standard on our results of operations, and do not believe it will have a material impact on revenue recognized. Our financial disclosures are required to be updated to reflect the New Revenue Standard beginning with our quarterly report on Form 10Q for the quarter ending March 31, 2018. Our inability to adopt the New Revenue Standard or any new accounting standard correctly, or to update or modify our internal controls as needed, by the mandated adoption dates could adversely affect our financial reporting obligations, corresponding regulatory compliance and/or investors’ confidence in us. Also, if we were to change our critical accounting estimates, including those related to the recognition of collaboration revenue and other revenue sources, our operating results could be significantly affected.

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

As a public company, we will continue to incur significant legal, accounting and other expenses. The Exchange Act requires, among other things, that we file annual, quarterly and current reports with respect to our business and operating results. In addition, the Sarbanes-Oxley Act and rules subsequently implemented by the SEC and Nasdaq, impose numerous requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to continue to devote a substantial amount of time to compliance with these laws and regulations. These requirements have resulted in significant legal, accounting, and financial compliance costs and have made and will continue to make some activities more time consuming and costly.

As an “emerging growth company,” we have availed ourselves of the exemption from the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404. However, we may no longer avail ourselves of this exemption when we cease to be an “emerging growth company.” When our independent registered public accounting firm is required to undertake an assessment of our internal control over financial reporting, the cost of our compliance with Section 404 will correspondingly increase. Our compliance with applicable provisions of Section 404 will require that we incur substantial accounting expense and expend significant management time on compliance-related issues as we implement additional corporate governance practices and comply with reporting requirements. Moreover, if we are not able to comply with the requirements of Section 404 applicable to us in a timely manner, or if we or our independent registered public accounting

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firm identifies deficiencies in our internal control over financial reporting that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by the SEC or other regulatory authorities, which would require additional financial and management resources.

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

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

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

Risks Related to Our Common Stock

If we are unable to continue to satisfy the applicable continued listing requirements of Nasdaq, our common stock could be delisted.

Our common stock is currently listed on The Nasdaq Capital Market under the symbol “HTGM.” Effective April 17, 2017, the listing of our common stock was transferred to The Nasdaq Capital Market from The Nasdaq Global Market following our appeal to a Nasdaq Hearings Panel (“Panel”) of the delisting notice we received from Nasdaq on February 14, 2017. On April 12, 2017, the Panel found us in compliance with the requirements for listing on The Nasdaq Capital Market as a result of the market value of our outstanding common stock exceeding $35.0 million, which satisfied Nasdaq’s market value of listed securities (“MVLS”) listing standard. On July 31, 2017, we received a notice from Nasdaq that we were no longer in compliance with the applicable MVLS requirement for continued listing on The Nasdaq Capital Market. We regained compliance with the applicable MVLS requirement for continued listing on The Nasdaq Capital Market in January 2018 following completion of our underwritten public offering. In order to maintain this listing, we must continue to satisfy minimum financial and other continued listing requirements and standards. There can be no assurance that we will be able to continue to comply with the applicable listing standards. If we were not able to comply with applicable listing standards, our shares of common stock would be subject to delisting. The delisting of our common stock from trading on Nasdaq may have a material adverse effect on the market for, and liquidity and price of, our common stock and impair our ability to raise capital. Delisting from Nasdaq could also have other negative results, including, without limitation, the potential loss of confidence by customers and employees, the loss of institutional investor interest and fewer business development opportunities. In the event that our common stock is delisted from Nasdaq and is not eligible for quotation or listing on another market or exchange, trading of our common stock could be conducted only in the over-the-counter market or on an electronic bulletin board established for unlisted securities such as the Pink Sheets or the OTC Bulletin Board. In such event, it could become more difficult to dispose of, or obtain accurate price quotations for, our common stock, and there would likely also be a reduction in our coverage by securities analysts and the news media, which could cause the price of our common stock to decline further.

We expect that our stock price will fluctuate significantly.

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

 

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

 

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

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

 

adverse regulatory or reimbursement announcements;

 

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

 

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

 

commencement of, or our involvement in, litigation;

 

market conditions in the life sciences and molecular diagnostics markets;

 

manufacturing disruptions;

 

any future sales of our common stock or other securities;

 

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

 

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

 

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

 

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

 

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

The stock market in general, and market prices for the securities of health technology companies like ours in particular, have from time to time experienced volatility that often has been unrelated to the operating performance of the underlying companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating performance. In several recent situations where the market price of a stock has been volatile, holders of that stock have instituted securities class action litigation against the company that issued the stock. If any of our stockholders were to bring a lawsuit against us, the defense and disposition of the lawsuit could be costly and divert the time and attention of our management and harm our operating results.

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

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

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

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

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

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

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

Pursuant to our 2014 Equity Incentive Plan (“2014 Plan”) our board of directors is authorized to grant stock options and other equity-based awards to our employees, directors and consultants. The number of shares available for future grant under the 2014 Plan will automatically increase on January 1 of each year by 4% of the total number of shares of our common stock outstanding on

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

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

Our executive officers, directors and principal stockholders, together with their respective affiliates, beneficially owned a significant portion of our capital stock at December 31, 2017. Accordingly, our executive officers, directors and principal stockholders acting together could exercise significant influence over all matters requiring stockholder approval, including mergers and other business combinations. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have a material adverse effect on our stock price and may prevent attempts by our stockholders to replace or remove the board of directors or management.

We do not intend to pay dividends on our common stock in the foreseeable future.

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

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

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

 

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

 

limiting the removal of directors by the stockholders;

 

creating a staggered board of directors;

 

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

 

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

 

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

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

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Item 1B. Unresolved Staff Comments

None.

Item 2. Properties.

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

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

Item 3. Legal Proceedings.

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

Item 4. Mine Safety Disclosures.

Not applicable.

 

 

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PART II

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

Market Information

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

 

Year ended December 31, 2016

 

High

 

 

Low

 

First quarter

 

 

4.68

 

 

 

2.03

 

Second quarter

 

 

4.17

 

 

 

2.07

 

Third quarter

 

 

3.09

 

 

 

2.13

 

Fourth quarter

 

 

4.45

 

 

 

1.82

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 2017

 

High

 

 

Low

 

First quarter

 

 

13.25

 

 

 

1.20

 

Second quarter

 

 

8.15

 

 

 

2.62

 

Third quarter

 

 

2.80

 

 

 

1.59

 

Fourth quarter

 

 

3.03

 

 

 

1.65

 

 

On March 16, 2018, the last reported sale price of our common stock was $4.96 per share.

Holders

As of March 16, 2018, there were approximately 183 holders of record of our common stock. The actual number of stockholders is greater than this number of record holders and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees.

Dividends

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

Item 6. Selected Financial Data.

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

 

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

You should read the following discussion and analysis together with our financial statements and related notes included elsewhere in this Annual Report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those expressed or implied in any forward-looking statements due to various factors, including those set forth under the caption “Item 1A. Risk Factors.” All forward-looking statements included in this Annual Report are based on information available to us as of the time we file this Annual Report and, except as required by law, we undertake no obligation to update publicly or revise any forward-looking statements. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Annual Report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain.

Overview

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

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

In 2014, we launched our HTG EdgeSeq technology, which generates a molecular profiling library for detection of RNA using NGS. Our HTG EdgeSeq assays are automated on our HTG EdgeSeq platform. Our innovative platform and menu of molecular profiling panels is being utilized by a wide range of customers including biopharmaceutical companies, academic institutions and molecular labs to simultaneously analyze a comprehensive set of molecular information from valuable clinical samples and improve the lab’s workflow efficiency. Customers can also obtain the advantages of our proprietary technologies by engaging our VERI/O laboratory for pre-clinical and clinical research-related services. We currently market several proprietary molecular profiling panels that address the needs of customers in translational research, biomarker discovery and potentially companion diagnostics. In addition, we have a focused development pipeline that includes planned panels for translational research, drug development and molecular diagnostics. Our product strategy is to develop a suite of profiling panels with initial focus in immuno-oncology and next generation pathology.

We have two primary sources of revenue: revenue from research use only (“RUO”) profiling for biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for companion diagnostic development programs for biopharmaceutical companies. RUO profiling revenue includes customer purchases of our HTG EdgeSeq instrument and related RUO assay kits, and the use of our HTG EdgeSeq instruments and RUO assay kits to process samples on the customer’s behalf in our VERI/O laboratory. Collaborative development revenue relates to services performed primarily for biopharmaceutical companies pursuant to our Master Assay Development, Commercialization and Manufacturing Agreement (“Governing Agreement”) with QIAGEN Manchester Limited (“QML”), a wholly owned subsidiary of QIAGEN N.V. Under the Governing Agreement, our HTG EdgeSeq proprietary technology is utilized to develop, seek regulatory approval for and commercialize companion diagnostic assays for biopharmaceutical drug candidates and corresponding therapeutics.

We have incurred significant losses since our inception, and we have never been profitable. We incurred net losses of $19.0 million and $26.0 million for the years ended December 31, 2017 and 2016, respectively, and had an accumulated deficit of $134.6 million as of December 31, 2017. As of December 31, 2017, we had available cash and cash equivalents totaling approximately $10.0 million and had current liabilities of approximately $13.3 million and long-term liabilities of approximately $11.0 million, primarily attributable to our NuvoGen and QNAH Convertible Note obligations.

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Recent Developments

In January 2018, we entered into a third statement of work under the Governing Agreement with QML. SOW Three relates to development activities for a NGS-based clinical-trial assay (the “SOW Three Project”) in connection with a sponsor project agreement (the “Project Agreement”) between QML and a pharmaceutical company (“Pharma Three”). The SOW Three Project is one of three development programs, each for a different pharmaceutical company, announced to date under the Governing Agreement. If successfully completed, the SOW Three Project is expected to lead to subsequent assay development activities and the potential commercialization of a companion diagnostic assay for a corresponding Pharma Three drug.

In January 2018, we entered into an underwriting agreement (the “Underwriting Agreement”) with Leerink Partners LLC and Cantor Fitzgerald & Co. (“Cantor”), as representatives of the several underwriters named therein, relating to the issuance and sale in a public offering of shares of our common stock being offered and sold pursuant to our shelf registration statement on Form S-3 (File No. 333-216977), previously filed with the SEC and declared effective by the SEC on April 6, 2017. On January 23, 2018, we completed an underwritten public offering of 13,915,000 shares of our common stock pursuant to the Underwriting Agreement at a price to the public of $2.90 per share, including 1,815,000 shares sold pursuant to the exercise in full of the underwriters’ option to purchase additional shares. All of the shares in the offering were sold by us. The aggregate net proceeds from the offering were approximately $37.7 million, after deducting underwriting discounts and commissions and offering expenses.

In January 2018, we and BMS amended the terms of our May 2016 collaboration agreement to increase the development fee payable by BMS to us for each of the two initial custom RUO assays contemplated by the collaboration agreement from a low six-figure dollar amount to a mid six-figure dollar amount, and to modify certain assay development requirements. We estimate that the first custom RUO assay development project under the collaboration agreement will be completed in the third quarter of 2018. If successfully completed, we believe this development project will lead to future revenue from laboratory services and/or custom RUO assay kits purchased by BMS and/or its subcontractors.

In December 2017, we entered into a Master Collaboration Agreement for translational programs with Merck KGaA. The Master Collaboration Agreement complements our Master Companion Diagnostic Agreement with Merck KGaA and includes a statement of work with EMD Serono, the biopharmaceutical business of Merck KGaA, in the United States and Canada. Under the EMD Serono statement of work, we plan to develop and manufacture a custom profiling assay to support biomarker research for six indications within Merck KGaA’s drug development pipeline. The assay is expected to be kitted for use on HTG EdgeSeq instruments acquired by Merck KGaA and/or their contract research organization partners.

Factors Affecting our Performance

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

Biopharmaceutical Biomarker and Companion Diagnostic Solutions

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

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Customer Adoption of HTG Technology

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

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

A key element of increasing adoption of our technology measured by instrument placements is our assay and panel “menu.” Menu is defined as what assays are available for use on the instruments to satisfy customer needs. To sell additional instruments, grow our installed base and drive larger consumable annuities we must develop and commercialize new assays. Our arrangements with biopharmaceutical companies are expected to generate new menu items in addition to our diagnostic development strategies in immuno-oncology and next generation pathology. As of December 31, 2017, we had an installed base of 44 HTG systems in various stages of use, including units that are under evaluation and an additional three instruments installed at third party sites in support of companion diagnostic collaborative development services projects. We remain focused on high quality instrument placements and consumable pull through as the primary indicators of commercial adoption and success in our business.

Timing and effectiveness of research and development expenses

Our spending on research and development might vary substantially from period to period due to the availability and cost of clinical samples, prioritization of research and development projects or timing of milestone payments under our technology development agreements. This variability is also related to costs incurred in our collaborative development programs, whereby the quantity of HTG EdgeSeq assay kits and instruments, third party sequencing equipment, and third party or internal labor required to complete each of the development milestones under these agreements, which costs are expensed to research and development expense in our statements of operations, may cause these expenses to vary significantly from one period to the next. We have instituted a stage-gate based method of new product development managed by our innovation council, led by our Chief Executive Officer. Program progress and priorities are assessed by time, quality and adherence to budgetary metrics at each phase of the project.

Financial Operations Overview and Results of Operations

Comparison of the Years Ended December 31, 2017 and 2016

 

 

 

Years Ended December 31,

 

 

Change

 

 

 

2017

 

 

2016

 

 

$

 

 

%

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product and product-related services

 

$

6,797,255

 

 

$

5,132,730

 

 

$

1,664,525

 

 

 

32

%

Collaborative development services

 

 

7,962,312

 

 

 

 

 

 

7,962,312

 

 

 

100

%

Total revenue

 

 

14,759,567

 

 

 

5,132,730

 

 

 

9,626,837

 

 

 

188

%

Cost of revenue

 

 

4,971,806

 

 

 

4,135,884

 

 

 

835,922

 

 

 

20

%

Gross margin

 

 

9,787,761

 

 

 

996,846

 

 

 

8,790,915

 

 

 

882

%

Gross margin percentage

 

 

66

%

 

 

19

%

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative

 

 

17,513,742

 

 

 

17,427,777

 

 

 

85,965

 

 

 

0

%

Research and development

 

 

9,996,627

 

 

 

7,900,311

 

 

 

2,096,316

 

 

 

27

%

Total operating expenses

 

 

27,510,369

 

 

 

25,328,088

 

 

 

2,182,281

 

 

 

9

%

Operating loss

 

 

(17,722,608

)

 

 

(24,331,242

)

 

 

6,608,634

 

 

 

(27

%)

Other expense, net

 

 

(1,234,488

)

 

 

(1,698,190

)

 

 

463,702

 

 

 

(27

%)

Net loss before income taxes

 

$

(18,957,096

)

 

$

(26,029,432

)

 

$

7,072,336

 

 

 

(27

%)

61


 

Revenue

We generate revenue from two primary sources: revenue from RUO profiling for biopharmaceutical companies, academic research centers and molecular testing laboratories; and revenue from collaborative development services for biopharmaceutical companies under our companion diagnostic development programs.

RUO profiling is currently made available to our customers through product sales and service offerings. Customers can purchase our HTG EdgeSeq instrument and related consumables, which consist primarily of our proprietary molecular profiling panels and other assay components. Customers can also access our technology through contracted services. We perform these services using our HTG EdgeSeq instruments and RUO assay kits to process samples in our VERI/O laboratory. Our proprietary technology is also used to develop custom RUO assay kits expected to generate future sample processing or RUO assay kit revenue.

In 2017, we began generating revenue from collaborative development services primarily relating to our Governing Agreement with QML. SOW One was entered into in June 2017 and SOW Two was entered into in October 2017. Under these agreements, we and QML combine our technological and commercial strengths to offer biopharmaceutical companies a complete NGS-based solution for the development, manufacture and commercialization of companion diagnostic assays in support of and in conjunction with, biopharmaceutical companies’ drug development programs.

Total revenue for the year ended December 31, 2017 increased by 188% to $14.8 million compared with total revenue of $5.1 million for the year ended December 31, 2016. The increase in total revenue was primarily driven by the initiation of collaborative development services in 2017, as well as increased demand for our RUO service offerings by our expanding customer base primarily in the United States and Europe.

Product and product-related services revenue

Product and product-related services revenue from the sale of our RUO HTG EdgeSeq instruments and consumables and from services performed for customers in our VERI/O laboratory using this proprietary RUO technology was $6.8 million compared with $5.1 million for the year ended December 31, 2016, and was comprised of the following:

 

 

 

Years Ended December 31,

 

 

Change

 

 

 

2017

 

 

2016

 

 

$

 

 

%

 

Product revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Instruments

 

$

385,143

 

 

$

522,813

 

 

 

(137,670

)

 

 

(26

%)

Consumables

 

 

1,463,347

 

 

 

2,237,129

 

 

 

(773,782

)

 

 

(35

%)

Total product revenue

 

 

1,848,490

 

 

 

2,759,942

 

 

 

(911,452

)

 

 

(33

%)

Product-related services revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Custom RUO assay development

 

 

419,515

 

 

 

235,818

 

 

 

183,697

 

 

 

78

%

Sample processing

 

 

4,529,250

 

 

 

2,136,970

 

 

 

2,392,280

 

 

 

112

%

Total product-related services revenue

 

 

4,948,765

 

 

 

2,372,788

 

 

 

2,575,977

 

 

 

109

%

Total product and product-related services revenue

 

$

6,797,255

 

 

$

5,132,730

 

 

 

1,664,525

 

 

 

32

%

 

Product revenue generated from the sale of our instruments and RUO assay kits for the year ended December 31, 2017 was $1.8 million compared with $2.8 million for the year ended December 31, 2016, and represented 13% and 54% of our total revenue for the years ended December 31, 2017 and 2016, respectively. The decrease in product revenue from 2017 to 2016 is primarily attributable to our focus on biopharmaceutical customers whose preference has been to access our technology via services through our VERI/O laboratory.

Service revenue, consisting of sample processing using our HTG EdgeSeq instruments and consumables and custom RUO assay development, increased from $2.4 million for the year ended December 31, 2016 to $4.9 million for the year ended December 31, 2017, and represented 35% and 46% of our total revenue for the years ended December 31, 2017 and 2016, respectively. The increase in service revenue for the period ended December 31, 2017 compared with 2016 reflects our success in growing the number of biopharmaceutical company customers who have chosen our proprietary technologies for use in their translational research and drug development programs and who prefer to gain access to our technology through purchase of our services. Our increase in service revenue reflects increased consumption of our RUO assay kits used in the processing of samples in our VERI/O laboratory. We expect our revenue mix to continue to contain a higher portion of biopharmaceutical service revenue in the near term until we enter the commercial clinical diagnostic market.

62


 

Collaborative development services revenue

Collaborative development services revenue includes services performed on newly initiated biopharmaceutical company companion diagnostic development programs using our HTG EdgeSeq proprietary technology to develop, seek regulatory approval for and commercialize clinical diagnostic assays for biopharmaceutical company drug candidates and corresponding therapeutics. Collaborative development services revenue, consisting of services performed for two large biopharmaceutical companies pursuant to SOW One and SOW Two under our Governing Agreement with QML, was approximately $8.0 million or 54% of our revenue for the year ended December 31, 2017, which included approximately $2.3 million in profit sharing payments. We had no collaborative development services revenue for the year ended December 31, 2016, as SOW One was initiated in June 2017.

Because of existing agreements with biopharmaceutical company customers (including SOW Three entered into for collaborative development services on an additional biopharmaceutical company program pursuant to our Governing Agreement with QML in January 2018) we expect our collaborative development services revenue to increase in both absolute dollars and as a percentage of total revenue for the year ending December 31, 2018. However, the amount or timing of work we perform, the timing and number of development deliverables and the timing and amount of any profit sharing payments under these agreements could result in significant variability in the timing and amount of revenue recognized in one or more fiscal periods. For example, we expect that the collaborative services revenue, and therefore our total revenue, recognized during an individual quarter within 2018 may be lower than the collaborative development services revenue and total revenue we recognized during the quarter ended December 31, 2017.

Cost of revenue and gross margin

Cost of revenue includes the aggregate costs incurred in manufacturing, delivering, installing and servicing instruments and consumables, as well as the costs incurred for services performed for customers in our VERI/O laboratory and product development group. The components of our 2017 cost of revenue are material, subcomponent and service costs, manufacturing costs incurred internally (which include direct labor costs), and equipment and infrastructure expenses associated with the manufacturing and distribution of our products. Additionally, internal costs incurred in our VERI/O laboratory and in product development, including direct labor and consumables, are included in cost of revenue. Our cost of revenue includes significant fixed costs comprised primarily of manufacturing and service headcount, field service engineers and facilities. Our facilities costs increased in 2016 with capital improvements made to our manufacturing facilities in the first quarter of 2016 to allow us to begin manufacturing our instruments internally and to improve our customer service throughput and capabilities. Due to the fixed nature of expenses associated with direct labor, equipment and infrastructure, we expect our cost of revenue as a percentage to decrease over time as we increase product and product-related services revenue, further absorbing these fixed costs.

Cost of revenue increased by $835,922, or 20%, for the year ended December 31, 2017 compared with the year ended December 31, 2016, while gross margin improved to 66% for the year ended December 31, 2017 compared to 19% for the year ended December 31, 2016. This gross margin improvement is primarily attributable to the initiation of two companion diagnostic development programs under our Governing Agreement with QML in 2017, the revenue from which is accounted for in collaborative development services revenue in our statements of operations. The development costs associated with collaborative development services revenue are included in research and development expense in our statements of operations for the year ended December 31, 2017. We anticipate variability in collaborative development services revenue from one quarter to the next. This will likely result in gross margin variability between fiscal periods. Increased sample processing services through our VERI/O laboratory for the year ended December 31, 2017 when compared to the year ended December 31, 2016 further accounted for the increase in cost of revenue year over year. Despite the year over year increase in direct material and labor costs incurred in our VERI/O laboratory to generate increased sample processing and custom RUO assay development service revenue, additional gross margin improvement is attributable to an overall increase in service revenue. This has resulted in further absorption of our fixed operating expenses which occurred in the expansion of our VERI/O laboratory staffing, facilities and equipment to accommodate the anticipated increase in demand for services when compared to prior years.

Research and development expenses

Research and development expenses represent amounts incurred to perform collaborative development services, costs to develop new proprietary panels and corresponding assays, to obtain FDA approval for our first U.S. IVD assay and to continue to develop and improve our HTG EdgeSeq platform. These expenses include payroll and related expenses, consulting expenses, laboratory supplies, facilities and equipment. Research and development costs are expensed as incurred. Research and development expenses increased by $2.1 million, or 27%, for the year ended December 31, 2017 compared with the year ended December 31, 2016. This increase is primarily due to collaborative development costs associated with biopharmaceutical customer companion diagnostic development programs initiated in 2017 under our Governing Agreement with QML, which costs are included in research and development expense in our statements of operations as the contracts are accounted for under the FASB’s guidance for collaborative arrangements. The increase in collaborative development program expenses in 2017 was partially offset by lower development costs incurred in 2017 for Project JANUS, which was suspended in the third quarter of 2016. We expect research and development costs to continue to increase in 2018 due to the continuation of our existing collaborative development programs, the addition of a third

63


 

collaborative development program in January 2018 and the remaining costs expected to be incurred as we approach the fourth and final module submission of our HTG EdgeSeq ALKPlus Assay to the FDA.

Selling, general and administrative expenses

Selling, general and administrative expenses consist primarily of personnel costs for our sales and marketing, regulatory, legal, executive management and finance and accounting functions. The expenses also include third-party professional and consulting fees incurred by these functions, promotional expenses and facility and overhead costs for our administrative offices. Selling, general and administrative expenses remained consistent for the year ended December 31, 2017 compared with the year ended December 31, 2016.

Interest expense

As of December 31, 2017, we had an obligation due to NuvoGen in the amount of $8.0 million under an asset purchase agreement, a Growth Term Loan obligation of $5.8 million, net of discount and deferred financing costs and a $3.0 million convertible debt liability to QNAH. Interest expense and non-cash interest expense recognized for discount, deferred financing fee amortization and final fee premium amounts relating to these obligations decreased by $0.6 million for the year ended December 31, 2017 as compared with the year ended December 31, 2016. The year over year decrease was primarily the result of decreased interest incurred on the Growth Term Loan and NuvoGen obligations as the principal balances outstanding were reduced through payments made on these obligations throughout 2017.

Cash Flows for the Years Ended December 31, 2017 and 2016

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

 

 

 

Years Ended December 31,

 

 

 

2017

 

 

2016

 

Net cash provided by (used in):

 

 

 

 

 

 

 

 

Operating activities

 

$

(16,572,308

)

 

$

(22,234,208

)

Investing activities

 

 

3,279,469

 

 

 

24,422,214

 

Financing activities

 

 

15,753,780

 

 

 

2,025,670

 

Increase in cash and cash equivalents

 

$

2,460,941

 

 

$

4,213,676

 

 

Operating Activities

Net cash used in operating activities for the year ended December 31, 2017 was $16.6 million and reflected (i) the net loss of $19.0 million, (ii) net non-cash items of $3.6 million, consisting primarily of stock-based compensation of $1.4 million, depreciation and amortization of $1.2 million, provision for excess inventory of $0.4 million, amortization of the discount, deferred financing costs and final payment premium on our Growth Term Loan of $0.4 million and amortization of the discount on our NuvoGen obligation of $0.2 million, and (iii) a net cash outflow from changes in balances of operating assets and liabilities of $1.2 million. This net cash outflow was due to an increase in accounts receivable attributable to our collaborative development services revenue partially offset by an increase in accrued liabilities primarily related to the accrual for our annual performance-based bonuses. The primary driver of the cash outflow from changes in balances of operating assets and liabilities was the increase in activities under SOW One and SOW Two of our QML Governing Agreement in the fourth quarter of 2017, which resulted in a significant increase in accounts receivable for monthly development fees and profit sharing payments receivable at year end for both programs.

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

64


 

Investing Activities

Net cash provided by investing activities of $3.3 million for the year ended December 31, 2017 consisted primarily of sales, redemptions and maturities of $4.3 million of our remaining available-for-sale securities. This was partially offset by investments in laboratory sample processing and automation equipment of $1.0 million.

Net cash provided by investing activities of $24.4 million for the year ended December 31, 2016 consisted primarily of the purchase of $3.4 million and sales, redemptions and maturities of $29.8 million of available-for-sale securities originally acquired with proceeds from our initial public offering. This was partially offset by investments in leasehold improvements and laboratory equipment of $1.9 million with capital improvements made to our manufacturing and research and development facilities during the year.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2017 of $15.8 million consisted primarily of $19.9 million in net proceeds from our ATM Offering and $3.0 million of proceeds from the QNAH Convertible Note, partially offset by $6.4 million in payments on our Growth Term Loan balance and $0.8 million in quarterly payments made on our NuvoGen obligation.

Net cash provided by financing activities for the year ended December 31, 2016 of $2.0 million included $5.0 million from the draw of our Term Loan B availability in March 2016 to fund ongoing business operations and $2.0 million in proceeds from an investment in our common stock by a strategic investor, partially offset by $4.4 million in payments on our Growth Term Loan balance, as principal payments resumed in April 2016, and $0.6 million in quarterly payments made on our NuvoGen obligation.

Liquidity and Capital Resources

Since our inception, our operations have primarily been financed through the issuance of our common stock, redeemable convertible preferred stock, the incurrence of debt, cash received from product, service and collaborative development services revenue and other income. As of December 31, 2017, we had $10.0 million of cash and cash equivalents and $16.9 million of debt outstanding on our Growth Term Loan, NuvoGen, capital lease and QNAH Convertible Note obligations.

In August 2014, we entered into a Growth Term Loan with Oxford Finance, LLC and Silicon Valley Bank (see Note 8). We borrowed the first tranche of the Growth Term Loan in the amount of $11.0 million in August 2014 and the second tranche of the Growth Term Loan in the amount of $5.0 million in March 2016. The first and second tranches of the Growth Term Loan accrue interest annually at 8.5% and 8.75%, respectively, and mature on September 1, 2018. Payments under the Growth Term Loan could result in a significant reduction of our working capital.

Pursuant to our Controlled Equity Offering Sales Agreement with Cantor, we offered and sold, through Cantor as our sales agent, 5,733,314 shares of our common stock for gross total proceeds of approximately $21.1 million through January 2018, under our Registration Statement on Form S-3 (File No. 333-216977) and a prospectus supplement thereunder, as amended. All shares of common stock pursuant to the agreement with Cantor were made by a method deemed to be an “at the market offering” as defined in Rule 415 under the Securities Act.

Pursuant to an underwriting agreement with Leerink Partners LLC and Cantor, as representatives of the other underwriters of the agreement, we offered and sold 13,915,000 shares of our common stock at a price of $2.90 per share, including 1,815,000 shares sold pursuant to the exercise in full of the underwriters’ option to purchase additional shares in January 2018. The aggregate net proceeds from the offering were approximately $37.7 million, after deducting the underwriting discounts and commissions and offering expenses. The shares of common stock described above were offered by the Company pursuant to a Registration Statement on Form S-3 (File No. 333‑216977) previously filed with the SEC and declared effective by the SEC on April 6, 2017, and a prospectus supplement thereunder.

Funding Requirements

We have had recurring operating losses and negative cash flows from operations since inception, and we had an accumulated deficit of approximately $134.6 million as of December 31, 2017. As of December 31, 2017, we had available cash and cash equivalents of approximately $10.0 million, and had current liabilities of approximately $13.3 million plus an additional $11.0 million in long-term liabilities primarily attributable to our Growth Term Loan, NuvoGen obligation and QNAH Convertible Note. Including additional funding generated from our public offering in January 2018, we believe that our existing resources will be sufficient to fund our planned operations for at least the next 12 months from the issuance of these financial statements. However, we cannot provide assurances that our plans will not change or that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate.

65


 

Until our revenue reaches a level sufficient to support self-sustaining cash flows, if ever, we may need to raise additional capital to fund our continued operations, including our product development and commercialization activities related to our current and future products. Future funding requirements will depend on a number of factors, including our ability to generate significant revenue, our ability to repay our debt obligations as they become due, the cost and timing of establishing additional sales, marketing and distribution capabilities, the ongoing cost of research and development activities, the cost and timing of regulatory clearances and approvals, the effect of competing technology and market developments, the nature and timing of companion diagnostic development collaborations we may establish and the successful commercialization of clinical diagnostic products developed and approved as a result of such collaborations and the extent to which we acquire or invest in businesses, products and technologies.

Additional capital may not be available at such times or in amounts needed by us. Even if sufficient capital is available to us, it might be available only on unfavorable terms. If we are unable to raise additional capital in the future when required and in sufficient amounts or on terms acceptable to us, we may have to delay, scale back or discontinue one or more product development programs, curtail our commercialization activities, significantly reduce expenses, sell assets (potentially at a discount to their fair value or carrying value), enter into relationships with third parties to develop or commercialize products or technologies that we otherwise would have sought to develop or commercialize independently, cease operations altogether, pursue an acquisition of our company at a price that may result in up to a total loss on investment to our stockholders, file for bankruptcy, seek other protection from creditors, or liquidate all of our assets.

Contractual Obligations

The following table summarizes our contractual obligation as of December 31, 2017: 

 

 

 

Payments due by Period

 

 

 

Total

 

 

Less Than

1 Year

 

 

1 - 3

Years

 

 

3 - 5

Years

 

 

More Than

5 Years

 

Debt obligations (1)

 

$

17,279,133

 

 

$

6,510,143

 

 

$

4,470,247

 

 

$

1,200,000

 

 

$

5,098,743

 

Operating lease obligations (2)

 

 

1,628,578

 

 

 

527,269

 

 

 

1,101,309

 

 

 

 

 

 

 

Capital lease obligations (3)

 

 

82,820

 

 

 

58,460

 

 

 

24,360