Washington, D.C. 20549
CASTLE BIOSCIENCES, INC.
Item 1. Financial Statements.
1. Organization and Description of Business
Castle Biosciences, Inc. (the ‘‘Company’Company,’’ “we,” “us” or “our”) was incorporated in the state of Delaware on September 12, 2007. The Company isWe are a commercial-stage dermatological cancerdiagnostics company focused on providing physicians and their patients with personalized, clinically actionable genomic information to make more accurateinform treatment decisions. The Company isdecisions and improve health outcomes. We are based in Friendswood, Texas (a suburb of Houston, Texas) and itsour laboratory operations are conducted at the Company’s facilityour facilities located in Phoenix, Arizona.Arizona, Pittsburgh, Pennsylvania and San Diego, California.
2. Summary of Significant Accounting Policies
Cash equivalents consist of short-term, highly liquid investments with original maturities of three months or less. CashOur cash equivalents consist primarily of amountsmoney market funds, which are not insured by the Federal Deposit Insurance Corporation (“FDIC”), that are primarily invested in money market accounts. A majority of the Company’s cash and cash equivalents are deposited with a singleshort-term U.S. government obligations. Cash deposits at financial institution. Deposits in this institutioninstitutions may exceed the amount of insurance provided on such deposits by the Federal Deposit Insurance Corporation for U.S. institutions. The Company has not experienced any losses on its deposits of cash and cash equivalents.
The Medicare claims that are covered by policy under a Local Coverage Determination (‘‘LCD’’(“LCD”) or otherwise are generally paid at thea rate established rateon Medicare’s Clinical Laboratory Fee Schedule or by the Company’srespective Medicare contractor within 30
days from receipt. Medicare claims that were either submitted to Medicare prior to the LCD or other coverage commencement date or are not covered by the terms of the LCD but meet the definition of being medically reasonable and necessary pursuant to the controlling Section 1862(a)(1)(A) of the Social Security Act are generally appealed and may ultimately be paid at the first (termed ‘‘redetermination’’), second (termed ‘‘reconsideration’’) or third level of appeal (de novo hearing with an Administrative Law Judge (“ALJ”)). A successful appeal at any of these levels resultsmay result in prompt payment.
13. Income Taxes
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning the impacts of COVID-19 on our business, our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,“anticipate,” “believes,“believe,” “estimates,“estimate,” “expects,” “intends,“expect,” “may,” “plans,“plan,” “projects,“potential,” “will,” “would” andor the negative or plural of these terms or other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions andor expectations disclosed in the forward-looking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A,1A., “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements, except as may be required by law.
We bill third-party payors and patients for the tests we perform. The majority of our revenue collections is paid by third-party insurers, including Medicare. We have received Local Coverage Determinations, or LCDs,local coverage determinations (“LCDs”), which provide coverage for our DecisionDx-Melanoma, MyPath Melanoma, DecisionDx-UM and IDgenetix tests that meet certain criteria for Medicare and Medicare Advantage beneficiaries, representing approximately 60 million covered lives. As it relates toIn 2022, DecisionDx-UM we have contracts or have received positive medical policy decisionscoverage from additional payors representingUnited Healthcare that represents approximately 8343 million covered lives. A ‘‘covered life’’ means a subscriber, or a dependent of a subscriber, who is insured under an insurance carrier’s policy. The TissueCypher Barrett’s Esophagus Assay is paid by Medicare at the rate published on Medicare’s Clinical Laboratory Fee Schedule (“CLFS”) for the test. Effective March 24, 2022, we received Advanced Diagnostic Laboratory Test (“ADLT”) status for our TissueCypher test, as discussed further below. ADLT status exempts TissueCypher from what is called the “14-day rule,” which simplifies the billing process for Medicare patients.
Also, on May 17, 2019, CMS determined that DecisionDx-Melanoma meets the criteria for ‘‘new ADLT’’“new ADLT” status. This means that from July 1, 2019 through March 31, 2020Initially, the Medicare reimbursement rate willwas equal to the initial list price of $7,193. TheSince 2022, the rate for April 1, 2020 through December 31, 2021 will be calculatedis set annually based upon the median private payor rate from July 1,for the first half of the second preceding calendar year. Our rate for 2022 continues to be $7,193, based on the median private payor rate.
We believe there are several important factors that have impacted, and that we expect will continue to impact, our operating performance and results of operations, including:
product candidates, we believe these studies are critical to gaining physician adoption of new products and driving favorable coverage decisions by payors for such products.
Our ability to increase our revenues will depend on our ability to further penetrate our target market,markets, and, in particular, generate sales through our direct sales force, develop and commercialize additional tests, including through acquisitions, obtain reimbursement from additional third-party payors and increase our reimbursement rate for tests performed. In the near term, our financial performance will be highly dependent on reimbursement for DecisionDx-Melanoma. The use of DecisionDx-Melanoma is not yet broadly covered under positive coverage policies, although many third-party payors have begun to reimburse for this test.
activities, payor outreach programs and allocated overhead, including rent, information technology, equipment depreciation, and utilities. In the near term, weWe expect continued increases in SG&A expenses related to compliance with the rules and regulations of the SEC and The Nasdaq investor relations activities, and additional insurance expenses.Stock Market LLC (“Nasdaq”). Other administrative and professional services expenses within SG&A are expected to increase with the scale of our business, but selling and marketing-related expenses are expected to increase significantly, consistent with our growth strategy.
The following table summarizes our results of operations for the periods indicated (in thousands, except percentages):
Comparison of the six months ended June 30, 20192022 and 20182021
The following table summarizes our results of operations for the periods indicated (in thousands, except percentages):
| | | | | | | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | Change |
| 2022 | | 2021 | |
| (unaudited) | | | | |
Net revenues | $ | 61,690 | | | $ | 45,571 | | | $ | 16,119 | | | 35.4 | % |
Operating expenses and other operating income | | | | | | | |
Cost of sales (exclusive of amortization of acquired intangible assets) | 13,630 | | | 6,725 | | | 6,905 | | | 102.7 | % |
Research and development | 22,687 | | | 12,701 | | | 9,986 | | | 78.6 | % |
Selling, general and administrative | 67,951 | | | 38,983 | | | 28,968 | | | 74.3 | % |
Amortization of acquired intangible assets | 3,745 | | | 256 | | | 3,489 | | | 1,362.9 | % |
Change in fair value of contingent consideration | (17,836) | | | — | | | (17,836) | | | NA |
| | | | | | | |
Total operating expenses, net | 90,177 | | | 58,665 | | | 31,512 | | | 53.7 | % |
Operating loss | (28,487) | | | (13,094) | | | (15,393) | | | (117.6) | % |
Interest income | 400 | | | 28 | | | 372 | | | 1,328.6 | % |
Interest expense | (7) | | | — | | | (7) | | | NA |
| | | | | | | |
| | | | | | | |
Loss before income taxes | (28,094) | | | (13,066) | | | (15,028) | | | (115.0) | % |
Income tax (benefit) expense | (1,823) | | | 5 | | | (1,828) | | | NM |
Net loss | $ | (26,271) | | | $ | (13,071) | | | $ | (13,200) | | | (101.0) | % |
NA = Not applicable
NM = Not meaningful
The following table provides a disaggregation of net revenues by type (in thousands):
| | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | |
| 2022 | | 2021 | | Change |
| (unaudited) | | |
Dermatologic(1) | $ | 56,236 | | | $ | 41,288 | | | $ | 14,948 | |
Other(2) | 5,454 | | | 4,283 | | | 1,171 | |
Total net revenues | $ | 61,690 | | | $ | 45,571 | | | $ | 16,119 | |
(1)Consists of DecisionDx-Melanoma, DecisionDx-SCC and Diagnostic GEP offering.
(2)Consists primarily of DecisionDx-UM. Also includes TissueCypher and IDgenetix.
The following table presents the calculation of gross margin (in thousands, except percentages):
| | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | |
| 2022 | | 2021 | | Change |
| (unaudited) | | |
Net revenues | $ | 61,690 | | | $ | 45,571 | | | $ | 16,119 | |
Less: Cost of sales (exclusive of amortization of acquired intangible assets) | 13,630 | | | 6,725 | | | 6,905 | |
Less: Amortization of acquired intangible assets | 3,745 | | | 256 | | | 3,489 | |
Gross margin | $ | 44,315 | | | $ | 38,590 | | | $ | 5,725 | |
Gross margin percentage | 71.8 | % | | 84.7 | % | | (12.9) | % |
|
| | | | | | | | | | | | | | |
| Six Months Ended June 30, | | Increase (Decrease) |
| 2019 | | 2018 | |
| (unaudited) | | | | |
Net revenues | $ | 19,456 |
| | $ | 7,638 |
| | $ | 11,818 |
| | 154.7 | % |
Cost of sales | 3,591 |
| | 2,580 |
| | 1,011 |
| | 39.2 | % |
Gross margin | 15,865 |
| | 5,058 |
| | 10,807 |
| | 213.7 | % |
Operating expenses: | | | | | | | |
Research and development | 2,711 |
| | 2,422 |
| | 289 |
| | 11.9 | % |
Selling, general and administrative | 12,868 |
| | 8,387 |
| | 4,481 |
| | 53.4 | % |
Total operating expenses | 15,579 |
| | 10,809 |
| | 4,770 |
| | 44.1 | % |
Operating income (loss) | 286 |
| | (5,751 | ) | | 6,037 |
| | 105.0 | % |
Interest income | 26 |
| | 8 |
| | 18 |
| | 225.0 | % |
Interest expense | (2,717 | ) | | (1,055 | ) | | (1,662 | ) | | (157.5 | )% |
Other income (expense), net | (222 | ) | | 13 |
| | (235 | ) | | (1,807.7 | )% |
Loss before income taxes | (2,627 | ) | | (6,785 | ) | | 4,158 |
| | 61.3 | % |
Income tax expense | — |
| | — |
| | — |
| | — | % |
Net loss | $ | (2,627 | ) | | $ | (6,785 | ) | | $ | 4,158 |
| | 61.3 | % |
The following table indicates the amount of stock-based compensation expense (non-cash) reflected in the line items above (in thousands): | | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | |
| 2022 | | 2021 | | Change |
| (unaudited) | | |
Cost of sales (exclusive of amortization of acquired intangible assets) | $ | 1,750 | | | $ | 925 | | | $ | 825 | |
Research and development | 3,659 | | | 2,131 | | | 1,528 | |
Selling, general and administrative | 11,793 | | | 6,623 | | | 5,170 | |
Total stock-based compensation expense | $ | 17,202 | | | $ | 9,679 | | | $ | 7,523 | |
| | | | | |
Net Revenues
Net revenues increased by $11.8 million, or 154.7%, to $19.5 million due to a combination of increased test volume and higher per-unit revenues. Approximately 92% of the increase is attributable to DecisionDx-Melanoma test revenues with the remainder primarily attributable to DecisionDx-UM. Forfor the six months ended June 30, 2019, we experienced an increase in DecisionDx-Melanoma and DecisionDx-UM test volume of 21.0%2022 increased by $16.1 million, or 35.4%, to $34.8 million compared to the six months ended June 30, 2018. Also contributing2021, primarily due to thea $14.9 million increase in revenue isfrom our dermatologic tests, primarily DecisionDx-Melanoma and DecisionDx-SCC, and to a lesser extent, a $1.2 million increase in revenue from our other tests (non-dermatologic). The increase in dermatologic revenue was primarily attributable to a 54.6% increase in test volumes, with higher test reports delivered across each of our dermatologic offerings, due to a combination of the effects of our dermatologic sales force expansion during the second quarter of 2021 and increased patient flow potentially attributable to the easing of COVID-19 restrictions. The higher revenues also reflect Medicare payments on DecisionDx-SCC, as discussed above. The higher volumes were partially offset by the effect of the issuance of the final LCD for DecisionDx-Melanoma, issued by Palmetto and effective December 3, 2018. Coincident with the issuance of the LCD, a Medicare reimbursement rate for the test was established along with an agreement for payment of covered claims submitted for reimbursement beginning in February 2018. Note that as the Medicare LCD was not effective and the reimbursement rate was not known until the fourth quarter of 2018, the associated revenues were not recognized until the fourth quarter of 2018, which is when the criteria forlower positive (negative) revenue recognition was met. Medicare revenues for DecisionDx-Melanoma associated with test reports delivered in the six months ended June 30, 2018, but not recognized in revenue until the fourth quarter of 2018, were $3.0 million. For the six months ended June 30, 2019 and 2018, we recorded net positive revenue adjustments of $2.8 million and $0.9 million, respectively, related to tests delivered in previous periods, associated with changes in estimated variable consideration. Additionally,consideration, which were $(0.3) million for the six months ended June 30, 2019, revenues included $0.22022 compared to $5.1 million for tests delivered associated with contract research activities.
Cost of Sales
Cost of sales for the six months ended June 30, 20192021. The year-over-year decrease is primarily attributable to the effect of favorable adjustments related to the settlement and collection during the six months ended June 30, 2021 of certain groups of receivables from prior years that did not recur during the six months ended June 30, 2022. The increase in revenue from our other tests (non-dermatologic) of $1.2 million was primarily attributable to higher test report volume of DecisionDx-UM and the acquisitions of Cernostics in December 2021 and AltheaDx in April 2022.
Cost of Sales (exclusive of amortization of acquired intangible assets)
Cost of sales (exclusive of amortization of acquired intangible assets) for the six months ended June 30, 2022 increased by $1.0$6.9 million, or 39.2%102.7%, compared to the six months ended June 30, 2018,2021, primarily due to higher personnel costs due to additionaland increased costs of supplies and third-party services. Personnel costs have increased with additions in headcount in our laboratory testing operations, as well as increased costs of supplies and services,including headcount attributable to theour acquisitions of Cernostics and AltheaDx. The increased personnel costs also reflect higher salaries and wages for existing employees. Supply and service expenses have increased due to higher laboratory activity, levels. Our gross margin percentage was 81.5% for the six months ended June 30, 2019, comparedwhich is attributable to 66.2% for the same period in 2018, with the improvement principally a result of the increased operating leverage on the higher revenues.test volumes. Due to the nature of our business, a significant portion of our cost of sales expenses representrepresents fixed costs associated with our testing operations. Accordingly, our cost of sales expense will not necessarily increase or decrease commensurately with the change in net revenues from period to period. We expect our cost of sales expenses (exclusive of amortization of acquired intangible assets) to continue to increase in future periods as we hire additional laboratory personnel and related resources to support our expected growth in volume for our dermatologic, gastrointestinal, mental health and pipeline tests.
Gross Margin
Our gross margin percentage was 71.8% for the six months ended June 30, 2022, compared to 84.7% for the same period in 2021. The decrease was primarily due to lower revenue adjustments related to tests delivered in previous periods, higher personnel costs attributable to investments in laboratory headcount as well as higher salaries and wages, and higher amortization expense associated with our acquired intangible assets. In the near term, we expect that our gross margin percentage will decline, compared to prior periods, as we invest in additional laboratory personnel and related resources to support the anticipated growth in our report volumes for tests in advance of obtaining reimbursement coverage. Additionally, our gross margin percentage will continue to be negatively impacted by amortization of intangible assets associated with recent acquisitions.
Research and Development
Research and development expenses increased by $0.3$10.0 million, or 11.9%78.6%, for the six months ended June 30, 2019,2022, compared to the six months ended June 30, 2018, primarily associated with increases in personnel costs, legal fees and other costs, partially offset by lower clinical studies expense.
Selling, General and Administrative
SG&A expense increased by $4.5 million, or 53.4%, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018.2021. Approximately 53%50.7% of the increase is attributable to higher personnel costs, particularly within our sales functionprimarily due to expansions in headcount expansion.in support of our growth, higher pay rates and higher stock-based compensation expense, and
approximately 22.0% is attributable to higher costs for clinical studies, including costs related to the PERSONALize, CONNECTION and DECIDE studies. In early 2019,the second quarter of 2022, we expandeddecided to close our sales organization from 14 territories to 23 territories.PERSONALize study. The remainder of the increase wasis primarily associated with higher professional feesmeeting costs and increased travel costs. expenses. We expect to continue to increase our research and development expenses as we fund ongoing evidence development for our existing products as well as additional pipeline programs.
Selling, General and Administrative
The higher professional fees were primarily attributable to accountingfollowing table provides a breakdown of SG&A expenses (in thousands):
| | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | |
| 2022 | | 2021 | | Change |
| (unaudited) | | |
Sales and marketing | $ | 39,802 | | | $ | 21,523 | | | $ | 18,279 | |
General and administrative | 28,149 | | | 17,460 | | | 10,689 | |
Total selling, general and administrative expense | $ | 67,951 | | | $ | 38,983 | | | $ | 28,968 | |
Sales and reimbursement services.
Interest Expense
Interest expensemarketing expenses increased by $1.7$18.3 million, or 157.5%84.9%, for the six months ended June 30, 20192022, compared to six months ended June 30, 2021. Approximately $10.6 million, or 57.9%, of the increase is attributable to higher personnel costs including salaries, bonuses and stock-based compensation. Personnel costs have increased through the expansion of our dermatology-facing commercial team headcount to the mid-60s during the second quarter of 2021 and through our acquisitions of Cernostics in December 2021 and AltheaDx in April 2022. Following our acquisition of Cernostics, we hired an initial commercial team of approximately 14 outside sales territories, along with commensurate internal sales associates and other personnel, to support our launch of the TissueCypher Barrett’s Esophagus Assay and to serve as a dedicated team focused on gastroenterology specialists that diagnose and manage patients with BE. Through our acquisition of AltheaDx, we added a commercial team of approximately 20 outside sales territories to support our launch of the IDgenetix test. In addition to increases through sales force expansion, higher personnel costs also reflect salary increases for members of our existing sales force. The remainder of the increase in sales and marketing expenses was primarily associated with training events, meetings, travel and other general increases. The higher expenses for training events and travel reflect an increase in our sales and commercial operations related to our expanded headcount and expanded test offerings, as well a return to more in-person activities resulting from the continued easing of COVID-19 restrictions. Stock-based compensation expense included in sales and marketing expense was $5.7 million for the six months ended June 30, 2022, compared to $3.0 million for the six months ended June 30, 2021. We expect sales and marketing expenses to increase in future periods as we intend to expand our outside sales territories and sales force further during 2022, as discussed under “Overview” above.
General and administrative expenses increased by $10.7 million, or 61.2%, for the six months ended June 30, 2022, compared to six months ended June 30, 2021. The increase is primarily attributable to $6.3 million in higher personnel costs including salaries, bonuses and stock-based compensation. The higher personnel costs reflect expanded headcount in our administrative support functions, including that related to the acquisitions of Cernostics and AltheaDx, as well as higher rates of salaries and wages. Stock-based compensation expense included in general and administrative expense was $6.1 million for the six months ended June 30, 2022, compared to $3.6 million for the six months ended June 30, 2021. Furthermore, we incurred $1.7 million of transaction costs associated with our acquisition of AltheaDx. The remainder of the increase in general and administrative expenses was primarily associated with professional fees and other general increases.
Amortization of Acquired Intangible Assets
Amortization of acquired intangible assets increased by $3.5 million for the six months ended June 30, 2022, compared to the six months ended June 30, 2018.2021. The effectincrease is primarily associated with amortization of developed technology attributable to the acquisitions of the issuanceMyriad MyPath Laboratory, Cernostics, and AltheaDx in May 2021, December 2021 and April 2022, respectively.
Change in Fair Value of the 2019 NotesContingent Consideration
The change in January and February 2019 added $1.3 million in interest expensefair value of contingent consideration for the six months ended June 30, 2019 and consisted2022 of $17.8 million, a net gain, is primarily related to the remeasurement of the accrualEarnout Payments associated with our acquisition of the contractual 8% interest plus the amortizationCernostics and reflects changes in management’s projections regarding attainment of issuance costs and debt discount. The remainder of the increase is due to a combination of higher average outstanding balances and higher interest rates on our variable-rate term debt and revolving line of credit under our banking credit facility. Average outstanding bank debt balances were approximately $5.0 million highercertain commercial milestones. There was no such activity during the six months ended June 30, 20192021.
Interest Income
Interest income increased by $0.3 million for the six months ended June 30, 2022, compared to the six months ended June 30, 2021, primarily as a result of higher interest rates.
Income Tax (Benefit) Expense
Our income tax benefit was $1.8 million for the six months ended June 30, 2022, and was primarily attributable to a reduction of $1.8 million in our valuation allowance on net deferred tax assets resulting from our acquisition of AltheaDx in April 2022. Specifically, we took into consideration the additional deferred tax liabilities resulting from the acquisition and determined that a portion of our existing valuation allowance should be reduced. Other than this item, we recorded minimal amounts in income tax benefit because in both the six months ended June 30, 2022 and 2021, the income tax benefit of the pre-tax loss was largely offset by corresponding changes in the valuation allowance on net deferred tax assets, as we have determined that it is more likely than not that these benefits will not be realized.
Stock-Based Compensation Expense
Stock-based compensation expense, which is allocated among cost of sales, research and development expense and SG&A expense, totaled $17.2 million for the six months ended June 30, 2018 and average interest rates increased by approximately 0.9% from the same period in 2018.
Other Income (Expense), Net
Other income (expense), net, consists of the change in fair value of our liability2022, compared to $9.7 million for convertible preferred stock warrants and, beginning in 2019, the change in fair value of the embedded derivative liability associated with the Q1 2019 Notes. These liabilities are adjusted to their current fair values each period.
Liquidity and Capital Resources
Since our inception, we have incurred significant operating losses and negative cash flows. For the year ended December 31, 2018, our net loss was $6.4 million, our net cash used in operating activities was $12.3 million and we had an accumulated deficit of $57.5 million as of December 31, 2018. For the six months ended June 30, 2019,2021. We expect material increases in stock-based compensation expense in future periods, reflecting mainly higher awards outstanding due to growth in our net loss was $2.6 million, our net cash provided by operating activities was $1.8 million andheadcount. As of June 30, 2022, we had an accumulated deficit of $60.1 million482 employees compared to 292 as of June 30, 2019. We also have substantial indebtedness, the terms of which require us to meet a monthly three-month trailing revenue covenant. Although we were in compliance with this covenant as of December 31, 2018 and the most recently tested month, management’s projections, including consideration of certain revenue recognition policies, previously indicated potential non-compliance with the revenue covenant during the 12 months following the date of issuance of our annual financial statements. For these reasons, the report of our independent registered public accounting firm on our financial statements as of December 31, 2017 and 2018 and for each of the years then ended includes an explanatory paragraph indicating that there is substantial doubt about our ability to continue as a going concern. Subsequently, in June 2019, we entered into an amendment to our 2018 LSA which, among other changes, modified the revenue covenant. As a result, management now expects to be in compliance with the amended covenant for at least the next 12 months.
2021. As of June 30, 2019,2022, the total unrecognized stock-based compensation cost related to outstanding awards was $99.5 million, which is expected to be recognized on a straight-line basis over a weighted-average period of 3.0 years. We expect to continue granting stock-based compensation awards, which we had raised aggregateexpect to further contribute to increases in stock-based compensation expense in future periods.
Liquidity and Capital Resources
Sources of Liquidity
Our principal sources of liquidity are our cash proceeds of $46.6 millionand cash equivalents and cash generated from the sale of our convertibleproducts. As of June 30, 2022 and December 31, 2021, we had cash and cash equivalents of $273.2 million and $329.6 million, respectively. In addition to the revenue generated from the sale of our commercial products, we have financed our operations through our IPO in July 2019, two follow-on public offerings of common stock in June 2020 and December 2020, and a $25.0 million secured term loan credit facility, which we repaid in full in December 2020.
On December 14, 2020, we filed an automatically effective shelf registration statement on Form S-3 (File No. 333-251331) (our “Shelf Registration Statement”) with the SEC as a “well-known seasoned issuer.” The Shelf Registration Statement allows us to issue an indeterminate number or amount of common stock, preferred stock, debt securities and warrants from time to time in various private placements beginningone or more offerings. However, there can be no assurance that we will complete any further offerings of securities under our Shelf Registration Statement. Any future offerings under our Shelf Registration Statement will be dependent upon, among other factors, market conditions, available pricing, our financial condition, investor perception of our prospects, our capital needs and our ability to maintain status as a well-known seasoned issuer. Our market capitalization as of August 1, 2022 is below the level required to maintain status as well-known seasoned issuer in 2008, whichthe future.
As mentioned above, we have usedexpect to funduse a portion of our operations. In addition, we have obtained financing through term debt, a revolving line of creditcash and convertible promissory notes, which are discussedcash equivalents, including any proceeds from subsequent offerings under our Shelf Registration Statement, to further below.
Initial Public Offering
In connection withsupport and accelerate our research and development activities, including the closingclinical studies noted above in “Components of the IPO on July 29, 2019, we issuedResults of Operations—Research and sold 4,600,000 shares of our common stock, including 600,000 shares associated with the full exercise of the underwriters’ option to purchase additional shares, at a price to the public of $16.00 per share. We received approximately $66.0 million in net proceeds, after deducting underwriting discounts and commissions and other offering expenses payable by us.Development.”
FundingMaterial Cash Requirements
Our primary uses of capital are, and we expect will continue to be, compensation and related expenses, clinical research and development services, laboratory operations, equipment and related supplies, legal and other regulatory expenses, and general administrative costs.costs and, from time to time, expansion of our laboratory and office facilities in support of our growth. We anticipate that a substantial portion of our capital resources and effortscash requirements in the foreseeable future will relate to the further commercialization of our currently marketed products, the development of our future product candidates in our pipeline and the potential commercialization of these pipeline products, should their development be focusedsuccessful.
In December 2021, we acquired Cernostics for $30.7 million in cash and in April 2022, we acquired AltheaDx, for $30.5 million in cash and $17.1 million in shares of our common stock. Under the definitive agreement to acquire Cernostics, we also agreed to pay up to an additional $50.0 million of Earnout Payments, based on the achievement of certain commercial milestones relating to the year ending December 31, 2022. With respect to AltheaDx, we agreed to pay up to an additional $75.0 million, 50% in cash and 50% in common stock, based on the achievement of certain commercial milestones relating to the years ending December 31, 2022, 2023 and 2024. In each case, the number of shares of our common stock that may be issued in connection with the Earnout Payments is subject to limitations, as discussed in Notes 5 and 10 to the unaudited
condensed consolidated financial statements. Our actual liability with respect to these commercial milestone payments from our acquisitions will depend, in part, on our ability to successfully integrate the TissueCypher Barrett’s Esophagus Assay (acquired from Cernostics) and IDgenetix (acquired from AltheaDx) into our suite of commercial product offerings and the timing thereof.
Since our inception, we have generally incurred significant losses and negative cash flows. For the year ended December 31, 2021 we had a net loss of $31.3 million and an accumulated deficit of $93.8 million as of December 31, 2021. For the six months ended June 30, 2022, we had a net loss of $26.3 million and an accumulated deficit of $120.0 million as of June 30, 2022. Our ability to generate revenue sufficient to achieve profitability will depend heavily on the successful commercialization of our currently marketed products and the products we plan to launch in the future as well as our spending on research and development activities. We expect to incur additional expenses and losses in the future as we invest in the commercialization of our existing products, the development of our future product candidates and the potential commercialization of our product candidates, should their development be successful, and general administrative costs.
We have two product candidates in the late stage developmentcandidates. Further, we expect that we plan to launch commercially in the second halfany acquisitions of 2020. The successful development of other product candidates is highly uncertain. At this time, we cannot reasonably estimatebusinesses, products, assets or know the nature, timing and estimated costs of the efforts that will be necessary to complete the clinical development of all our product candidates. We are also unable to predict when, if ever, revenue will commence from sales of our product candidates. This is due to the numerous risks and uncertainties associated with developing genomic tests, including, among others, the uncertainty of:
successful commencement and completion of clinical study protocols;
successful identification and acquisition of tissue samples;
the development and validation of genomic classifiers; and
acceptance of new genomic tests by physicians, patients and third-party payors.
A change in the outcome of any of these variables with respect to the development of any of our product candidates would significantly change the costs and timing associated with the development of that product candidate.
Wetechnologies will also incur costs as a public company that we have not previously incurred or have previously incurred at lower rates, including increased costs and expenses for fees to members ofincrease our board of directors, increased personnel costs, increased director and officer insurance premiums, audit and legal fees, investor relations fees and expenses for compliance with public-company reporting requirements under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and rules implemented by the SEC and The Nasdaq Stock Market LLC, or Nasdaq.
As of June 30, 2019 and December 31, 2018, we had cash and cash equivalents of $17.5 million and $4.5 million, respectively. In the first quarter of 2019, we received proceeds of $11.8 million from the sale of the Q1 2019 Notes. In July 2019, we received proceeds of $10.0 million from the issuance of a convertible promissory note to an investor, or the July 2019 Note.expenses. We believe that the net proceeds from the IPO, together with our existing cash and cash equivalents and anticipated cash generated from salesthe sale of our commercial products will be sufficient to fund our operating expenses through at leastoperations for the next 24twelve months.
We believe we will meet longer-term expected cash requirements and obligations through a combination of existing cash and cash equivalents, anticipated cash generated from sales of our products and issuances of equity securities or debt offerings, including through our Shelf Registration Statement. However, we have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. There are numerous risks and uncertainties associated with developing genomic tests, including, among others, the uncertainty of:
•successful commencement and completion of clinical study protocols;
•successful identification and acquisition of tissue samples;
•the development and validation of genomic classifiers; and
•acceptance of new genomic tests by physicians, patients and third-party payors.
Because of the numerous risks and uncertainties associated with research, development and commercialization of product candidates, we are unable to estimate theour exact amount of our working capital requirements. Our future funding requirements will depend on and could increase significantly as a result of many factors, including those listed above.above as well as those listed in Part II, Item 1A., “Risk Factors” in this Quarterly Report on Form 10-Q.
Until such time, if ever, as we can generate revenue sufficient to achieve profitability,We do not currently have any committed external source of funds. In the event additional funding is required, we expect to finance our operations through our cash on hand (including the proceeds from the IPO) andthat we would use a combination of equity and debt financings, which may not be available to us on the timingwhen needed, or on terms that we deem to be favorable. We do not currently have any committed external source of funds.favorable or at all. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of our stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. Any disruptions to, or volatility in, the credit and financial markets or any deterioration in overall economic conditions may make any necessary debt or equity financing more difficult to obtain, more costly and/or more dilutive. If we are unable to raise additional funds through equitydebt or debtequity financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our product discovery and development activities or future commercialization efforts.
Leases
Long-Term Debt
Our long-term debt consists of term debtWe have entered into various operating and a revolving line of credit and are presented in the table below (in thousands):
|
| | | | | | | |
| June 30, 2019 | | December 31, 2018 |
| (unaudited) | | |
Term debt | $ | 26,688 |
| | $ | 21,350 |
|
Revolving line of credit | — |
| | 5,000 |
|
Total principal amount | 26,688 |
| | 26,350 |
|
Unamortized discount and issuance costs | (1,996 | ) | | (1,850 | ) |
Total long-term debt | 24,692 |
| | 24,500 |
|
Less: Current portion of long-term debt | (833 | ) | | — |
|
Long-term debt, less current portion | $ | 23,859 |
| | $ | 24,500 |
|
The table above excludes the Q1 2019 Notes,finance leases, which are classifiedprimarily associated with our laboratory facilities and office space. Total undiscounted future minimum payment obligations under our operating leases and finance leases as current liabilitiesof June 30, 2022 totaled approximately $10.1 million, of which $0.7 million is payable through the remainder of 2022 and $9.4 million through the end of 2033. The leases expire on various dates through 2033 and provide certain options to renew for additional periods. On March 11, 2022, we amended an existing lease agreement to lease additional laboratory space in the balance sheet. See the ‘‘Convertible Promissory Notes’’ section below for details.
Term Debt
Phoenix, Arizona. On November 30, 2018,April 1, 2022, we entered into the 2018 LSAa new lease agreement with Oxford Finance LLC, or Oxford, as collateral agent, and Oxford and Silicon Valley Bank, or SVB, as equal syndicated lenders, or the Lenders. The 2018 LSA replaced the 2017 Loan and Security Agreement and provided for a $20.0 million term loan, or the 2018 Term Loan, and a credit line of up to $5.0 million (discussed in the ‘‘Revolving Line of Credit’’ section below), prior to amendment of the 2018 LSA on June 13, 2019, as discussed below. Our obligations under the 2018 LSA are secured by substantially all of our assets, excluding intellectual property and subject to certain other exceptions and limitations. We have the right to prepay the 2018 Term Loan in whole or in part at any time, subject to a prepayment fee of 2.50% if prepaid on or prior to November 30, 2019, 1.50% if prepaid after November 30, 2019 and on or prior to November 30, 2020, and 0.75% thereafter. Upon prepayment, we are also obligated to pay a non-refundable early termination fee of $496,785. Amounts prepaid or repaid under the 2018 Term Loan may not be reborrowed. Initially, the 2018 LSA contained a financial covenant that requires us to achieve a monthly trailing six-month revenue target each month throughout thean initial term of the agreement, but the covenant amended on June 13, 201910.5 years for laboratory and changed to a monthly trailing three-month revenue target, as discussed further below.office space located in Pittsburgh, Pennsylvania. As of June 30, 2019 and December 31, 2018, we were in compliance with this covenant.
On June 13, 2019, we entered into an amendment to the 2018 LSA, or the Amendment, which, among other things, (i) eliminated the $5.0 million revolving line and increased the 2018 Term Loan by $5.0 million and (ii) amended the financial covenant to require us to achieve a monthly trailing three-month revenue target each month throughout the term2022, neither of the agreement. The financial covenant was amended primarilytwo leases had commenced. Upon commencement, we expect these two leases to align with a more current reflection ofincrease our revenue projections after taking into account the impact on our revenue recognition following our early adoption of ASC 606. The Amendment was accounted for as a modification of the 2018 LSA, and therefore no extinguishment gain or loss was recognized.
For each month through December 31, 2019, the trailing three-month revenue requirements are calculated as a percentage of our previously approved applicable monthly revenue projections, which requirements, for the monthly periods from April to December 2019, are equal to increasing dollar amounts, in millions, in the mid-single digits to high single digits. For monthly periods ending after December 31, 2019, the trailing three-month revenue requirements will be determined by the Lenders upon receipt and review of our monthly financial projections for the year, subject to certain specified criteria regardingundiscounted future minimum requirements. Revenues, if any, that we recognize as a result of an ALJ appeal process from consolidated claims initiatives for DecisionDx-Melanoma do not count toward the minimum revenue requirements. We were in compliance with this covenant as of the most recently tested month.
In addition, the 2018 LSA contains customary conditions of borrowing, events of default and covenants, including covenants that restrict our ability to dispose of assets, merge with or acquire other entities, incur indebtedness and make distributions to holders of our capital stock. Should an event of default occur, including the occurrence of a material adverse change, we could be liable for immediate repayment of allpayment obligations under the 2018 LSA. Should we seek to further amend the terms of the 2018 LSA, the consent of Oxford and SVB would be required, and there can be no assurance that any such amendment would be available on terms acceptable to us, if at all.
The 2018 Term Loan bears interest at a floating rate equal to the greater of 8.55% and the 30-day U.S. LIBOR rate as reported in The Wall Street Journal on the last business day of the month that precedes the month in which the interest will accrue, plus 6.48%. The applicable interest rate on the 2018 Term Loan was 8.88% as of June 30, 2019 and 8.98% as of December 31, 2018,
respectively. Interest on the 2018 Term Loan is payable monthly in arrears. We are permitted to make interest-only payments on the 2018 Term Loan through May 31, 2020. The principal is required to be repaid in 30 equal monthly installments beginning on June 1, 2020. All unpaid principal and accrued and unpaid interest is due on November 1, 2022, or the 2018 Term Loan Maturity Date. We are also obligated to make an additional final payment of 6.75% of the aggregate original principal amount, or $1,687,500 as of June 30, 2019, upon any prepayment or on the 2018 Term Loan Maturity Date. The final payment amount is being amortized as additional interest expense using the effective interest method of the term of the debt.
The 2018 Term Loan was fully funded on November 30, 2018 and the 2018 Revolving Line (defined and discussed below) was fully drawn upon on November 30, 2018. Proceeds from the 2018 LSA were used to repay all outstanding obligations under the 2017 LSA and to provide working capital. As a condition of the loan, we issued Series F preferred stock warrants to the Lenders with an aggregate initial fair value of $158,000. In accordance with ASC 480-10, the warrants are liability-classified as the underlying to the warrant is a puttable security. The initial recognition of the warrant liability created a discount to the debt, which is being amortized over the debt term using the effective interest method. The 2018 LSA was accounted for as a modification of the previous lending arrangement with SVB and Oxford, and therefore no extinguishment gain or loss was recognized.
Revolving Line of Credit
Under the 2018 LSA, the Company had a $5.0 million revolving line of credit (the “2018 Revolving Line”), contingent on the Company’s satisfaction of borrowing base eligibility requirements. The 2018 Revolving Line bore interest at a floating per annum rate equal to the greater of 1) 6.25% and 2) 5.48% above the U.S. LIBOR rate. The applicable interest rate on the 2018 Revolving Line at December 31, 2018 was 7.98%. The 2018 Revolving Line was to be due in full no later than November 30, 2020, but was eliminated in connection with the Amendment.
Q1 2019 Convertible Promissory Notes
In January and February 2019, we issued $11,770,375 principal amount of unsecured convertible promissory notes of which $4,755,882 was with related parties (executive officers, members of our board of directors or entities affiliated with them). The Q1 2019 Notes bear simple interest at a rate of 8% per annum. Originally, the Q1 2019 Notes had a maturity date of January 31, 2020, but on July 3, 2019 we entered into an amendment with the holders of the Q1 2019 Notes to extend the maturity date to June 30, 2020.
Prior to the actual conversion of the Q1 2019 Notes on July 29, 2019 (discussed below), on or before the maturity date, the entire outstanding principal amount of and accrued interest on the Q1 2019 Notes, or the Conversion Amount, was automatically convertible into shares of our equity securities issued and sold in a single or series of related transactions, with the principal purpose of raising capital, in which we sell shares of such equity securities for aggregate gross proceeds of at least $10.0 million, or the Next Equity Financing. The number of shares of such equity securities issuable in the Next Equity Financing was equal to the quotient of the Conversion Amount as of the closing date of the Next Equity Financing divided by a per share price that is equal to 80%total of the lowest per share purchase priceapproximately $13.8 million.
The closing of the IPO on July 29, 2019 was considered to be the Next Equity Financing under the terms of the Q1 2019 Notes. Accordingly, on July 29, 2019, the Conversion Amount of the Q1 2019 Notes as of such date converted into 954,074 shares of common stock based on a price of $12.80 per share, or 80% of the IPO price of $16.00 per share.
As discussed further in Note 7 to the unaudited interim condensed financial statements appearing elsewhere in this Quarterly Report on Form 10-Q, the Q1 2019 Notes contained a beneficial conversion feature and an embedded derivative, both of which created a significant debt discount that was being amortized over the life of the debt (that is, through June 30, 2020) using the effective interest method, which resulted in increases in non-cash interest expense in each succeeding reporting period until the Notes were converted on July 29, 2019.
The following table summarizes the aggregate values recorded for the Q1 2019 Notes at issuance and as of June 30, 2019 (in thousands):
|
| | | | | | | |
| June 30, 2019 | | At Issuance(1) |
| (unaudited) |
Liability component: | | | |
|
Principal | $ | 11,770 |
| | $ | 11,770 |
|
Unamortized issuance costs | (68 | ) | | (74 | ) |
Unamortized discount from beneficial conversion feature | (7,655 | ) | | (8,378 | ) |
Unamortized discount from embedded derivative | (2,573 | ) | | (2,816 | ) |
Net carrying amount of the liability component | 1,474 |
| | 502 |
|
Embedded derivative liability | 2,952 |
| | 2,816 |
|
Total | $ | 4,426 |
| | $ | 3,318 |
|
Equity component: | |
| | |
|
Carrying value of beneficial conversion feature recorded in additional paid-in capital | $ | 8,378 |
| | $ | 8,378 |
|
________________(1) The Q1 2019 Notes were issued on January 31, 2019, February 12, 2019 and February 27, 2019.
The Q1 2019 Notes are classified as current liabilities on the balance sheet due to their contractual maturity date.
July 2019 Convertible Promissory Note
On July 12, 2019, we issued an unsecured convertible promissory note having a principal amount of $10,000,000. The July 2019 Note bore simple interest at a rate of 8% per annum and had an original maturity date of June 30, 2020. As a result of the IPO, the outstanding principal amount plus accrued interest on the July 2019 Note converted into 707,032 shares of common stock on July 29, 2019, based on a price derived from a minimum valuation calculated pursuant to the terms of the July 2019 Note.
Cash Flows
The following table summarizes our sources and uses of cash and cash equivalents for each of the periods presented (in thousands):
| | | | | | | | | Six Months Ended June 30, | |
| | Six Months Ended June 30, | | | 2022 | | 2021 | |
| | 2019 | | 2018 | | | (unaudited) | |
| | (unaudited) | |
Net cash provided by (used in) operating activities | | $ | 1,770 |
| | $ | (7,206 | ) | |
Net cash used in operating activities | | Net cash used in operating activities | | $ | (30,431) | | | $ | (10,069) | | |
Net cash used in investing activities | | (424 | ) | | (185 | ) | Net cash used in investing activities | | (27,913) | | | (34,845) | | |
Net cash provided by financing activities | | 11,644 |
| | 11,384 |
| Net cash provided by financing activities | | 1,877 | | | 3,401 | | |
Net increase in cash and cash equivalents | | $ | 12,990 |
| | $ | 3,993 |
| |
Net change in cash and cash equivalents | | Net change in cash and cash equivalents | | (56,467) | | | (41,513) | | |
Cash and cash equivalents, beginning of period | | Cash and cash equivalents, beginning of period | | 329,633 | | | 409,852 | | |
Cash and cash equivalents, end of period | | Cash and cash equivalents, end of period | | $ | 273,166 | | | $ | 368,339 | | |
Operating Activities
Net cash provided byused in operating activities was $1.8$30.4 million for the six months ended June 30, 2019 and was primarily attributable to decrease in accounts receivable of $3.6 million and net non-cash charges of $1.9 million (consisting primarily of $1.2 million in amortization of debt discount and issuance costs, stock compensation expense of $0.3 million, depreciation expense of $0.2 million and change in fair value of embedded derivatives of $0.1 million) and increases in other accrued liabilities of $0.9 million, partially offset by the net loss of $2.6 million and decreases in accrued compensation of $1.8 million.
Net cash used in operating activities was $7.2 million for the six months ended June 30, 20182022, and was primarily attributable to the net loss of $6.8$26.3 million, andthe change in fair value of contingent consideration of $17.8 million, increases in accounts receivable of $0.6$5.6 million and deferred income taxes of $1.8 million, partially offset by non-cash stock compensation expense of $17.2 million and depreciation and amortization of $4.8 million.
Net cash used in operating activities was $10.1 million for the six months ended June 30, 2021, and was primarily attributable to the net loss of $13.1 million, increases in accounts receivable of $5.3 million and recoupment of $2.2 million of an advance payment from CMS under its Accelerated and Advance Payment Program, partially offset by non-cash stock compensation expense of $9.7 million and decreases in prepayments and other current assets of $1.3 million.
The $20.4 million additional net cash used in operating activities for the six months ended June 30, 2022 compared to the six months ended June 30, 2021 is primarily due to cash requirements associated with the increases in operating expenses, the majority of which were attributable to salaries, bonuses and benefits due to our growth in headcount, as discussed in further detail under “Results of Operations—Comparison of the six months ended June 30, 2022 and 2021” above. The effect of the higher expenses on net cash used in operating activities was partially offset by cash inflows from the higher revenues.
Investing Activities
Net cash used in investing activities was $27.9 million for the six months ended June 30, 20192022 and 2018 consisted entirelyprimarily of the cash portion of the AltheaDx purchase consideration of $26.7 million (net of cash and cash equivalents acquired) and purchases of property and equipment.equipment of $1.8 million. Net cash used in investing activities was $34.8 million for the six months ended June 30, 2021 and consisted primarily of the purchase of Myriad MyPath Laboratory of $33.2 million (including transaction costs) and purchases of property and equipment of $1.7 million.
Financing Activities
Net cash provided by financing activities was $11.6$1.9 million for the six months ended June 30, 20192022, and primarily consisted primarily of $11.7$1.5 million of netin proceeds from contributions to the employee stock purchase plan and $0.5 million in proceeds from the issuanceexercise of the Q1 2019 Notes, $1.8 million of net proceeds associated with an increase
in the 2018 Term Loan in connection with an amendment to the 2018 LSA, partially offset by principal repayments of $1.8 million on our line of credit.stock options.
Net cash provided by financing activities was $11.4$3.4 million for the six months ended June 30, 20182021, and primarily consisted primarily of $10.4 million attributable to proceeds received from the issuance of preferred stock, and $1.0$2.3 million in proceeds from additional borrowings on the lineexercise of credit.stock options and $1.4 million in proceeds from contributions to the employee stock purchase plan.
Off-Balance Sheet Arrangements
We do not currently have, nor did we have any off-balance sheet arrangements, as definedIn 2021, the rate of inflation in the rulesUnited States began to increase and regulationshas since risen to levels not experienced in over 40 years. We are experiencing inflationary pressures, primarily in personnel costs, and we anticipate impacts on other cost areas within the next twelve months. The extent of any future impacts from inflation on our business and our results of operations will be dependent upon how long the elevated inflation levels persist and the extent to which the rate of inflation further increases, if at all, neither of which we are able to predict. If elevated levels of inflation were to persist or if the rate of inflation were to accelerate, the purchasing power of our cash and cash equivalents may be diminished, our expenses could increase faster than anticipated and we may utilize our capital resources sooner than expected. Further, given the complexities of the SEC, duringreimbursement landscape in which we operate, our payors may be unwilling or unable to increase reimbursement rates to
compensate for inflationary impacts. As such, the periods presented.effects of inflation may adversely impact our results of operations, financial condition and cash flows.
Critical Accounting Policies and Significant Judgments and Estimates
During the six months ended June 30, 2019,2022, except as noted below, there were no significant changes to the information discussed under “Critical Accounting Policies and Significant Judgments and Estimates” included in the Management’s Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the Prospectus.year ended December 31, 2021.
The following is an updated discussion of our critical accounting estimates related to contingent consideration. This information should be read in conjunction with our other information on critical accounting estimates included in our Annual Report on Form 10-K for the year ended December 31, 2021.
Recent Accounting PronouncementsUnder the terms of business combinations or asset acquisitions, we may be required to pay additional consideration if specified future events occur or if certain conditions are met.
ReferIn a business combination, in accordance with to Note 2, ‘‘SummaryASC Topic 805, Business Combinations, contingent consideration is recorded at fair value as of Significant Accounting Policies,’’the acquisition date and classified as liabilities or equity based on applicable accounting principles generally accepted in the accompanying notesUnited States of America (“U.S. GAAP”). For contingent consideration classified as liabilities, we remeasure the contingent consideration at fair value each period with changes in fair value recorded in the statements of operations and comprehensive loss each period.
For contingent consideration in transactions that are not business combinations, we apply applicable U.S. GAAP. With respect to the additional consideration that may be payable in connection with the acquisition of Cernostics, an asset acquisition we completed on December 3, 2021, we account for the contingent consideration as liability in accordance with ASC 480, Distinguishing Liabilities from Equity (“ASC 480”), under the guidance for obligations that must or may be settled by issuance of a variable number of shares. In accordance with ASC 480, we record the contingent consideration initially and subsequently at fair value with changes in fair value recorded in the condensed consolidated statements of operations and comprehensive loss each period.
Liabilities for contingent consideration are classified as a “Level 3” fair value measurements (as defined in Note 11 to our unaudited condensedconsolidated financial statements included in this Quarterlyour Annual Report on Form 10-Q10-K for the year ended December 31, 2021) due to the use of significant unobservable inputs and a discussion of recent accounting pronouncements.
JOBS Act Accounting Election
We are an emerging growth company within the meaningMonte Carlo simulation to determine its fair value. The Monte Carlo simulation uses projections of the JOBS Act. Section 107(b)commercial milestones for the applicable period as well as the corresponding targets and approximate timing of payment based on the terms of the JOBS Act provides that an emerging growth company can leverage the extended transition period, provided in Section 102(b)arrangement. The analysis also uses assumptions for expected volatility of the JOBS Act, for complying with new or revised accounting standards. Thus, an emerging growth company can delayfinancial metrics and a risk-adjusted discount rate. The assumptions and estimates we use in the adoption of new or revised accounting standards that have different effective dates for publicMonte Carlo simulation require considerable judgment and private companies until those standards apply to private companies. We have elected to use this extended transition period and,may change in future periods as a result of new information. For example, during the three months ended June 30, 2022, as a result of a change in management’s projections regarding the outcome of certain commercial milestones associated with our financial statements may not be comparable to companies that comply with public company effective dates. We also intend to rely on other exemptions provided byacquisition of Cernostics, the JOBS Act, including without limitation, not being required to comply with the auditor attestation requirements of Section 404(b)fair value of the Sarbanes-Oxley Act of 2002, as amended.related contingent consideration liability decreased by $20.8 million.
We will remain an emerging growth company until the earliest of (1) the last day of the fiscal year following the fifth anniversary of the consummation of the IPO (that is, July 29, 2024), (2) the last day of the fiscal year in which we have total annual gross revenue of at least $1.07 billion, (3) the last day of the fiscal year in which we are deemed to be a ‘‘large accelerated filer’’ as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock held by non-affiliates exceeded $700.0 million as of the last business day of the second fiscal quarter of such year or (4) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.
Item 3. QualitativeQuantitative and QuantitativeQualitative Disclosures About Market Risk.
Interest Rate RiskAs a smaller reporting company, we are not required to provide the information required by this Item.
Our primary market risk exposure relates to interest rates on our outstanding long-term debt, which bears interest at variable market rates. Based on bank borrowings outstanding as of June 30, 2019, if market interest rates were to increase by 1.0%, our interest expense and operating cash flows would be adversely impacted by approximately $250,000 on an annual basis.
Effects of Inflation
Inflation generally affects us by increasing our cost of labor and research and development costs. We do not believe inflation has had a material effect on our results of operations during the periods presented.
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. Procedures
We maintain “disclosuredisclosure controls and procedures” as (as defined in Rules 13a-15(e) andor 15d-15(e) under the Exchange Act,Act) that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms and (2) accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2019.2022. Based upon the evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were not effective at athe reasonable assurance level as a resultlevel.
Material WeaknessesChanges in Internal Control over Financial Reporting
In connection with the audit of our financial statements as of and for each of the years ended December 31, 2017 and 2018, we identified material weaknesses in our internal control over financial reporting.
We are implementing measures designed to improve our internal control over financial reporting to remediate these material weaknesses, including the following:
WeThere have hired a full-time director of SEC reporting and technical accounting, a certified public accountant with an active license, with public company reporting experience to provide oversight and technical expertise with respect to financial reporting and technical accounting matters. Further, we have added an additional full-time accounting resource, also a certified public accountant with an active license, to assist with financial reporting and technical accounting activities.
We commenced development of a new information technology tool designed to improve the efficiency of our processes with respect to revenue recognition under ASC 606.
We began an evaluation of third parties to assist us with formalizing our internal control documentation and implementation of enhancements to our internal control over financial reporting.
These additional resources and activities are designed to enable us to broaden the scope and quality of our internal review of underlying information related to financial reporting and to formalize and enhance our internal control procedures. With the oversight of senior management and our audit committee, we have begun taking steps and plan to take additional measures to remediate the underlying causes of the material weaknesses.
Changes in Internal Control over Financial Reporting.
Other than the implementation of measures described above under Material Weaknesses in Internal Control over Financial Reporting, there werebeen no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) that occurred during the second quarter ended June 30, 2019of 2022 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II—OTHER INFORMATION
Item 1. Legal Proceedings.
From time to time, the Companywe may be involved in legal proceedings arising in the ordinary course of business. The Company believesWe believe there is no pending or threatened litigation or litigation pending that could have, individually or in the aggregate, a material adverse effect on the Company’sour financial position, results of operations or cash flows.
Item 1A. Risk Factors.
Risk Factors Summary
We face many risks and uncertainties, as more fully described in this section under the heading “Risk Factors.” Some of these risks and uncertainties are summarized below. The summary below does not contain all of the information that may be important to you, and you should read this summary together with the more detailed discussion of these risks and uncertainties contained in “Risk Factors.”
Risk Related to our Financial Condition
•We rely upon a small number of third-party payors for a significant portion of our revenue.
•Our method of recognizing revenue may not reflect our underlying business.
•We have incurred significant losses since inception, and we may never achieve profitability.
•We are an early, commercial-stage company and have a limited operating history, which may make it difficult to evaluate our current business and predict our future performance.
•Our financial results could fluctuate in the future, causing the market price of our stock to decline substantially.
•If our internal control over financial reporting is ineffective, we may not be able to accurately report our financial results or file our periodic reports in a timely manner.
•We may need to raise additional capital to commercialize new products, to expand operations or to fund existing operations.
Risks Related to our Business
•Our revenue heavily relies upon the sale of a single product and our current or future products may not achieve or maintain significant commercial market acceptance.
•We have been, and may continue to be, adversely impacted by the COVID-19 pandemic, which has, at times, caused decreased test report volume.
•Billing for our products is complex and we require substantial time and resources to collect payment.
•We rely on third parties for sample collection, preparation and delivery.
•A depletion or loss of our sample database could significantly harm our business.
•If our primary clinical laboratory facility becomes damaged or inoperable or we are required to vacate our existing facility, our ability to conduct our laboratory work for our commercial products and pursue our research and development efforts may be jeopardized.
•New product development is lengthy and complex, and our revenues could be limited if we are unable to increase and support adoption of our products by both physicians and other healthcare providers.
•We rely on limited or sole suppliers for some of the reagents, equipment, chips and other materials used by our products, and we may not be able to find replacements or transition to alternative suppliers if these suppliers are unable or unwilling to continue providing these materials.
•The sizes of the addressable markets for our current and future products have not been established with precision and may be smaller than we estimate.
•The diagnostic testing industry is subject to rapid change, which could make our current or future products obsolete.
Risks Related to Reimbursement and Government Regulation
•We currently have limited reimbursement coverage for our lead product, DecisionDx-Melanoma, and if third-party payors, including government and commercial payors, do not provide sufficient coverage of, or adequate reimbursement for, our products, our commercial success, including revenue, will be negatively affected.
•We conduct business in a heavily regulated industry and failure to comply with regulatory requirements, including those established by the CMS, and the U.S. Food and Drug Administration (“FDA”) or changes in enforcement discretion for laboratory developed tests could harm our business.
•Data from our clinical studies may change materially, which could harm our business.
•Changes in healthcare policy, statutes or regulations, or our ability to comply with applicable healthcare requirements, could have a material adverse effect on our business and operations.
Risks Related to Intellectual Property
•If we are unable to obtain and maintain sufficient intellectual property protection for our technology, our ability to successfully commercialize our products may be impaired.
•Our commercial success depends significantly on our ability to operate without infringing upon the intellectual property rights of third parties.
•We rely on information technology systems that we license from third parties and other royalty-bearing license agreements.
Risks Related to Employee Matters and Managing Growth and Other Risks Related to Our Business
•We are highly dependent on the services of our key personnel, including our President and Chief Executive Officer.
•Our employees and any current or potential commercial partners may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements and insider trading.
•We have, and may continue to, engage in strategic transactions, such as the acquisition of businesses, assets, products or technologies, which could be disruptive to our existing operations, divert the attention of our management team and adversely impact our liquidity, cash flows, financial condition and results of operations.
•Our business may be negatively impacted by cybersecurity threats, natural disasters and public health crises.
•Product or professional liability lawsuits against us could cause us to incur substantial liabilities and could limit our commercialization of our products.
Risks Related to Ownership of Our Common Stock.
•The price of our common stock may be volatile or may decline regardless of our operating performance, and you may lose all or part of your investment.
•We have broad discretion in the use of working capital and may not use it effectively or in ways that increase our share price.
•Related party transactions that create conflicts of interest, or the appearances of conflicts of interest, may harm our business and cause our stock price to decline.
•The concentration of our stock ownership will likely limit your ability to influence corporate matters, including the ability to influence the outcome of director elections and other matters requiring stockholder approval.
•Delaware law and provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make a merger, tender offer or proxy contest difficult, thereby depressing the trading price of our common stock.
•Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for certain disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Risk Factors
You should consider carefully the risks described below, as well as the other information in this Quarterly Report on Form 10‑Q, before deciding whether to purchase, hold or sell shares of our common stock. The occurrence of any of the following risks could harm our business, financial condition, results of operations and/or 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. You should consider all of the factors described as well as the other information in the Prospectus,this Quarterly Report on Form 10-Q, including our unaudited condensed consolidated financial statements and the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” when evaluating our business. The risk factors set forth below that are marked with an asterisk (*) are new or contain changes to the similarly titled risk factors included in our Annual Report on Form 10-K for the Prospectus.year ended December 31, 2021. If any of the following risks actually occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected. In these circumstances, the market price of our common stock could decline and you may lose all or part of your investments.investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations.
Risks Related to Our Financial Condition
Our reliance upon a small number of third-party payors for a significant portion of our revenue may materially adversely affect our financial condition and results of operations.
We receive a substantial portion of our revenue from a small number of third-party payors, primarily Medicare and United Healthcare.Medicare. Our revenue for our test reports provided for patients covered by Medicare and United HealthcareMedicare Advantage plans as a percentage of total revenue, was 9%57% and 11%28%, respectively, for the year ended December 31, 2017,2021 and 36%58% and 12%29%, respectively, for the year ended December 31, 2018. In addition, our current accounts receivable balances for Medicare and United Healthcare, as a percentage of our total current accounts receivable, were 0% and 10%, respectively, as of December 31, 2017, and 54% and 7%, respectively, as of December 31, 2018. Our long-term accounts receivable balances for Medicare and United Healthcare, as a percentage of our total long-term accounts receivable, were 0% and 15%, respectively, as of December 31, 2017, and 0% and 15%, respectively, as of December 31, 2018.2020. If our largest current payors were to significantly reduce, or cease to pay, the amount they reimburse for our products, or if they do not reach favorable coverage and reimbursement decisions for our products, or attempt to recover amounts they had already paid, it could have a material adverse effect on our business, financial condition and results of operations and cause significant fluctuations in our results of operations.
Due to how we recognize revenue, our quarterly revenues may not reflect our underlying business.*
We have concluded that our contracts include variable consideration because the amounts paid by Medicare or commercial health insurance carriers may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration attributable to these price concessions is measured at the expected value using the ‘‘most likely amount’’ method under ASC 606. The amounts are determined by historical average collection rates by test type and payor category taking into consideration the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as the judgment and actions of third parties. Determining variable consideration through a consideration of these factors involves a significant level of estimation uncertainty, and our estimations may turn out to be incorrect. Such variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. Variable consideration may be constrained and excluded from the transaction price in situations where there is no contractually agreed upon reimbursement coverage or in the absence of a predictable pattern and history of collectability with a payor. Variable consideration for Medicare claims that are not covered by an LCD or otherwise, including those claims undergoing appeal, is deemed to be fully constrained when the payment of such claims is subject to approval by an Administrative Law Judge, or ALJ, at an appeal hearing, due to factors outside our influence (i.e.(e.g., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. As a result of the timing and amount of adjustments for variable consideration, our operating results and comparisons of such results on a period-to-period basis may be difficult to understand and may not be meaningful. In addition, these fluctuations in revenue may make it difficult for us, for research analysts and for
investors to accurately forecast our revenue and operating results. If our revenue or operating results fall below expectations, the price of our common stock would likely decline.
We have incurred significant losses since inception, and we may never achieve or sustain profitability.*
Since our inception, we have had a history of net losses. As of June 30, 2019,For the year ended December 31, 2021 we had a cash balancenet loss of approximately $17.5$31.3 million and an accumulated deficit of approximately $60.1$93.8 million as of December 31, 2021. For the six months ended June 30, 2022, we had a net loss of $26.3 million. As of June 30, 2022, we had an accumulated deficit of $120.0 million. We cannot predict if we will achieve sustained profitability in the near future or at all. We expect that ourto incur losses will continue forin the foreseeable future as we plan to invest significant additional funds toward the expansion of our commercial organization, the conduct of clinical utility and validity studies to support adoption of our products and the development or acquisition of additional products. Our auditors have issued a going concern opinion onWe also expect significant increases in our financial statementsstock-based compensation expense in future periods, reflecting higher stock option valuations as of and for the years ended December 31, 2017 and 2018, expressing substantial doubt about our ability to continue as a going concern. As a public company and additional awards outstanding due to increased headcount. Additionally, our performance could be affected by the impacts of the ongoing COVID-19 pandemic, the invasion of Ukraine by Russia, economic slowdowns, recessions or market corrections, inflation, rising interest rates and tightening of credit markets resulting from the pandemic, the conflict or another cause. Due to the requirements associated with being a public company, including those associated with no longer qualifying as an emerging growth company, we will alsoexpect to continue incur significant additional legal, accounting and other expensesexpenses. We also expect that we did not incur as a private company.any acquisitions of businesses, assets, products or technologies will increase our expenses. These increased expenses will make it harder for us to achieve and sustain future profitability. We may also incur significant losses in the future for a number of reasons, many
of which are beyond our control, including the other risks described in this Quarterly Report on Form 10‑Q, adoption of our products, coverage of and reimbursement rates for our products from third-party payors, and future research and development activities. Our failure to achieve and sustain profitability in the future could cause the market price of our common stock to decline.decline and make it more difficult or costly for us to raise additional capital.
We are an early, commercial-stage company and have a limited operating history, which may make it difficult to evaluate our current business and predict our future performance.*
We are an early commercial-stage company and have a limited operating history. Our limited operating history may make it difficult to evaluate our current business and this makes predictions about our future success or viability subject to significant uncertainty. In particular, we intend to use a portion of our working capital to increase our headcount, including through the expansion of our sales and marketing and research and development teams, which will increase our operating costs in a manner not historically reflected in our consolidated financial statements. In combination with our other anticipated increased operating expenses in connection with becomingthe ongoing demands of a public company, these anticipated changes in our operating expenses may make it difficult to evaluate our current business, assess our future performance relative to prior performance and accurately predict our future performance.
We will continue to encounter risks and difficulties frequently experienced by early commercial-stage companies, including those associated with increasing the size of our organization and the prioritization of our commercial, research and business development activities. If we do not address these risks successfully, our business could suffer.
The terms of our credit facility place restrictions on our operating and financial flexibility, and failure to comply with covenants or to satisfy certain conditions of the agreement governing the credit facility may result in acceleration of our repayment obligations and foreclosure on our pledged assets, which could significantly harm our liquidity, financial condition, operating results, business and prospects and cause the price of our securities to decline.*
Our 2018 LSA, which we amended in June 2019, with Oxford and SVB, is secured by a lien covering substantially all of our assets, excluding intellectual property. The 2018 LSA provides for a five-year $25.0 million term-loan facility, all of which has been disbursed to us.
The 2018 LSA requires us to achieve certain revenue levels tested monthly on a trailing three-month basis. As of the most recently tested month, we were in compliance with this covenant. However, there can be no assurance of our ability to maintain compliance with the revenue covenant as of any future date. For example, prior to the amendment of the 2018 LSA, our projections indicated that we were at risk of noncompliance with the financial covenant existing under the 2018 LSA prior to the June 2019 amendment. Among other things, the June 2019 amendment revised our financial covenant to require us to achieve a monthly trailing three-month revenue target, tested on a monthly basis. The financial covenant was amended primarily to align with a more current reflection of our revenue projections after taking into account the impact on our revenue recognition following our early adoption of ASC 606. Our ability to amend the 2018 LSA in the future is subject to the approval of Oxford and SVB. Accordingly, should we seek to further amend the 2018 LSA, there can be no assurance that any such amendment would be available on terms acceptable to us, if at all.
The 2018 LSA also requires us to comply with a number of other covenants (affirmative and negative), including restrictive covenants that limit our ability to: incur additional indebtedness; encumber the collateral securing the loan; acquire, own or make investments; repurchase or redeem any class of stock or other equity interest; declare or pay any cash dividend or make a cash distribution on any class of stock or other equity interest; transfer a material portion of our assets; acquire other businesses; and merge or consolidate with or into any other organization or otherwise suffer a change in control, in each case subject to exceptions.
In addition to other specified events of default, and subject to limited exceptions, the lenders could declare an event of default upon the occurrence of any event that they interpret as having a material impairment in their lien on the collateral under the agreement, a material adverse change in our business, operations or condition (financial or otherwise) or a material impairment in the prospect of repayment of our obligations under the agreement. If we default under the credit facility, the lenders may accelerate all of our repayment obligations and, if we are unable to access funds to meet those obligations or to renegotiate our agreement, the lenders could take control of our pledged assets and we would have to immediately cease operations. During the continuance of an event of default, the then-applicable interest rate on the then-outstanding principal balance will increase by 5.0%. Upon an event of default, the lenders could also require us to repay the loan immediately, together with a prepayment charge of up to 2.5% of the then-outstanding principal balance, together with other fees. If we were to renegotiate the agreement under such circumstances, the terms may be significantly less favorable to us. If we were liquidated, the lenders’ right to repayment would be senior to the rights of our stockholders to receive any proceeds from the liquidation. Any declaration by the lenders of an event of default could significantly harm our liquidity, financial condition, operating results, business, and prospects and cause the price of our securities to decline.
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. If we are unable to repay, refinance or restructure our indebtedness when payment is due, the lenders could proceed against the collateral or force us into bankruptcy or liquidation.
The audit report of our independent registered public accounting firm expresses substantial doubt about our ability to continue as a going concern.
The audit report from our independent registered public accounting firm expresses substantial doubt that we can continue as an ongoing business due to uncertainties about our ability to comply with certain debt covenants under our long-term debt that is required to finance operations and our future financial statements may include a similar qualification about our ability to continue as a going concern. Our audited financial statements were prepared assuming that we will continue as a going concern and do not include any adjustments that may result from the outcome of this uncertainty.
If we are unable to meet the applicable debt covenants, the lenders could accelerate all of our repayment obligations under the 2018 LSA and we would need to seek additional or alternate financing or modify our operational plans. If we seek additional financing to fund our business activities in the future and there remains substantial doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding to us on commercially reasonable terms or at all.
We have identified material weaknesses in our internal control over financial reporting. If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or file our periodic reports in a timely manner, which may cause adverse effects on our business and may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.*
Effective internal control over financial reporting is necessary for us to provide reliable financial reports in a timely manner. In connection with the audits of our financial statements for the years ended December 31, 2017 and 2018, we concluded that there were material weaknesses in our internal control over financial reporting.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis.
These material weaknesses related to a lack of (i) appropriately designed and implemented controls over the review and approval of manual journal entries and the related supporting journal entry calculations, (ii) personnel with appropriate knowledge, experience and training commensurate with accounting and reporting requirements and (iii) appropriately designed and implemented controls to evaluate variable consideration and the related constraint in accordance with ASC 606, and resulted in certain material corrections to the financial statements.
In an attempt to remediate these weaknesses, we have hired a full-time director of SEC reporting and technical accounting and another full-time accounting resource, both certified public accountants with active licenses, to augment our accounting staff and to provide more resources for complex accounting matters and financial reporting. We also have commenced development of a new information technology tool designed to improve the efficiency of our processes with respect to revenue recognition under ASC 606 and have begun an evaluation of third parties to assist us with formalizing our internal control documentation and implementation of enhancements to our internal control over financial reporting. However, we cannot assure you that these efforts will remediate our material weaknesses in a timely manner, or at all.
If we are unable to successfully remediate our material weaknesses or identify any future significant deficiencies or material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, a material misstatement in our financial statements could occur, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports, which may adversely affect our business and our stock price may decline as a result.
In addition, even if we remediate our material weaknesses, we will be required to expend significant time and resources to further improve our internal controls over financial reporting, including by further expanding our finance and accounting staff to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley. If we fail to adequately staff our accounting and finance function to remediate our material weaknesses, or fail to maintain adequate internal control over financial reporting, any new or recurring material weaknesses could prevent our management from concluding our internal control over financial reporting is effective and impair our ability to prevent material misstatements in our financial statements, which could cause our business to suffer.
Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported operating results.*
Accounting principles generally accepted in the United States of America are subject to interpretation by the Financial Accounting Standards Board, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles. A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. For example, as described in Note 2 to our audited financial statements included in the Prospectus, we adopted the revenue recognition standard under ASC 606 which superseded previous revenue recognition guidance applicable to us. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business. As of December 31, 2021, we are no longer an emerging growth company and now apply public company adoption dates for new or revised accounting standards.
Our quarterly and annual operating results and cash flows may fluctuate in the future, which could cause the market price of our stock to decline substantially.
Numerous factors, many of which are outside our control may cause or contribute to significant fluctuations in our quarterly and annual operating results. For example, following the onset of the COVID-19 pandemic in 2020 we experienced decreases in revenue and test report volumes. These fluctuations may make financial planning and forecasting uncertain. In addition, these fluctuations may result in unanticipated decreases in our available cash, which could negatively affect our business and prospects. 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. As a result, comparing our operating results on a period-to-period basis may be difficult to understand and may not be meaningful. You should not rely on our past results as indicative of our future performance.
In addition, a significant portion of our operating expense is relatively fixed in nature, and planned expenditures are based in part on expectations regarding future revenue. Accordingly, unexpected revenue shortfalls could decrease our gross margins and cause significant changes in our operating results from quarter to quarter. If this occurs, the trading price of our stock could fall substantially.
This variability and unpredictability caused by factors such as those described above could also result in our failing to meet the expectations of industry or financial analysts or investors for any period. If our revenue or operating results fall below the expectations of analysts or investors or below any guidance we may provide, or if the guidance we provide is below the expectations of analysts or investors, the price of our common stock could decline substantially. Such a stock price decline could occur even when we have met any previously publicly stated guidance we may provide.
If our internal control over financial reporting is not effective, we may not be able to accurately report our financial results or file our periodic reports in a timely manner, which may cause adverse effects on our business and may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.
Effective internal control over financial reporting is necessary for us to provide reliable financial reports in a timely manner. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected on a timely basis.
If we fail to adequately staff our accounting and finance function or fail to maintain adequate internal control over financial reporting, any new or recurring material weaknesses could prevent our management from concluding our internal control over financial reporting is effective and could result in our auditor issuing an adverse opinion on our internal control over financial reporting. If we identify any future significant deficiencies or material weaknesses, the accuracy and timeliness of our financial reporting may be adversely affected, our ability to prevent material misstatements in our consolidated financial statements could be impaired, a material misstatement in our consolidated financial statements could occur and we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports, which could cause our business to suffer and our stock price to decline.
Since becoming a publicly traded company in 2019, we have increased the headcount of our accounting and finance functions to further support the demands placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). We expect to continue expending significant time and resources related to our internal control over financial reporting, including by further expanding our finance and accounting staff over time, but there can be no assurance our efforts will be effective.
We may need to raise additional capital to fund our existing operations, commercialize new products or expand our operations.*
We believe our existing cash and cash equivalents and anticipated cash generated from sales of our products will be sufficient to fund our operating expenses through at leastoperations for the next 24 months.foreseeable future. If our available cash balancesand cash equivalents and anticipated cash generated from sales of our products are insufficient to satisfy our liquidity requirements including because of lower demand for our products, lower than currently expected rates of reimbursement from third-party payors or other risks described in this Quarterly Report on Form 10-Q,10‑Q, we may finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. We do not currently have any committed external source of funds. In addition, we may seek additional capital due to favorable market conditions or strategic considerations, even if we believe we have sufficient funds for our current or future operating plans.
We may consider raising additional capital in the future to expand our business, to pursue strategic investments, to take advantage of financing opportunities or for other reasons, including to:
•increase our sales and marketing efforts for the DecisionDx-Melanoma, DecisionDx-SCC, DiffDx-Melanoma, MyPath Melanoma, DecisionDx-UM, TissueCypher and IDgenetix tests and address competitive developments;developments among these or future commercial products;
•fund ongoing evidence development offor our existing products as well as additional pipeline products, including for SCC and suspicious pigmented lesions, in addition to other programs in development;programs;
•expand our laboratory testing facility and related testing capacity;
•expand our technologies into other types of skin cancer, ocular cancer, gastrointestinal or mental health management and detection products;
•acquire, license or invest in technologies;
•acquire or invest in complementary businesses or assets; and
•finance capital expenditures and general and administrative expenses.
Our present and future funding requirements will depend on many factors, including:
•our ability to achieve revenue growth;
•our rate of progress in establishing payor coverage and reimbursement arrangements with third-party payors;
•our rate of progress in, and cost of the sales, marketing, coverage and reimbursement activities associated with, establishing adoption of our lead product, DecisionDx-Melanoma, among our other products;
•the cost of expanding our laboratory operations and offerings, including our sales, marketing, coverage and reimbursement efforts;
•our rate of progress in, and cost of research and development activities associated with, diagnostic products in research and early development;
•the potential cost of, and delays in, the development of new products as a result of changes in regulatory oversight applicable to our products;
•acquisitions of businesses, assets, products or technologies;
•the duration and effects of elevated inflation;
•the effects on our operations of general political and economic conditions, including the COVID-19 pandemic, the invasion of Ukraine by Russia, economic slowdowns, recessions or market corrections, the duration and effects of elevated inflation, rising interest rates and tightening of credit markets resulting from the pandemic, the conflict or another cause; and
•the effect of competing technological and market developments.
To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends.
If we raise additional funds through collaborations, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or products, or grant licenses on terms that may not be favorable to us.
Any disruptions to, or volatility in, the credit and financial markets or any deterioration in overall economic conditions, resulting from the pandemic, the conflict or another cause, may make any necessary debt or equity financing more difficult to obtain, more costly and/or more dilutive. If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate our commercialization, research and development efforts or grant rights to third parties to market and/or develop products that we would otherwise prefer to market and develop ourselves.
Risks Related to Our Business
Our revenue currently depends primarily on sales of DecisionDx-Melanoma, and we will need to generate sufficient revenue from this and other products to grow our business.*
Most of our revenue in 20172021 and 20182020 was derived from the sale of our lead product, DecisionDx-Melanoma. While we also derive revenue from DecisionDx-UM, DecisionDx-SCC, our Diagnostic GEP offering (which consists of MyPath Melanoma and DiffDx-Melanoma), the TissueCypher Barrett’s Esophagus Assay and the IDgenetix test, we expect that the majority of our revenue for the foreseeable future will be derived from sales of DecisionDx-Melanoma. Further, we believe that our long-term commercial success will depend on our ability to develop and market additional products, such as our pipeline products for SCC and suspicious pigmented lesions.products. Our ability to derive revenue from DecisionDx-Melanoma, DecisionDx-UM, DecisionDx-SCC, MyPath Melanoma, DiffDx-Melanoma, the TissueCypher Barrett’s Esophagus Assay, the IDgenetix test and any future products that we commercialize or acquire is uncertain and depends on favorable coverage and reimbursement policies from government payors, likesuch as Medicare, and from private payors, likesuch as insurance companies. Without positive coverage policies, our products may not be reimbursed and we may not be able to recognize revenue. If we are unable to increase sales and expand coverage and reimbursement for
DecisionDx-Melanoma, develop and commercialize other products, and successfully obtain coverage and adequate reimbursement for such products, our revenue and our ability to achieve and sustain profitability would be impaired, and the market price of our stock could decline substantially.
The COVID-19 pandemic has adversely impacted and could continue to adversely impact our business, including the demand for our test reports, as well as the business or operations of physicians and other healthcare providers who order our test reports and the third-party payors responsible for reimbursement for our tests, customers and other third parties with whom we conduct business.*
Public health crises such as pandemics or similar outbreaks have adversely impacted and could continue to adversely impact our business.As a result of the ongoing COVID-19 pandemic, or public health crises, and federal, state and local government responses to these events, we have and/or may in the future experience disruptions that could adversely impact our business, including, but not limited to:
•decreased test report volume due to a decline in orders of DecisionDx-Melanoma and DecisionDx-UM tests as patient visits for routine examinations and biopsies have been, and may continue to be, delayed and/or canceled;
•disruption of our sales and commercialization activities due to limitations on our ability to communicate with physicians as a result of travel restrictions and hindered means of communicating with physicians;
•delays or disruptions by third parties in the collection, preparation or delivery of the tumor samples that we test;
•delays or difficulties in delivering test reports, interruptions in research and development and other limitations of key business activities due to members of our workforce becoming ill, compliance with applicable vaccination mandates and/or stay-at-home or other similar orders imposed by or that may be imposed by state and local governments, including at our Phoenix, Arizona, San Diego, California, Pittsburgh, Pennsylvania and Friendswood, Texas locations;
•delayed reimbursement from third-party payors, disruption in our supply channel and other adverse impacts on our business resulting from the negative effects of the COVID-19 pandemic on our suppliers, service providers and other third parties on whom we rely; and
•delayed or postponed interactions with regulators and other important agencies and contractors, due to limitations in employee resources, travel restrictions or forced furlough of government employees.
Following the onset of the COVID-19 pandemic, we experienced declines in orders and test report volume in certain periods. For example, in the second quarter of 2020, test reports delivered for our lead product, DecisionDx-Melanoma, decreased 18.5% compared to the second quarter of 2019. We believe these decreases in our test report volume were linked to delays and/or cancellations in patient visits, resulting in fewer diagnostic biopsies and thus a reduction in the number of diagnoses of cutaneous melanoma in response, as well as the cumulative impact on promotional responsiveness as a result of reduced sales calls per day and in-person sales calls during the ongoing COVID-19 pandemic.
Our future results will be dependent upon the extent and duration of the COVID-19 crisis, including the emergence and spread of variants of the virus, and government restrictions, which are beyond our control. Although state and local government restrictions put in place to slow the spread of the virus have been eased in most locations, restrictions may be reinstated from time to time in various regions depending on the circumstances, potentially impacting the flow of future patient visits as well as access to our sales targets. Even with the easing of state and local restrictions and the availability of vaccinations, patient visits and diagnoses of the diseases covered by our diagnostic and prognostic tests may be impacted by continued apprehension regarding possible exposure to the virus as well as a general shift from in-person clinical visits to telehealth approaches, which may result in missed or delayed diagnoses of skin cancer and other diseases.
Under legislation enacted (or that may be enacted) by the United States federal government to respond to COVID-19, we have received and may receive in the future, cash payments or other forms of assistance allocated to healthcare and other companies. The eligibility requirements for any such payments or other assistance may be subject to restrictive terms and conditions, which may be ambiguous or subject to further modification, interpretation and guidance issued by government agencies on an ongoing basis. In the event we fail to comply with any of the terms or conditions associated with a payment we receive or if the terms and conditions or related interpretations change, we may be required to return it. The receipt of government payments or other assistance during the COVID-19 crisis has generated negative publicity for some companies and may continue to generate negative publicity for companies in the future. If we receive any negative publicity as a result of receiving or accepting a government payment or other assistance, such as the $1.9 million in provider relief funds we received from The U.S. Department of Health and Human Services (“HHS”) on April 16, 2020, it could harm our reputation, trigger a review or audit by applicable government agencies and/or adversely impact our stock price.
The COVID-19 crisis continues to evolve. The extent to which COVID-19 will further impact our business will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the duration of the crisis, resurgences of the virus, the emergence and spread of variants of the virus, vaccination rates, vaccination mandates, vaccination effectiveness, therapeutic treatments, the use of telemedicine, travel restrictions, stay-at-home or other similar orders and social distancing in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken in the United States and other countries to contain and treat the virus. Any of these factors, individually or in combination, could materially and adversely affect our business, results of operations, financial condition or cash flows. In addition, the current and potential adverse impacts of the COVID-19 crisis on our business, financial condition, results of operations and growth prospects, may also have the effect of heightening many of the other risks and uncertainties described elsewhere in this “Risk Factors” section.
Billing for our products is complex and requires substantial time and resources to collect payment.*
Billing for clinical laboratory testing services is complex, time-consuming and expensive. Depending on the billing arrangement and applicable law, we bill various payors, including Medicare, Medicaid, private insurance companies, private healthcare institutions, and patients, all of which have different billing requirements. We generally bill third-party payors for products and pursue reimbursement on a case-by-case basis where pricing contracts are not in place. To the extent laws or contracts require us to bill patient co-payments or co-insurance, we must also comply with these requirements. We may also face increased risk in our collection efforts, including potential write-offs of accounts receivable and long collection cycles, which could adversely affect our business, results of operations and financial condition.
Several factors make the billing process complex, including:
•differences between the billing rates and reimbursement rates for our products;
•compliance with complex federal and state regulations related to billing government healthcare programs, including Medicare, Medicaid, Veterans Health Administration and TRICARE;
•risk of government audits related to billing;
•disputes among payors as to which party is responsible for payment;
•differences in coverage and information and billing requirements among payors, including the need for prior authorization and/or advanced notification;
•the effect of patient co-payments or co-insurance and our ability to collect such payments from patients;
•changes to billing codes used for our products;
•changes to requirements related to our current or future clinical studies, including our registry studies, which can affect eligibility for payment;
•ongoing monitoring provisions of LCDs for our products, which can affect the circumstances under which a claim would be considered medically necessary;
•incorrect or missing billing information; and
•the resources required to manage the billing and claims appeals process.
We use standard industry billing codes, known as CPTCurrent Procedural Terminology codes, to bill for our products. If these codes were to change, there is a risk of an error being made in the claim adjudication process. Such errors can occur with claims submission, third-party transmission or in the processing of the claim by the payor. Claim adjudication errors may result in a delay in payment processing or a reduction in the amount of the payment we receive.
As we introduce new products, we may need to add new codes to our billing process as well as our financial reporting systems. Failure or delays in effecting these changes in external billing and internal systems and processes could negatively affect our collection rates, revenue and cost of collecting.
Additionally, our billing activities require us to implement compliance procedures and oversight, train and monitor our employees, and undertake internal audits to evaluate compliance with applicable laws and regulations as well as internal compliance policies and procedures. When payors deny our claims, we may challenge the reason, low payment amount or payment denials. Payors also conduct external audits to evaluate payments, which add further complexity to the billing process. If the payor makes an overpayment determination, there is a risk that we may be required to return all or some portion of prior payments we have received.
Additionally, the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the “ACA”) requires providers and suppliers to report and return any overpayments received from government payors under the Medicare and Medicaid programs within 60 days of identification. Failure to identify and return such overpayments exposes the provider or supplier to liability under federal false claims laws. These billing complexities, and the related uncertainty in obtaining payment for our products, could negatively affect our revenue and cash flow, our ability to achieve profitability, and the consistency and comparability of our results of operations.
In addition to the complexities noted above, we rely upon a third-party software application in the administration of our billing and collection process. Any significant disruption in our billing operations or the discovery of a deficiency in the design of our billing process could adversely impact our ability to generate and send invoices, calculate revenues, track payments and collect our accounts receivable. Although to date we have not experienced any disruptions or identified any deficiencies with our billing process or billing system, there can be no assurances that any disruptions or deficiencies will not occur in the future. Additionally, any failure in the design or operation of our internal controls related to our billing and collection processes could adversely impact our ability to conclude on the effectiveness of our internal control over financial reporting and could cause our auditor to issue an adverse opinion on our internal control over financial reporting.
We rely on third parties for tumortissue sample collection, preparation and delivery. Any defects in sample collection or preparation by such third parties and any delays in delivery of such samples could cause errors in our test reports and delay our ability to deliver test reports in a timely manner, which could significantly harm our business.*
The tumor tissue samples that we test are biopsied, preserved, prepared and delivered to us by third parties, including dermatopathologists and laboratory facilities. As such, we rely on these third parties to prepare, label and deliver the tissue
samples that we test in compliance with applicable laws and guidelines, and in a timely manner. Therefore, the accuracy and correctness of the test reports that we deliver are dependent on proper chain of custody and appropriate methods of sample collection or preparation utilized by these third parties, and our ability to timely deliver reports is dependent upon the ability of these third parties to provide these samples to us in a timely manner. The ability of these third parties to provide these samples to us in a timely manner could be delayed by events beyond our control, including but not limited to natural disasters and public health epidemics, such as the COVID-19 pandemic. Any errors in any part of the sample collection or preparation process could cause us to deliver incorrect test reports, potentially resulting in harm to patients whose physicians implement a change in treatment decisions based upon our test report. If we are unable to timely deliver test reports, physicians may be less likely to
recommend and order our products. The occurrence of any of the foregoing could significantly harm our reputation and our results of operations, causing significant harm to our business.
We rely on our database of tumor samples for the development and improvement of our products. Depletion or loss of our tumor samples could significantly harm our business.
The development and validation of accurate products is a complex process that requires access to tumor tissue specimens and long-term outcomes data. Our research and development efforts to improve our existing commercial products and develop new pipeline products may require the depletion of our existing database of tumor samples. If our tumor samples are lost or destroyed, or substantially depleted before we are able to generate meaningful data, we may be unable to improve our existing products, continue the development of pipeline products or validate product candidates. While we have historically been able to create and maintain a large sample bank to expand the clinical use of our products and develop new products, we may be unable to do so in the future. If we were unable to maintain or replenish our sample bank, we may be unable to improve our products or develop new products.
If our soleprimary clinical laboratory facility becomes damaged or inoperable or we are required to vacate our existing facility, our ability to conduct our laboratory analysis and pursue our research and development efforts may be jeopardized.*
We currently perform allmost of our testing and store our database of tumor samples at a singleour primary clinical laboratory facility in Phoenix, Arizona. Our facility and equipment could be harmed or rendered inoperable by natural or man-made disasters, including war, fire, earthquake, power loss, communications failure, terrorism, burglary, public health crises (including restrictions that may be imposed on businesses by state and local governments under stay-at-home or similar orders and mandates) or other events, which may make it difficult or impossible for us to perform our testing services for some period of time or to receive and store samples. The inability to perform tests or to reduce the backlog of sample analysis that could develop if our facility becomes inoperable, for even a short period of time, may result in the loss of revenue, loss of customers or harm to our reputation, and we may be unable to regain that revenue, those customers or repair our reputation in the future. Furthermore, integral parties in our supply chain are operating from single sites, increasing their vulnerability to natural disasters and man-made disasters or other sudden, unforeseen and severe adverse events.
In addition, the loss of our tumortissue samples due to such events could limit or prevent our ability to conduct research and development analysis on existing tests as well as tests in active pipeline development.
While we have a business continuity plan in place, and have an additional laboratory facility in close proximity to our primary facility to support our growth and provide certain operational redundancy, our facilities and the equipment we use to perform our testing and research and development could be unavailable or costly and time-consuming to repair or replace. It would be difficult, time-consuming and expensive to rebuild our facility,facilities, to locate and qualify a new facility, replace certain pieces of equipment or license or transfer our proprietary technology to a third-party, particularly in light of licensure and accreditation requirements. Even in the unlikely event that we are able to find a third party with such qualifications to enable us to resume our operations, we may be unable to negotiate commercially reasonable terms.
We carry insurance for damage to our property and the disruption of our business, but this insurance may not cover all of the risks associated with damage or disruption to our business, may not provide coverage in amounts sufficient to cover our potential losses and may not continue to be available to us on acceptable terms, if at all.
Our current or future products may not achieve or maintain significant commercial market acceptance.
We believe our commercial success is dependent upon our ability to continue to successfully market and sell our products, to continue to expand our current relationships and develop new relationships with healthcare providers, to expand and maintain coverage for our products, and to develop and commercialize new products. Our ability to achieve and maintain commercial market acceptance of our existing and future products will depend on a number of factors, including:
•our ability to increase awareness of our products through successful clinical utility and validity studies;
•the rate of adoption of our products by physicians and other healthcare providers;
•our ability to achieve guideline inclusion for our products;
•the timeliness with which we can provide our clinical reports to the ordering physician;
•the timing and scope of any regulatory approval for our products, if such approvals become required, and maintaining ongoing compliance with regulatory requirements;
•our ability to obtain and maintain positive coverage decisions for our products from government and commercial payors;
•our ability to obtain and maintain adequate reimbursement from third-party payors, including Medicare, Medicare Advantage plans United Healthcare and BlueCross BlueShield plans, which accounted for an aggregate of approximately 73%92% and 83%93% of our total revenue for the years ended December 31, 20172021, and 2018,2020, respectively;
•the impact of our investments in research and development and commercial growth;
•negative publicity regarding our or our competitors’ products resulting from scientific publications, or defects or errors in the products; and
•our ability to further validate our products through clinical research and accompanying publications.
We cannot assure you that we will be successful in addressing each of these factors or other factors that might affect the market acceptance of our products. If we are unsuccessful in achieving and maintaining market acceptance of our products, our business and results of operations will suffer.
New product development involves a lengthy and complex process, and we may be unable to develop and commercialize, or receive reimbursement for, on a timely basis, or at all, new products.
We continually seek to develop new product offerings, which requires us to devote considerable resources to research and development. For example, beforeBefore we can commercialize oura new pipeline products for SCC and suspicious pigmented lesions,product, we will need to expend significant resources in order to conduct substantial research and development, including clinical utility and validity studies, and further develop and scale our laboratory processes and infrastructure to accommodate additional products. For example, in 2021, we launched our innovative pipeline to develop a genomic test aimed at predicting response to systemic therapy in patients with moderate to severe psoriasis, atopic dermatitis and related inflammatory skin conditions. We have initiated a 4,800 patient, prospective, multi-center clinical study to develop and validate this inflammatory skin disease pipeline test with the expectation of having initial validation and development data in 2023 and in launching this pipeline test by the end of 2025.
Our product development process takes time and involves a high degree of risk, and such development efforts may fail for many reasons, including failure of the product to perform as expected, failure to successfully complete analytic and clinical validation, or failure to demonstrate the clinical utility of the product.
As we develop new products, we will have to make significant investments in research and development, marketing, selling, coverage and reimbursement activities. Typically, few research and development projects result in a commercialized product, and there can be no assurance that we will be able to successfully develop new products that can be commercialized. At any point, we may abandon development of a product or we may be required to expend considerable resources conducting research, which would adversely affect the timing for generating potential revenue from a new product and our ability to invest in other products in our pipeline. If a clinical validation study fails to demonstrate the prospectively defined endpoints of the study or if we fail to sufficiently demonstrate analytical validity or clinical utility, we might choose to abandon the development of the product, which could harm our business. In addition, competitors may develop and commercialize competing products or technologies faster than us or at a lower cost.
We may experience limits on our revenue if we are unable to increase and support adoption of our products by physicians and other healthcare providers.*
Physicians and other healthcare providers may be unwilling to adopt our products due to their reliance on existing traditional clinical and pathology staging criteria and our ability to generate revenue from our products would be significantly impaired if we were unable to educate physicians, healthcare providers, patients and third-party payors about the benefits and advantages of our products. The COVID-19 crisis has impacted our in-person healthcare interactions, such as field-based sales and medical affairs, and we have had to convert visits, programs and projects to be performed online and by telephone. Although our in-person healthcare interactions have returned to more normal levels, they may become subject to restrictions or cancellations from time to time, due to the uncertainties surrounding the duration, extent and ongoing impacts of the COVID-19 crisis, possibly impacting the effectiveness of our efforts. We will need to continue to educate physicians and pathologists about the benefits and cost-effectiveness of our products through published papers, presentations at scientific conferences, one-on-one marketing efforts by our sales force and one-on-one education by our medical affairs team. However, physicians and other healthcare providers may be reluctant to adopt our products in circumstances where our products are not incorporated into the current standard of care or practice guidelines. For example, while clinical utility of DecisionDx-Melanoma has been demonstrated in peer reviewedpeer-reviewed publications, the SLNB surgery is the most widely used staging tool for determining a cutaneous melanoma patient’s metastatic risk. Whether healthcare providers adopt DecisionDx-Melanoma as a complementary or triage diagnostic method relative to the SLNB surgery will depend on our ability to increase awareness of DecisionDx-Melanoma and its clinical validation.
In addition, all of our testing services are performed by our certified laboratorylaboratories located in Phoenix, Arizona, San Diego, California and Pittsburgh, Pennsylvania, under the Clinical Laboratory Improvement Amendments of 1988 or CLIA,(“CLIA”) rather
than by local laboratory or pathology practices. Accordingly, it may be difficult for us to collect samples from pathologists, and pathologists may be reluctant to support our testing services.
We rely on limited or sole suppliers for some of the reagents, equipment, chips and other materials used by our products, and we may not be able to find replacements or transition to alternative suppliers.*
We rely on limited or sole suppliers for certain reagents and other materials and components that we use for our products. Some of these items are unique to these suppliers and vendors. While we have developed alternate sourcing strategies for these materials and vendors, we cannot be certain whether these strategies will be effective or the alternative sources will be available when we need them. If these suppliers can no longer provide us with the materials we need, if the materials do not meet our quality specifications or are otherwise unusable, if we cannot obtain acceptable substitute materials, or if we elect to change suppliers, an interruption in laboratory operations could occur, we may not be able to deliver patient reports on a timely basis, or at all, and we may incur higher one-time switching costs. Any such interruption may significantly affect our future revenue, cause us to incur higher costs, and harm our customer relationships and reputation. In addition, in order to mitigate these risks, we maintain inventories of these supplies at higher levels than would be the case if multiple sources of supply were available. If our testing volume decreases or we switch suppliers, we may hold excess supplies with expiration dates that occur before use which would adversely affect our losses and cash flow position. As we introduce any new products, we may experience supply issues as we ramp up test volume.volume, or encounter additional disruptions to trade, commerce, pricing stability, credit availability and global supply chain continuity as a result of the invasion of Ukraine by Russia, particularly if we contract with suppliers with operations or commercial relationships in Eastern Europe or to the extent the conflict escalates to involve additional countries, further economic sanctions or wider military conflict. If we should encounter delays or difficulties in securing, reconfiguring or revalidating the equipment, reagents or other materials we require for our products, our business, financial condition, results of operations and reputation could be adversely affected.
If our products do not meet the expectations of physicians and patients, our operating results, reputation and business could suffer.
Our success depends on physician and patient confidence that we can provide reliable, high-quality information that will improve treatment outcomes, lower healthcare costs and enable better patient care. We believe that patients, physicians and other healthcare providers are likely to be particularly sensitive to defects and errors in our products, including if our products fail to accurately predict risk of metastasis with high accuracy from samples, and there can be no guarantee that our products will meet their expectations. As a result, the failure of our products to perform as expected could significantly impair our operating results and our reputation, including if we become subject to legal claims arising from any defects or errors in our products or reports.
If we are unable to compete successfully, our business will suffer and we may be unable to increase or sustain our revenue or achieve profitability.
We face competition from companies and academic institutions that have either developed or may seek to develop products intended to compete with our products. Potential competitors within the broader genomics profiling space based on tissue sample collection include laboratory companies such as Laboratory Corporation of America and Myriad Genetics, and other companies which have strong infrastructures capable of supporting the commercialization of diagnostic services.
In addition, competitors may develop their own versions of our solutions in countries where we do not have patents or where our intellectual property rights are not recognized and compete with us in those countries, including encouraging the use of their solutions by physicians in other countries.
Some potential competitors may have longer operating histories, larger customer bases, greater brand recognition and market penetration, substantially greater financial, technological and research and development resources and selling and marketing capabilities, and more experience dealing with third-party payors. As a result, they may be able to respond more quickly to changes in customer requirements, devote greater resources to the development, promotion and sale of their products than we do or sell their products at prices designed to win significant levels of market share. We may not be able to compete effectively against these organizations. Increased competition and cost-saving initiatives on the part of governmental entities and other third-party payors are likely to result in pricing pressures, which could harm our sales, profitability or ability to gain market share. In addition, competitors may be acquired by, receive investments from or enter into other commercial relationships with larger, well-established and well-financed companies. Certain potential competitors may be able to secure key inputs from vendors on more favorable terms, devote greater resources to marketing and promotional campaigns, adopt more aggressive pricing policies and devote substantially more resources to test development than we can. In addition, companies or governments that control access to testing through umbrella contracts or regional preferences could promote our competitors or prevent us from performing certain services. If we are unable to compete successfully against current and future competitors, our business will suffer and we may be unable to increase market acceptance and sales of our products, which could prevent us from increasing our revenue or achieving profitability and could cause our stock price to decline. As we add new tests and services, we will face many of these same competitive risks for these new tests.
The sizes of the markets for our current and future products have not been established with precision and may be smaller than we estimate.*
Our estimates of the total addressable markets for the DecisionDx-Melanoma, DecisionDx-UM, DecisionDx-SCC, MyPath Melanoma, DiffDx-Melanoma, TissueCypher and our products in developmentIDgenetix tests are based on a number of internal and third-party estimates, including, without limitation, the annual rate of patients with the applicable form of skin cancer,indications, the list price of our products relative to the reimbursement we expect to receive from third-party payors and the assumed prices at which we can sell our products in markets that have not been established. For example, we estimate that the total addressable market for DecisionDx-Melanoma is approximately $540 million, which is based, in part, on our review of multiple recent publications which show that diagnosis of melanoma is underreported by 30% to 40%72%. While we believe our assumptions and the data underlying our estimates are reasonable, these assumptions and estimates may not be correct and the conditions supporting our assumptions or estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors. As a result, our estimates of the annual total addressable market for our current or future products may prove to be incorrect. If the actual number of patients who would benefit from our products, the price at which we can sell future products, or the annual total addressable market for our products is smaller than we have estimated, it may impair our sales growth and have an adverse impact on our business.
The diagnostic testing industry is subject to rapid change, which could make our current or future products obsolete.
Our industry is characterized by rapid changes, including technological and scientific breakthroughs, frequent new product introductions and enhancements and evolving industry standards, all of which could make our current products and the other products we are developing obsolete. Our future success will depend on our ability to keep pace with the evolving needs of physicians and patients on a timely and cost-effective basis and to pursue new market opportunities that develop as a result of scientific and technological advances. In recent years, there have been numerous advances in technologies relating to the diagnosis and treatment of cancer. There have also been advances in methods used to analyze very large amounts of molecular information. We must continuously enhance our existing products and develop new products to keep pace with evolving standards of care. If we do not update our products to reflect new scientific knowledge about cancer biology, information about new cancer therapies or relevant clinical trials,studies, our products could become obsolete and sales of our current products and any new products we develop could decline or fail to grow as expected.
Risks Related to Reimbursement and Government Regulation and Reimbursement
We currently have limited reimbursement coverage for our lead product, DecisionDx-Melanoma, and if third-party payors, including government and commercial payors, do not provide sufficient coverage of, or adequate reimbursement for, our products, our commercial success, including revenue, will be negatively affected.*
Our revenue depends on achieving broad coverage and adequate reimbursement for our products from third-party payors, including both government and commercial third-party payors. If third-party payors do not provide coverage of, or do not provide adequate reimbursement for, a substantial portion of the list price of our products, we may need to seek additional payment from the patient beyond any co-payments and deductibles, which may adversely affect demand for our products. Coverage determinations by a third-party payor may depend on a number of factors, including, but not limited to, a third-party payor’s determination of whether our products are appropriate, medically necessary or cost-effective. If we are unable to provide third-party payors with sufficient evidence of the clinical utility and validity of our products, they may not provide coverage, or may provide limited coverage, which will adversely affect our revenues and our ability to succeed. To the extent that more competitors enter our markets, the availability of coverage and the reimbursement rate for our products may decrease as we encounter pricing pressure from these competitors.
Since each third-party payor makes its own decision as to whether to establish a policy to cover our products, enter into a contract with us and set the amount it will reimburse for a product, these negotiations are a time-consuming and costly process, and they do not guarantee that the third-party payor will provide coverage or adequate reimbursement for our products. In addition, the determinations by a third-party payor whether to cover our products and the amount it will reimburse for them are often made on an indication-by-indication basis.
In cases where there is no coverage policy or we do not have a contracted rate for reimbursement as a participating provider, the patient is typically responsible for a greater share of the cost of the product, which may result in further delay of our revenue, increase our collection costs or decrease the likelihood of collection.
Our claims for reimbursement from third-party payors may be denied upon submission, and we may need to take additional steps to receive payment, such as appealing the denials. Such appeals and other processes are time-consuming and expensive and may not result in payment. Third-party payors may perform audits of historically paid claims and attempt to recoup funds years after the funds were initially distributed if the third-party payors believe the funds were paid in error or determine that our
products were medically unnecessary. If a third-party payor audits our claims and issues a negative audit finding, and we are not able to overturn the audit findings through appeal, the recoupment may result in a material adverse effect on our revenue. Additionally, in some cases commercial third-party payors for whom we are not a participating provider may elect at any time
to review claims previously paid and determine the amount they paid was too much. In these situations, the third-party payor will typically notify us of their decision and then offset whatever amount they determine they overpaid against amounts they owe us on current claims. We cannot predict when, or how often, a third-party payor might engage in these reviews and we may not be able to dispute these retroactive adjustments. We adopted the new revenue recognition guidance under ASC 606 on January 1, 2018 using the full retrospective method and adjusted the comparative reporting period for the year ended December 31, 2017.
Under ASC 606, we recognize revenue at the amount we expect to be entitled, subject to a constraint for variable consideration, in the period in which our tests are delivered to the treating physician. We have determined that our contracts contain variable consideration under ASC 606 because the amounts paid by third-party payors may be paid at less than our standard rates or not paid at all, with such differences considered implicit price concessions. Variable consideration is recognized only to the extent it is probable that a significant reversal of revenue will not occur in future periods when the uncertainties are resolved. We consider variable consideration to be fully constrained (and therefore not recognized) for Medicare claims when the payment of such claims is subject to approval by an ALJ at an appeal hearing, due to the level of uncertainty and timing of the outcome.
Variable consideration is evaluated each reporting period and adjustments are recorded as increases or decreases in revenues. Variable consideration for Medicare claims that are not covered by an LCD or otherwise, including those claims undergoing appeal, is deemed to be fully constrained due to factors outside our influence (e.g., judgment or actions of third parties) and the uncertainty of the amount to be received is not expected to be resolved for a long period of time. For these fully constrained claims, we generally recognize revenue in the period the uncertainties are resolved, if favorable. Due to the outcome of ALJ hearings, potential future changes in Medicare coverage policies and appeal cycles, insurance coverage policies, contractual rates and other trends in the reimbursement of our tests, our revenues may fluctuate significantly from period to period.
Although we are an in-network participating provider with some commercial third-party payors, including several Blue Cross Blue Shield plans, and certain large, national commercial third-party payors, including Aetna, other commercial third-party payors have issued non-coverage policies that currently categorize DecisionDx-UM and DecisionDx-Melanomaour tests as experimental or investigational. If we are not successful in obtaining coverage from third-party payors, in reversing existing non-coverage policies, or if other third-party payors issue similar non-coverage policies, this could have a material adverse effect on our business and operations.
Palmetto, the MAC responsible for administering MolDX, the program that assesses molecular diagnostic technologies, issued a final LCD for DecisionDx-Melanoma, which became effective on December 3, 2018.2018, and issued a final expanded LCD effective November 22, 2020. This LCD provides for coverage of DecisionDx-Melanoma for certain sentinel lymph node biopsy, or SLNB, eligibleSLNB-eligible patients with cutaneous melanoma tumors with clinically negative sentinel node basins who are being considered for SLNB to determine eligibility for adjuvant therapy. Similarly,The final expanded LCD also covers use of DecisionDx-Melanoma by physicians for assessment of appropriate treatment plans, regardless of the decision to undergo or avoid the SLNB surgery. In the second quarter of 2021, Palmetto and the other MACs that participate in the MolDX program each released a revised draft LCD for DecisionDx-Melanoma. The draft LCD included commentary about two publications regarding the clinical utility of GEP tests and included an assessment stating that the new data is not sufficient to change the coverage criteria. There was an open public comment period, and we submitted comments in support of Medicare coverage. The comment period ended on August 8, 2021. Palmetto issued a final LCD on May 19, 2022 with Noridian issuing the same on June 16, 2022. The final LCDs did not result in any change in coverage.
Separately, Palmetto issued a final LCD for DecisionDx-UM effective July 10, 2017. This LCD provides for coverage of DecisionDx-UM to determine metastatic risk in connection with the management of a patient’s newly diagnosed uveal melanomaUM and to guide surveillance and referral to medical oncology for those patients.
We worked with Palmetto to obtain these positive coverage decisions through the submission of a detailed dossier of analytical and clinical data to substantiate that the tests meet Medicare’s medical necessity requirements. Per their joint operating agreement, Noridian, the MAC responsible for administering claims for laboratory services performed in Arizona, has adopted the same coverage policy as Palmetto for DecisionDx-UM and DecisionDx-Melanoma. This coverage process is lengthy, time-consuming, has changed over time, may change in the future and requires significant dedication of resources, and as we develop new products, we may be unsuccessful in receiving LCD determinations for those products or in maintaining our current LCDs. On a periodic basis, the Centers for Medicare & Medicaid Services, or CMS requests bids for its MAC services, and MAC jurisdictions have changed in the past. A change in our MAC, or future changes in the MolDxMolDX program, the elimination of the program, or a change in the administrator of that program, may affect our ability to obtain Medicare coverage and reimbursement for products for which we have coverage, for products for which we do not yet have coverage, or for any products we may launch in the future, or delay payments for our tests.
Under Medicare, payment for products like ours is generally made under the Clinical Laboratory Fee Schedule, or CLFS with payment amounts assigned to specific procedure billing codes. In April 2014, Congress passed the Protecting Access to Medicare Act of 2014 or PAMA,(“PAMA”) which included substantial changes to the way in which clinical laboratory services are paid under Medicare. Under PAMA, certain laboratories wereare required to report to CMS beginning in 2017 and every three years thereafter (or annually for advanced diagnostic laboratory tests, or ADLTs), commercial third-party payor payment rates and volumes for each test they perform. CMS uses this data to calculate a weighted median payment rate for each test, which will be used to establish revised Medicare CLFS reimbursement rates for the test. Laboratories that fail to report the required payment information may be subject to substantial civil monetary penalties. We bill Medicare for our products, and therefore we are subject to reporting requirements under PAMA.
On May 17, 2019, CMS determinedIn the second quarter of 2020, we submitted our technical assessment dossier for DecisionDx-SCC to Palmetto and Noridian. The dossier was accepted as complete in the third quarter of 2020. In early 2021, we submitted our technical assessment dossier for DiffDx-Melanoma. The dossier was accepted as complete in the first quarter of 2021. In June 2022, Palmetto and Noridian each posted a draft LCD that DecisionDx-UM meets thewould provide coverage criteria for ‘‘existing ADLT’’ status. This means that beginning in 2021,DiffDx-Melanoma. We believe the DecisionDx-UM Medicare rateLCD for DiffDx-Melanoma will be set annually based uponfinalized by the median private payor rate for the first halfend of the second preceding calendar year. Specifically, the median private payor rate from January 1 to June 30, 2019quarter of 2023. However, there is no assurance that any draft or final LCD will match our expectations, be posted in a timeframe consistent with our historical experience or will be usedposted at all. Regarding DecisionDx-SCC, no draft LCD has been posted by Palmetto or Noridian to setdate.
In the Medicaresecond quarter of 2022, following the completion of a requested medical review and pricing of our DecisionDx-SCC test by Novitas, we have been receiving reimbursement from Novitas on DecisionDx-SCC at a rate forof approximately $3,800 per test. On June 9, 2022, Novitas posted a draft oncology biomarker LCD that proposes to rely upon evidentiary reviews sourced from three databases: ClinGen, OncoKB and NCCN. Two of the calendar year 2021. From May 17, 2019 through December 31, 2020,databases do not review gene expression profile tests and NCCN has not yet, to our rateknowledge, reviewed DecisionDx-SCC. As such, if finalized as proposed, then DecisionDx-SCC would not be included as a covered test in the associated billing and coding article. We cannot predict whether this draft LCD will be set by Noridian, our local MAC. Also, on May 17, 2019, CMS determined that DecisionDx-Melanoma meetsfinalized as proposed or what the criteria for ‘‘new ADLT’’ status. This means that from July 1, 2019 through March 31, 2020 the Medicare reimbursement rate will equal the initial list pricetiming of $7,193.00. The rate for April 1, 2020 through December 31, 2021 will be calculated based upon the median private payor rate from July 1, 2019 to November 30, 2019. Accordingly, beginning in 2022, the rate will be set annually based upon the median private payor rate for the first half of the second preceding calendar year. For example, the rate for 2022 will be set using median private payor rate data from January 1, 2020 to June 30, 2020. If CMS determines the list charge amount for DecisionDx-Melanoma was greater than 130% of the weighted median of private payor rates, CMS will recoup from us the difference between the actual list charge and 130% of the weighted median. any final LCD might be.
If we are unable to obtain and maintain adequate reimbursement rates from commercial third-party payors, this may adversely affect our Medicare rate. It is unclear what impact new pricing structures, such as those adopted under PAMA, may have on our business, financial condition, results of operations or cash flows.
The U.S. federal government continues to show significant interest in pursuing health carehealthcare reform and reducing health carehealthcare costs. Similarly, commercial third-party payors may seek to reduce costs by limiting coverage or reducing reimbursement for our products. Any government-adopted reform measures or changes to commercial third-party payor coverage and reimbursement policies could cause significant pressure on the pricing of, and reimbursement for, health carehealthcare products and services, including our products, which could decrease demand for our products, and adversely affect our sales and revenue.
In addition, some third-party payors have implemented, or are in the process of implementing, laboratory benefit management programs, often using third-party benefit managers to manage these programs. The stated goals of these programs are to help improve the quality of outpatient laboratory services, support evidence-based guidelines for patient care and lower costs. The impact on laboratories, such as ours, of active laboratory benefit management by third parties is unclear, and we expect that it could have a negative impact on our revenue in the short term. It is possible that third-party payors will resist reimbursement for the products that we offer, in favor of less expensive products, may require pre-approval for our products or may impose additional pricing pressure on and substantial administrative burden for reimbursement for our products.
We expect to continue to focus substantial resources on increasing coverage and reimbursement for our current products and any future products we may develop. We believe it may take several years to achieve broad coverage and adequate contracted reimbursement with a majority of third-party payors for our products.
However, we cannot predict whether, under what circumstances, or at what payment levels third-party payors will cover and reimburse our products. If we fail to establish and maintain broad adoption of, and coverage and reimbursement for, our products, our ability to generate revenue could be harmed and our future prospects and our business could suffer.
Our products are currently marketed as laboratory developed tests, and any changes in regulations or the U.S. Food and Drug Administration’sFDA’s enforcement discretion for laboratory developed tests, or violations of regulations by us, could adversely affect our business, prospects, results of operations or financial condition.*
The diagnostics industry is highly regulated, and we cannot assure you that the regulatory environment in which we operate will not change significantly and adversely in the future. In many instances, there are no significant regulatory or judicial interpretations of these laws and regulations. Although the U.S. Food and Drug Administration, or FDA has statutory authority to assure that medical devices are safe and effective for their intended uses, the FDA has generally exercised its enforcement discretion and not enforced applicable regulations with respect to in vitro diagnostics that are designed, manufactured and used within a single laboratory. These tests are referred to as laboratory developed tests or LDTs.(“LDTs”). We currently market our products as LDTs.
The FDA has adopted a policy of enforcement discretion with respect to LDTs whereby the FDA does not actively require premarket review of LDTs or otherwise impose its requirements applicable to other medical devices on LDTs. However, the FDA has stated its intention to modify its enforcement discretion policy with respect to LDTs. The FDA could ultimately modify its current approach to LDTs in a way that would subject our products marketed as LDTs to the enforcement of additional regulatory requirements. Moreover, legislative measures have recently been proposed in Congress that, if ultimately enacted, could provide the FDA with additional authority to require premarket review of and regulate LDTs. If and when such changes to the regulatory framework occur, we could for the first time be subject to enforcement of regulatory requirements as a device manufacturer such as registration and listing requirements, medical device reporting requirements and the requirements of the FDA’s Quality System Regulation. We may be required to conduct clinical trials prior to continuing to sell
our existing
products or launching any other products we may develop. This may increase the cost of conducting, or otherwise harm, our business.
Moreover, even if the FDA does not modify its policy of enforcement discretion, the FDA may disagree that we are marketing our LDTs within the scope of its policy of enforcement discretion and may impose significant regulatory requirements. While we believe that we are currently in material compliance with applicable laws and regulations as historically enforced by the FDA, we cannot assure you that the FDA will agree with our determination. A determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business, prospects, results of operations or financial condition.
If the FDA begins to actively regulate our diagnostic products, we may be required to obtain premarket clearance under Section 510(k) of the U.S. Federal Food, Drug and Cosmetic Act or FDCA,(“FDCA”) or a premarket approval or PMA.(“PMA”). The process for submitting a 510(k) premarket notification and receiving FDA clearance usually takes from three to 12 months, but it can take significantly longer and clearance is never guaranteed. The process for submitting and obtaining FDA approval of a PMA is much more costly, lengthy and uncertain. It generally takes from one to three years or even longer, and approval is not guaranteed. PMA approval typically requires extensive clinical data and can be significantly longer, more expensive and more uncertain than the 510(k) clearance process. Despite the time, effort and expense expended, there can be no assurance that a particular device ultimately will be cleared or approved by the FDA through either the 510(k) clearance process or the PMA process on a timely basis, or at all. Moreover, there can be no assurance that any cleared or approved labeling claims will be consistent with our current claims or adequate to support continued adoption of and reimbursement for our products. If premarket review is required for some or all of our products, the FDA may require that we stop selling our products pending clearance or approval, which would negatively impact our business. Even if our products are allowed to remain on the market prior to clearance or approval, demand or reimbursement for our products may decline if there is uncertainty about our products, if we are required to label our products as investigational by the FDA, or if the FDA limits the labeling claims we are permitted to make for our products. As a result, we could experience significantly increased development costs and a delay in generating additional revenue from our products, or from other products now in development.pipeline products.
If the FDA imposes significant changes to the regulation of LDTs it could reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations or financial condition.
We conduct business in a heavily regulated industry, and failure to comply with federal, state and foreign laboratory licensing requirements and the applicable requirements of the FDA or any other regulatory authority, could cause us to lose the ability to perform our tests, experience disruptions to our business, or become subject to administrative or judicial sanctions.*
The diagnostics industry is highly regulated, and the laws and regulations governing the marketing of diagnostic tests are extremely complex. Areas of the regulatory environment that may affect our ability to conduct business include, without limitation:
•federal and state laws applicable to test ordering, documentation of tests ordered, billing practices and claims payment and/or regulatory agencies enforcing those laws and regulations;
•federal and state fraud and abuse laws;
•federal and state laboratory anti-mark-up laws;
•coverage and reimbursement levels by Medicare, Medicaid, other governmental payors and private insurers;
•restrictions on coverage of and reimbursement for tests;
•federal and state laws governing laboratory testing, including CLIA, and state licensing laws;laws and accreditation requirements;
•federal and state laws and enforcement policies governing the development, use and distribution of diagnostic medical devices, including LDTs;
•federal, state and local laws governing the handling and disposal of medical and hazardous waste;
•federal and state Occupational Safety and Health Administration rules and regulations; and
•the Health Insurance Portability and Accountability Act of 1996 or HIPAA,(“HIPAA”) and similar state health data privacy laws.
In particular, the FDCA defines a medical device to include any instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including a component, part, or accessory, intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals.
Our products are considered by the FDA to be subject to regulation as medical devices, and marketed under FDA’s policy of
enforcement discretion for LDTs. Among other things, pursuant to the FDCA and its implementing regulations, the FDA regulates the research, testing, manufacturing, safety, labeling, storage, recordkeeping, premarket clearance or approval, marketing and promotion, and sales and distribution of medical devices in the United States to ensure that medical products distributed domestically are safe and effective for their intended uses. In addition, the FDA regulates the import and export of medical devices manufactured between the United States and international markets.
We are also subject to CLIA, a federal law that regulates clinical laboratories that perform testing on specimens derived from humans for the purpose of providing information for the diagnosis, prevention or treatment of disease. CLIA regulations establish specific standards with respect to personnel qualifications, facility administration, proficiency testing, quality control, quality assurance and inspections. Any testing subject to CLIA regulation must be performed in a CLIA certifiedCLIA-certified or accredited lab. CLIA certification or accreditation is also required in order for us to be eligible to bill state and federal healthcare programs, as well as commercial third-party payors, for our products.
We have a current CLIA accreditation under the College of American Pathologists or CAP,(“CAP”) program to conduct our tests at our clinical reference laboratory in Phoenix, Arizona.
To In April 2022, we acquired a laboratory in San Diego, California which is currently CLIA-certified and CAP accredited. Additionally, our laboratory in Pittsburgh, Pennsylvania, which we acquired in December of 2021, is currently CLIA-certified and we are working through the application and inspection process toward CAP accreditation.CAP maintains a clinical laboratory accreditation program. While not required for the operation of a CLIA-certified laboratory, many private insurers require CAP accreditation as a condition to contracting with clinical laboratories to cover their tests. In addition, some countries outside the United States require CAP accreditation as a condition to permitting clinical laboratories to test samples taken from their citizens. CAP accredited laboratories are surveyed for compliance with CAP standards every two years in order to maintain accreditation. Failure to maintain CAP accreditation could have a material adverse effect on the sales of our products and the results of our operations. Therefore, to maintain our CLIA accreditation, we have elected to be subject to survey and inspection every two years by CAP. Moreover, CLIA inspectors may make random inspections of our laboratory from time to time.
Our most recent CAP inspection occurred in March 2022 for our Phoenix, Arizona laboratory. Our CLIA accreditation certificate for our Pittsburgh, Pennsylvania laboratory expires on December 20, 2022, and the certificate for our San Diego, California laboratory expires in 2024.
In addition, certain states require our laboratory to be licensed in such states in order to test specimens from those states. Accordingly, our laboratory is also licensed by California, Maryland, New York, Pennsylvania and Rhode Island. Other states may have similar requirements or may adopt similar requirements in the future.
Although we have obtained licenses from states where we believe we are required to be licensed, we may become aware of other states that require out-of-state laboratories to obtain licensure in order to accept specimens from the state, and it is possible that other states currently have such requirements or will have such requirements in the future.
In order to test specimens from New York, LDTs must be approved by the New York State Department of Health or NYSDOH,(“NYSDOH”) on a test-by-test basis before they are offered. Our laboratory director must also be separately qualified to be a laboratory director in New York. DecisionDx-Melanoma, DecisionDx-UM, DecisionDx-PRAME, DecisionDx-SCC, DiffDx-Melanoma and DecisionDx-MelanomaIDgenetix have each been approvedformally approved. In July 2022, we submitted TissueCypher for review by NYSDOH and ourexpect a response in the first quarter of 2023. Our laboratory director has been qualified by NYSDOH. We are subject to periodic inspection by the NYSDOH and are required to demonstrate ongoing compliance with NYSDOH regulations and standards. To the extent NYSDOH identified any non-compliance and we are unable to remedy such non-compliance, the State of New York could withdraw approval for our products. We will need to seek NYSDOH approval of any future LDTs we develop and want to offer for clinical testing to New York residents, and there can be no assurance that we will be able to obtain such approval.
We may also be subject to regulation in foreign jurisdictions as we seek to expand international utilization of our products or such jurisdictions adopt new licensure requirements, which may require review of our products in order to offer them or may have other limitations such as restrictions on the transport of human tissue samples necessary for us to perform our tests that may limit our ability to make our products available outside of the United States. Complying with licensure requirements in new jurisdictions may be expensive, time-consuming and subject us to significant and unanticipated delays.
CAP maintains a clinical laboratory accreditation program. While not required for the operation of a CLIA-certified laboratory, many private insurers require CAP accreditation as a condition to contracting with clinical laboratories to cover their tests. In addition, some countries outside the United States require CAP accreditation as a condition to permitting clinical laboratories to test samples taken from their citizens. CAP accredited laboratories are surveyed for compliance with CAP standards every two years in order to maintain accreditation. Failure to maintain CAP accreditation could have a material adverse effect on the sales of our products and the results of our operations. Our most recent CAP inspection occurred in the fourth quarter of 2018 and our CLIA accreditation certificate expires on December 20, 2020.
Failure to comply with applicable clinical laboratory licensure requirements may result in a range of enforcement actions, including suspension, limitation or revocation of our CLIA accreditation and/or state licenses, imposition of a directed plan of action, onsite monitoring, civil monetary penalties, criminal sanctions and revocation of the laboratory’s approval to receive Medicare and Medicaid payment for its services, as well as significant adverse publicity. Any sanction imposed under CLIA, its implementing regulations, or state or foreign laws or regulations governing clinical laboratory licensure or our failure to renew our CLIA accreditation, or a state or foreign license, could have a material adverse effect on our business, financial condition
and results of operations. Even if we were able to bring our laboratory back into compliance, we could incur significant expenses and potentially lose revenue in doing so.
Doing business with the public sector, including the U.S. government, subjects us to risk of audits, investigations, sanctions and penalties.*
We have entered into, and may enter into in the future, contracts with the U.S. government or other governmental entities, and this subjects us to statutes and regulations applicable to companies doing business with the government. Government contracts normally contain additional requirements that may increase our costs of doing business, reduce our profits (or increase our losses) and expose us to liability for failure to comply with these terms and conditions. Such requirements may include mandatory socioeconomic compliance requirements, including labor requirements, non-discrimination and affirmative action programs and environmental compliance requirements. Being a government contractor also subjects us to reviews, audits and investigations regarding our compliance. If we fail to comply with our obligations associated with being a government contractor, our contracts may be subject to termination, and we may be subject to financial and/or other liability under our contracts, which could adversely affect our results of operations.
The FDA may modify its enforcement discretion policy with respect to LDTs in a risk-based manner, and we may become subject to extensive regulatory requirements and may be required to conduct additional clinical trials prior to continuing to sell our existing tests or launching any other tests we may develop, which may increase the cost of conducting, or otherwise harm, our business.
If the FDA changes or ends its policy of enforcement discretion with respect to LDTs, and our products become subject to the FDA’s requirements for premarket review of medical devices, we may be required to cease commercial sales of our products and conduct clinical trials prior to making submissions to the FDA to obtain premarket clearance or approval. If we are required to conduct such clinical trials, delays in the commencement or completion of clinical trials could significantly increase our product development costs and delay commercialization of any currently marketed testing that we may be required to cease selling or the commercialization of any future tests that we may develop. Many of the factors that may cause or lead to a delay in the commencement or completion of clinical trials may also ultimately lead to delay or denial of regulatory clearance or approval. The commencement of clinical trials may be delayed due to insufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites and the eligibility criteria for the clinical trial.
The FDA requires medical device manufacturers to comply with, among other things, current good manufacturing practices for medical devices, known as the Quality System Regulation, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process; the medical device reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur; labeling regulations, including the FDA’s general prohibition against promoting products for unapproved or ‘‘off-label’’ uses; and the reports of corrections and removals regulation, which requires manufacturers to report to the FDA if a device correction or removal was initiated to reduce a risk to health posed by the device or to remedy a violation of the FDCA caused by the device which may present a risk to health.
Even if we were able to obtain FDA clearance or approval for one or more of our products, if required, a diagnostic test may be subject to limitations on the indications for which it may be marketed or to other regulatory conditions. In addition, such clearance or approval may contain requirements for costly post-market testing and surveillance to monitor the safety or efficacy of the test.
In addition, the FDA’s and other regulatory authorities’ policies may change and additional government regulations may be enacted that could prevent, limit or delay regulatory approvals. If we are slow or unable to adapt to changes in existing requirements or the adoption of new requirements or policies, or if we are not able to maintain regulatory compliance, we may lose any marketing authorization that we may have obtained and we may not achieve or sustain profitability, which would adversely affect our business, prospects, financial condition and results of operations.
Interim, topline and preliminary data from our clinical studies that we announce or publish from time to time may change as more data become available and are subject to audit and verification procedures that could result in material changes in the final data.
From time to time, we may publicly disclose preliminary or topline or data from our clinical studies, which is based on a preliminary analysis of then-available data, and the results and related findings and conclusions are subject to change following a more comprehensive review of the data related to the particular study. We also make assumptions, estimations, calculations and conclusions as part of our analyses of data, and we may not have received or had the opportunity to fully and carefully evaluate all data. As a result, the topline results that we report may differ from future results of the same studies, or different conclusions or considerations may qualify such results once additional data have been received and fully evaluated. Topline
data also remain subject to audit and verification procedures that may result in the final data being materially different from the preliminary data we previously published. As a result, topline data should be viewed with caution until the final data are available. From time to time, we may also disclose interim data from our clinical studies. Interim data from clinical studies that we may complete are subject to the risk that one or more of the clinical outcomes may materially change as more patient data become available. Adverse differences between preliminary or interim data and final data could significantly harm our reputation and marketing efforts.
Further, others, including healthcare providers or payors, may not accept or agree with our assumptions, estimates, calculations, conclusions or analyses or may interpret or weigh the importance of data differently, which could impact the value of the particular program, the approvability or commercialization of the particular product candidate or product and our company in general. In addition, the information we choose to publicly disclose regarding a particular study is based on what is typically extensive information, and you or others may not agree with what we determine is the material or otherwise appropriate information to include in our disclosure, and any information we determine not to disclose may ultimately be deemed
significant with respect to future decisions, conclusions, views, activities or otherwise regarding our business. If the topline or interim data that we report differ from actual results, or if others, including healthcare providers or payors, disagree with the conclusions reached, our ability to commercialize, our product candidates may be harmed, which could harm our business, operating results, prospects or financial condition.
Changes in health carehealthcare policy could increase our costs, decrease our revenues and impact sales of and reimbursement for our products.*
In March 2010, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, or the ACA became law. This law substantially changed the way health carehealthcare is financed by both government and commercial third-party payors, and significantly impacted our industry. The ACA contains a number of provisions that are expected to impact our business and operations, some of which in ways we cannot currently predict, including those governing enrollment in state and federal health carehealthcare programs, reimbursement changes and fraud and abuse, which impact existing state and federal health carehealthcare programs and will result in the development of new programs. Among other things, the ACA requiresrequired medical device manufacturers to pay a sales tax equal to 2.3% of the price for which such manufacturer sells its medical devices, and began to apply to sales of taxable medical devices after December 31, 2012. FDA officials have indicated that a laboratory will not have to pay2012, but was suspended in 2016. Further, the tax under the proposed ‘‘notification’’ procedure in the Notification draft guidance. However, the laboratory would have to pay the tax at the time that it lists a test with FDA. In FDA’s Notification draft guidance, listing occurs at the time a laboratory submits either a PMA or 510(k) for the test. While it is possible that this tax will apply to some or all of our products or products that are in development, for the time being, Congress has enacted a two-year moratorium on2020 federal spending package permanently eliminated, effective January 1, 2020, the medical device tax untiland “Cadillac” tax on high-cost employer-sponsored health coverage and, effective January 1, 2020.2021, also eliminated the health insurer tax.
Since 2016, there have been efforts to repeal all or part of the ACA, and the currentprevious administration and the U.S. Congress have taken action to roll back certain provisions of the ACA. The current administration and
For example, on June 17, 2021, the U.S. Congress may take further action regarding the ACA, including, but not limited to, repeal or replacement.
Additionally,Supreme Court dismissed a challenge on December 14, 2018, a Texas U.S. District Court Judge ruledprocedural grounds that argued the ACA is unconstitutional in its entirety because the tax penalty on certain individuals who fail to maintain qualifying health coverage for all or part of a year, commonly referred to as the ‘‘individual mandate,’’“individual mandate” was repealed by Congress as partCongress. Thus, the ACA will remain in effect in its current form.Further, prior to the U.S. Supreme Court ruling, on January 28, 2021, President Biden issued an executive order that initiated a special enrollment period for purposes of obtaining health insurance coverage through the Tax CutsACA marketplace, which began on February 15, 2021, and Jobs Act of 2017,remained open through August 15, 2021. The executive order also instructed certain governmental agencies to review and reconsider their existing policies and rules that limit access to healthcare, including among others, reexamining Medicaid demonstration projects and waiver programs that include work requirements, and policies that create unnecessary barriers to obtaining access to health insurance coverage through Medicaid or the TCJA. While the Texas District Court Judge, as well as the current administration and CMS, have statedACA. It is possible that the rulingACA will have no immediate effect pending appeal ofbe subject to judicial or Congressional challenges in the decision, itfuture. It is unclear how this decision, subsequent appeals,any such challenges and other efforts to repeal and replace the ACAhealthcare reform measures of the Biden administration will impact the ACA and our business.
On August 2, 2011, the Budget Control Act of 2011 was signed into law, which, among other things, reduced Medicare payments to providers by 2% per fiscal year, effective on April 1, 2013 and, due to subsequent legislative amendments to the statute, including the Infrastructure Investment and Jobs Act, will remain in effect through 2027,2030, unless additional Congressional action is taken. The CARES Act and other COVID-19 relief legislation suspended the 2% Medicare sequester from May 1, 2020, through March 31, 2022. Under current legislation, the actual reduction in Medicare payments will vary from 1% in 2022 to up to 3% in the final fiscal year of this sequester. Further, Congress is considering additional health reform measures as part of other reform initiatives.
We anticipate there will continue to be proposals by legislators at both the federal and state levels, regulators and commercial third-party payors to reduce costs while expanding individual healthcare benefits. For example, it is possible that additional governmental action is taken in response to the COVID-19 crisis. Certain of these changes could impose additional limitations on the prices we will be able to charge for our products, the coverage of or the amounts of reimbursement available for our products from third-party payors, including government and commercial payors.
We are subject to numerous federal and state healthcare statutes and regulations, and complying with laws pertaining to our business is an expensive and time-consuming process. If we are unable to comply, or have not fully complied, with such laws, we could face substantial penalties and a material adverse effect to our business and operations.*
Physicians, other healthcare providers and third-party payors play a primary role in the recommendation of our products. Our arrangements with healthcare providers, third-party payors and customers may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations that affect the business and financial arrangements and relationships through which we market and sell our products. The laws that affect our ability to operate include, but are not limited to:
•the federal Anti-Kickback Statute or the AKS,(“AKS”), which prohibits, among other things, any person or entity from knowingly and willfully soliciting, receiving, offering or paying any remuneration, directly or indirectly, overtly or covertly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of an item or service reimbursable, in whole or in part, under a federal healthcare program, such as the Medicare and Medicaid programs. The term ‘‘remuneration’’ has been broadly interpreted to include anything of value, such as specimen collection materials or test kits. There are a number of statutory exceptions and regulatory safe harbors protecting some common activities from prosecution, however these are drawn narrowly. Additionally, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have
committed a violation. Violations are subject to civil and criminal fines and monetary penalties of up to $100,000 for each violation, plus up to three times the remuneration involved, imprisonment of up to ten years and exclusion from government healthcare programs. In addition, the ACA codified case law that a claim including items or services resulting from a violation of the AKS constitutes a false or fraudulent claim for purposes of the federal False Claims Act or the FCA;(“FCA”);
•the Stark Law, which prohibits a physician from making a referral for certain designated health services covered by the Medicare or Medicaid program, including laboratory and pathology services, if the physician or an immediate family member of the physician has a financial relationship with the entity providing the designated health services and prohibits that entity from billing, presenting or causing to be presented a claim for the designated health services furnished pursuant to the prohibited referral, unless an exception applies. Sanctions for violating the Stark Law include denial of payment, civil monetary penalties and exclusion from the federal health carehealthcare programs. Failure to refund amounts received as a result of a prohibited referral on a timely basis may constitute a false or fraudulent claim and may result in civil penalties and additional penalties under the FCA;
•federal civil and criminal false claims laws and civil monetary penalty laws, such as the FCA, which can be enforced by private citizens through civil qui tam actions, prohibitsaction, and civil monetary penalty laws prohibit individuals or entities from, among other things, knowingly presenting, or causing to be presented through distribution of template medical necessity language or other coverage and reimbursement information, false, fictitious or fraudulent claims for payment or approval by the federal government, including federal health carehealthcare programs, such as Medicare and Medicaid, and knowingly making, using or causing to be made or used a false record or statement material to a false or fraudulent claim, or knowingly making a false statement to improperly avoid, decrease or conceal an obligation to pay money to the federal government. In addition, a claim including items or services resulting from a violation of the AKS constitutes a false or fraudulent claim for purposes of the FCA. Private individuals can bring False Claims Act ‘‘qui tam’’ actions, on behalf of the government and such individuals, commonly known as ‘‘whistleblowers,’’ may share in amounts paid by the entity to the government in fines or settlement. When an entity is determined to have violated the federal civil False Claims Act, the government may impose civil fines and penalties, plus treble damages, and exclude the entity from participation in Medicare, Medicaid and other federal healthcare programs;
•the Eliminating Kickbacks in Recovery Act of 2018 (“EKRA”) prohibits payments for referrals to recovery homes, clinical treatment facilities, and laboratories. EKRA’s reach extends beyond federal healthcare programs to include private insurance (i.e., it is an “all payor” statute). For purposes of EKRA, the term “laboratory” is defined broadly and without reference to any connection to substance use disorder treatment. The law includes a limited number of exceptions, some of which closely align with corresponding federal Anti-Kickback Statute exceptions and safe harbors, and others that materially differ;
•HIPAA, which, among other things, imposes criminal liability for executing or attempting to execute a scheme to defraud any healthcare benefit program, including private third-party payors, knowingly and willfully embezzling or stealing from a healthcare benefit program, willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation, in connection with the delivery of or payment for healthcare benefits, items or services. Like the AKS, a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation;
•HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act or HITECH,(“HITECH”), and their implementing regulations, which imposes privacy, security and breach reporting obligations with respect to
individually identifiable health information upon entities subject to the law, such as health plans, healthcare clearinghouses and certain healthcare providers, known as covered entities, and their respective business associates, individuals or entities that perform services for them that involve individually identifiable health information.information as well as their covered subcontractors. Failure to comply with the HIPAA privacy and security standardsHIPAA’s obligations can result in civil monetary penalties, and, in certain circumstances, criminal penalties. HITECH also created new tiers of civil monetary penalties, amended HIPAA to make civil and criminal penalties directly applicable to business associates, and gave state attorneys general new authority to file civil actions for damages or injunctions in U.S. federal courts to enforce HIPAA and seek attorneys’ fees and costs associated with pursuing federal civil actions;
•state laws that prohibit other specified practices, such as billing physicians for tests that they order or providing tests at no or discounted cost to induce physician or patient adoption; insurance fraud laws; waiving coinsurance, copayments, deductibles, and other amounts owed by patients; billing a state Medicaid program at a price that is higher than what is charged to one or more other third-party payors employing, exercising control over or splitting professional fees with licensed professionals in violation of state laws prohibiting fee splitting or the corporate practice of medicine and other professions; and
•federal and state consumer protection and unfair competition laws, which broadly regulate marketplace activities and activities that potentially harm consumers;
•the federal transparency requirements under the Physician Payments Sunshine Act, created under the ACA, which requires, among other things, certain manufacturers of drugs, devices, biologics and medical supplies reimbursed
under Medicare, Medicaid, or the Children’s Health Insurance Program to annually report to CMS information related to payments and other transfers of value provided to physicians certain(defined to include doctors, dentists, optometrists, podiatrists and chiropractors), other healthcare professionals (such as physician assistants and nurse practitioners) and teaching hospitals and information regarding physician ownership and investment interests, including such ownership and investment interests held by a physician’s immediate family members. Failure to submit required information may result in civil monetary penalties for all payments, transfers of value or ownership or investment interests that are not timely, accurately, and completely reported in an annual submission, and may result in liability under other federal laws or regulations. We believe that we are exempt from these reporting requirements. We cannot assure you, however, that our regulators, principally the federal government, will agree with our determination, and a determination that we have violated these laws and regulations, or a public announcement that we are being investigated for possible violations, could adversely affect our business;
•the prohibition on reassignment of Medicare claims, which, subject to certain exceptions, precludes the reassignment of Medicare claims to any other part;
•state and foreign law equivalents of each of the above federal laws, such as anti-kickback and false claims laws, thatwhich may impose similar or more prohibitive restrictions, and may apply to items or services reimbursed by any non-governmental third-party payors, including private insurers; and
•federal, state, local and foreign laws that govern the privacy and security of health information or personally identifiable information in certain circumstances, including state health information privacy and data breach notification laws which govern the collection, use, disclosure, and protection of health-related and other personal information, many of which differ from each other in significant ways and often are not pre-empted by HIPAA, thus complicating compliance efforts.
As a clinical laboratory, our business practices may face additional scrutiny from government regulatory agencies such as the Department of Justice, the U.S. Department of Health and Human Services Office of Inspector General or OIG,(“OIG”) and CMS. Certain arrangements between clinical laboratories and referring physicians have been identified in fraud alerts issued by the OIG as implicating the AKS. The OIG has stated that it is particularly concerned about these types of arrangements because the choice of laboratory, as well as the decision to order laboratory tests, typically are made or strongly influenced by the physician, with little or no input from patients. Moreover, the provision of payments or other items of value by a clinical laboratory to a referral source could be prohibited under the Stark Law unless the arrangement meets all criteria of an applicable exception. The government has been active in enforcement of these laws as they apply to clinical laboratories.
We have entered into consulting and scientific advisory board arrangements, speaking arrangements and clinical research agreements with physicians and other healthcare providers, including some who could influence the use of our products. Because of the complex and far-reaching nature of these laws, regulatory agencies may view these transactions as prohibited arrangements that must be restructured, or discontinued, or for which we could be subject to other significant penalties. We could be adversely affected if regulatory agencies interpret our financial relationships with providers who may influence the ordering of and use of our products to be in violation of applicable laws.
The scope and enforcement of each of these laws is uncertain and subject to rapid change in the current environment of healthcare reform. Federal and state enforcement bodies have recently increased their scrutiny of interactions between
healthcare companies, healthcare providers and other third parties, including charitable foundations, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. It is possible that governmental authorities may conclude that our business practices, including our consulting arrangements with physicians, as well as our financial assistance programs, do not comply with current or future statutes, regulations, agency guidance or case law involving applicable healthcare laws. Responding to investigations can be time and resource-consuming and can divert management’s attention from the business. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business.
Ensuring that our business arrangements with third parties comply with applicable healthcare laws and regulations is costly. If our operations are found to be in violation of any of these laws or any other current or future governmental laws and regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, damages, fines, disgorgement, individual imprisonment, exclusion from government funded healthcare programs, such as Medicare and Medicaid, contractual damages, reputational harm, diminished profits and future earnings, additional reporting obligations and oversight if we become subject to a corporate integrity agreement or other agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations, any of which could substantially disrupt our operations. If any of the physicians or other healthcare providers or entities with whom we do business is found to be not in compliance
with applicable laws, they may be subject to significant criminal, civil or administrative sanctions, including exclusions from government funded healthcare programs.
We are subject to certain U.S. anti-corruption, anti-money laundering, export control, sanctions, and other trade laws and regulations and may become subject to their similar foreign equivalents. We can face serious consequences for violations.
U.S. and foreign anti-corruption, anti-money laundering, export control, sanctions, and other trade laws and regulations or collectively, Trade Laws, prohibit, among other things, companies and their employees, agents, legal counsel, accountants, consultants, contractors, and other partners from authorizing, promising, offering, providing, soliciting, or receiving, directly or indirectly, corrupt or improper payments or anything else of value to or from recipients in the public or private sector. Violations of Trade Lawsthese trade laws can result in substantial criminal fines and civil penalties, imprisonment, the loss of trade privileges, debarment, tax reassessments, breach of contract and fraud litigation, reputational harm, and other consequences. We have direct or indirect interactions with officials and employees of government agencies or government-affiliated hospitals, universities, and other organizations. We also expect that we may engage in non-U.S. activities over time. We expect to rely on third-party suppliers and/or third parties to obtain necessary permits, licenses, and patent registrations. We can be held liable for the corrupt or other illegal activities of our personnel, agents, or partners, even if we do not explicitly authorize or have prior knowledge of such activities. Any violations of the laws and regulations described above may result in substantial civil and criminal fines and penalties, imprisonment, the loss of export or import privileges, debarment, tax reassessments, breach of contract and fraud litigation, reputational harm and other consequences.
Our collection, use and disclosure of individually identifiable information, including health and/or employee information, isWe are subject to stringent and changing state, federal, local, foreign, and foreignother privacy and security laws, regulations, rules, contractual obligations, policies and other obligations, and our failure to comply or perceived failure to comply with those regulations or to adequately secure the information we holdobligations could result in significant liabilityregulatory investigations or actions; litigation; fines and penalties; disruptions of our business operations; reputational harm.harm; loss of revenue or profits; loss of customers or sales; and other adverse business consequences.*
WeIn the ordinary course of our business, we collect, store, use, transmit, disclose, or otherwise process (“Process”) confidential, proprietary, and any potential collaborators aresensitive data, including PHI, personal information, credit card and other financial information, intellectual property and proprietary business information owned or controlled by ourselves or our customers, payors and other parties. Our data processing activities may subject us to federal, state, and foreignnumerous data protection laws and regulations (i.e., laws and regulations that address privacy and data security). security obligations, such as laws, regulations, guidance, industry standards, external and internal privacy and security policies, contracts and other obligations that govern the Processing of personal information by us and on our behalf.
In the United States, numerous federal, state, and statelocal governments have enacted data privacy and security laws, and regulations, including federal health information privacy laws, state data breach notification laws, state health information privacy laws, and federal and state consumer protection laws (e.g., Section 5 of the Federal Trade Commission Act), that govern. For example, HIPAA, as amended by HITECH, imposes specific requirements relating to the collection, use, disclosure, and protection of health-related and other personal information could apply to our operations or the operations of our collaborators.
In the ordinary course of our business, we collect and store sensitive data, including protected health information, or PHI, personally identifiable information, or PII, credit card and other financial information, intellectual property and proprietary business information owned or controlled by ourselves or our customers, payors and other parties. We manage and maintain our applications and data utilizing a combination of on-site systems, managed data centers, and cloud-based data centers. We utilize externalprivacy, security, and infrastructure vendors to manage parts of our data centers.
The secure processing, storage, maintenance and transmission of this critical information is vital to our operations and business strategy, and we devote significant resources to protecting suchindividually identifiable health information. Although we take measures to protect sensitive data from unauthorized access, use or disclosure, our information technology and infrastructure may be vulnerable to attacks by hackers or viruses or breached due to employee error, malfeasance, or other malicious or inadvertent disruptions. Any such breach or interruption could compromise our networks andAdditionally, California has enacted several laws governing the information stored there could be accessed by unauthorized parties, publicly disclosed, lost, or stolen. Any such access, breach, or other loss of information could result in legal claims or proceedings, and liability under federal or state laws that protect the privacyProcessing of personal information, such as HIPAA, as amended by HITECH,the California Consumer Privacy Act of 2018 (“CCPA”), which provides California residents certain rights relate to their personal information, the California Rights Privacy Act of 2020 (“CPRA”), effective January 1, 2023, which will expand the CCPA, and regulatory penalties. Notice of breaches must be made to affected individuals, the Secretary of the Department of Health and Human Services, and for extensive breaches, notice may need to be made to the media or State Attorneys General. Such a notice could harm our reputation and our ability to compete. Although we have implemented security measures and a formal, dedicated enterprise security program to prevent unauthorized access to patient data, such data is currently accessible through multiple channels, and there is no guarantee we can protect our data from breach. Unauthorized access, loss or dissemination could also disrupt our operations (including our ability to conduct our analyses, provide test results, bill payers or patients, process claims and appeals, provide customer assistance, conduct research and development activities, collect, process, and prepare company financial information, provide information about our products and other patient and physician education and outreach efforts through our website, and manage the administrative aspects of our business) and damage our reputation, any of which could adversely affect our business. In addition, we may obtain health information from third parties that are also subject to privacy and security requirements under HIPAA, as amended by HITECH.
Further, various states, such as California and Massachusetts, have implemented similar privacy laws and regulations, such as the California Confidentiality of Medical Information Act, that impose restrictive requirements regulatingwhich restricts the use and disclosure of health information and other personally identifiablepersonal information. TheseAlthough the CCPA exempts some personal information processed in the context of clinical trials, the CCPA, to the extent applicable to our business and operations, may increase compliance costs and potential liability with respect to other personal information we maintain about California residents.In addition, other states have enacted or proposed privacy laws, further complicating compliance efforts.Outside the United States, there are also an increasing number of laws,
regulations, industry standards and other obligations concerning privacy and security, including for example the European Union’s (“EU”) General Data Protection Regulation (EU) 2016/679 (“GDPR”), the United Kingdom’s GDPR (“UK GDPR”), Brazil’s General Data Protection Law (Lei Geral de Proteção de Dados Pessoais, or “LGPD”) (Law No. 13,709/2018), and China’s Personal Information Protection Law (“PIPL”).
Moreover, certain jurisdictions have enacted data localization laws and regulationscross-border personal information transfer laws, which could make it more difficult to transfer personal information across jurisdictions (such as transferring or receiving personal information that originates in the EU).Existing mechanisms that may facilitate cross-border personal information transfers may change or be invalidated. The more reliant our business is on the ability to effectuate cross-border data transfers, the more impact we may experience in light of any changes in the legal landscape.
In addition, privacy advocates and industry groups have proposed, and may in the future propose, standards with which we are not necessarily preemptedlegally or contractually bound to comply. In addition to data privacy and security laws, we may be contractually subject to industry standards adopted by HIPAA, particularlyindustry groups and may become subject to such obligations in the future. For example, we may also be subject to the Payment Card Industry Data Security Standard (“PCI DSS”). The PCI DSS requires companies to adopt certain measures to ensure the security of cardholder information, including using and maintaining firewalls, adopting proper password protections for certain devices and software, and restricting data access. Noncompliance with PCI-DSS can result in penalties ranging from $5,000 to $100,000 per month by credit card companies, litigation, damage to our reputation, and revenue losses. We may also rely on vendors to process payment card data, and those vendors may be subject to PCI DSS, and our business may be negatively affected if our vendors are fined or suffer other consequences as a state affords greater protectionresult of PCI DSS noncompliance
More generally, we may also bound by contractual obligations related to individuals than HIPAA. Where state laws are more protective, we havedata privacy and security, and our efforts to comply with the stricter provisions. In addition to fines and penalties imposed upon violators, some of these state laws also afford private rights of action to individuals who believe their personal information has been misused. California’s patientsuch obligations may not be successful. For example, certain privacy laws, for example, provide for penaltiessuch as the GDPR and the CCPA, require our customers to impose specific contractual restrictions on their service providers. Additionally, we may publish privacy policies and other statements regarding data privacy and security, and, if these policies or statements are found to be deficient, lacking in transparency, deceptive, unfair, or misrepresentative of upour practices, we could experience adverse consequences.
Our obligations related to $250,000data privacy and permit injured partiessecurity are quickly changing in an increasingly stringent fashion, creating some uncertainty as to sue for damages. The interplay of federal and statethe effective future legal framework. These laws may be subject to varying interpretations, by courts and government agencies, creating complex compliance issues for us and our clientsclients. Preparing for and potentially exposingcomplying with these obligations requires us to additional expense, adverse publicitydevote significant resources (including, without limitation, financial and liability. Further, as regulatory focus on privacy issues continuestime-related resources).
These obligations may necessitate changes to increaseour information technologies, systems, and lawspractices and regulations concerning the protectionto those of any third parties that process personal information expand and become more complex,on our behalf.In addition, these potential risksobligations may require us to change our business model or to take on more onerous obligations in our contracts.Although we endeavor to comply with all applicable obligations, we may, at times, fail or be perceived to have failed to do so.Moreover, despite our efforts, our personnel or third parties upon whom we rely on may fail to comply with such obligations, which could intensify. Changesnegatively impact our business operations and compliance posture. Failure or perceived failure to comply with these obligations could result in laws significant consequences, including but not limited to government enforcement actions (which could include civil, criminal, and administrative penalties), private litigation, additional reporting requirements and/or regulations associated with the enhanced protectionoversight, bans on processing personal information, and orders to destroy or not use personal information.Any of certain types of sensitive data, such PHIthese events could have a material adverse effect on our reputation, business, or PII along with increased customer demands for enhanced data security infrastructure, could greatlyfinancial condition, including but not limited to: increase our cost of providing our services, decrease demand for our services, reduce our revenue, and/or subject us to additional liabilities.
Compliance with U.S. and international data protection laws and regulations could require us to take on more onerous obligations ininterrupt our contracts, restrictbusiness operations, limit our ability to collect, usedevelop our services, expenditure of time and disclose data, or in some cases, impact our ability to operate in certain jurisdictions. Failure to comply with U.S. and international data protection laws and regulations could result in government enforcement actions (which could include civil, criminal, and administrative penalties), private litigation, and/or adverse publicity and could negatively affect our operating results and business. Claims that we have violated individuals’ privacy rights, failed to comply with data protection laws, or breached our contractual obligations, even if we are not found liable, could be expensive and time-consumingresources to defend any claim or inquiry, and could result in adverse publicity that could harm our business.publicity.
Ethical, legal and social concerns related to the use of genetic information could reduce demand for our products.
Genetic testing has raised ethical, legal, and social issues regarding privacy and the appropriate uses of the resulting information. Governmental authorities have, through the Genetic Information Nondisclosure Act of 2008, and could further, for social or other purposes, limit or regulate the use of genetic information or genetic testing or prohibit testing for genetic predisposition to certain conditions, particularly for those that have no known cure. Ethical and social concerns may also influence governmental authorities to deny or delay the issuance of patents for technology relevant to our business. While we do not currently perform genetic tests for genetic predisposition to certain conditions, these concerns may lead patients to refuse to use, or clinicians to be reluctant to order, our genomic tests or genetic tests for somatic mutations even if permissible. These and other ethical, legal and social concerns may limit market acceptance of our products or reduce the potential markets for our products, either of which could have an adverse effect on our business, financial condition, or results of operations.
Risks Related to Intellectual Property
If we are unable to obtain and maintain sufficient intellectual property protection for our technology, or if the scope of the intellectual property protection obtained is not sufficiently broad, our competitors could develop and commercialize diagnostic tests similar or identical to ours, and our ability to successfully commercialize our products may be impaired.*
We rely on patent protection as well as trademark, copyright, trade secret and other intellectual property rights protection as well as nondisclosure, confidentiality and other contractual restrictions to protect our brands and proprietary tests and technologies, all of which provide limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. If we fail to protect our intellectual property, third parties may be able to compete more effectively against us. In addition, we may incur substantial litigation costs in our attempts to recover or restrict use of our intellectual property.
As is the case with other life science companies, our success depends in large part on our ability to obtain and maintain protection of the intellectual property we may own solely or jointly with others or in-license from others, particularly patents, in the United States and other countries with respect to our products and technologies. We apply for patents covering our products and technologies and uses thereof, as we deem appropriate. However, obtaining and enforcing life sciences patents is costly, time-consuming and complex, and we may fail to apply for patents on important tests, services and technologies in a timely fashion or at all, or we may fail to apply for patents in potentially relevant jurisdictions. We may not be able to file and prosecute all necessary or desirable patent applications, or maintain, enforce and license any patents that may issue from such patent applications, at a reasonable cost or in a timely manner. It is also possible that we will fail to identify patentable aspects of our research and development output before it is too late to obtain patent protection.
We may not have the right to control the preparation, filing and prosecution of patent applications, or to maintain the rights to patents licensed from or to third parties. Therefore, these patents and applications may not be prosecuted and enforced in a manner consistent with the best interests of our business.
We have four licensedOur patent portfolio as of December 31, 2021 includes 12 issued U.S. patents and twoten pending U.S. patent applications, with foreign counterparts. It is possible that none of our pending patent applications will result in issued patents in a timely fashion or at all, and even if patents are granted, they may not provide a basis for intellectual property protection of commercially viable tests or services, may not provide us with any competitive advantages, or may be challenged and invalidated by third parties. It is possible that others will design around our future patented technologies. We may not be successful in defending any suchchallenges made against our patents or patent applications. Any successful third-party challenge to our patents could result in the unenforceability or invalidity of such patents and increased competition to our business. Even if our patents are held valid and enforceable, they may still be found insufficient to provide protection against competing products and services sufficient to achieve our business objectives. We may have to challenge the patents or patent applications of third parties, such as to counter infringement or unauthorized use. In addition, in an infringement proceeding, a court may decide that a patent of ours is invalid or unenforceable, or may refuse to enjoin the other party from using the technology at issue on the grounds that our patents do not cover the technology in question. Even if we prevail against an infringer in a U.S. district court or foreign trial-level court, there is always the risk that the infringer will file an appeal and the initial court judgment will be overturned at the appeals court and/or that an adverse decision will be issued by the appeals court relating to the validity or enforceability of our patents. The outcome of patent litigation or other proceeding can be uncertain, and any attempt by us to enforce our patent rights against others or to challenge the patent rights of others may not be successful, or, if successful, may take substantial time and result in substantial cost, and may divert our efforts and attention from other aspects of our business.
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 or elsewhere. Courts frequently render opinions in the life sciences field that may affect the patentability of certain inventions or discoveries, including opinions that may affect the patentability of methods for analyzing or comparing DNA sequences.
In particular, the patent positions of companies engaged in the development and commercialization of genomic diagnostic tests are particularly uncertain. Various courts, including the U.S. Supreme Court, have rendered decisions that affect the scope of patentability of certain inventions or discoveries relating to certain diagnostic tests and related methods. These decisions state, among other things, that a patent claim that recites an abstract idea, natural phenomenon or law of nature (for example, the relationship between particular genetic variants and cancer) are not themselves patentable. Precisely what constitutes a law of nature is uncertain, and it is possible that certain aspects of genetic diagnostics tests would be considered natural laws. Accordingly, the evolving case law in the United States may adversely affect our ability to obtain patents and may facilitate third-party challenges to any owned or licensed patents. The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States, and we may encounter difficulties in protecting and defending such rights in foreign jurisdictions. The legal systems of many other countries do not favor the enforcement of patents and other intellectual property protection, particularly those relating to life science technologies, which could make it difficult for us to
stop the infringement of our patents in such countries. 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.
To the extent our intellectual property offers inadequate protection, or is found to be invalid or unenforceable, we would be exposed to a greater risk of direct competition, and 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. Moreover, if a third party has intellectual property rights that cover the practice of our technology, we may not be able to fully exercise or extract value from our intellectual property rights. The following examples are illustrative:
•others may be able to develop and/or practice technology that is similar to our technology or aspects of our technology, but that are not covered by the claims of the patents that we own or control, assuming such patents have issued or do issue;
•we or our licensors or any future strategic partners might not have been the first to conceive or reduce to practice the inventions covered by the issued patents or pending patent applications that we own or have exclusively licensed;
•we or our licensors or any future strategic partners might not have been the first to file patent applications covering certain of our inventions;
•others may independently develop similar or alternative technologies or duplicate any of our technologies without infringing our intellectual property rights;
•it is possible that our pending patent applications will not lead to issued patents;
•issued patents that we own or have exclusively licensed may not provide us with any competitive advantage, or may be held invalid or unenforceable, as a result of legal challenges by our competitors;
•our competitors might conduct research and development activities in countries where we do not have patent rights and then use the information learned from such activities to develop competitive tests for sale in our major commercial markets;
•third parties performing manufacturing or testing for us using our products or technologies could use the intellectual property of others without obtaining a proper license;
•parties may assert an ownership interest in our intellectual property and, if successful, such disputes may preclude us from exercising exclusive rights over that intellectual property;
•we may not develop or in-license additional proprietary technologies that are patentable;
•we may not be able to obtain and maintain necessary licenses on commercially reasonable terms, or at all; and
•the patents of others may have an adverse effect on our business.
Should any of these events occur, they could significantly harm our business and results of operations.
Changes in patent law in the United States and other jurisdictions could diminish the value of patents in general, thereby impairing our ability to protect our products.*
As is the case with other life sciences companies, our success is heavily dependent on intellectual property, particularly patents relating to our research programs and products. Obtaining and enforcing patents in the life sciences industry involves both technological and legal complexity and is therefore costly, time consuming and inherently uncertain. Changes in either the patent laws or interpretation of the patent laws in the United States or the United States Patent and Trademark Office or the USPTO,(“USPTO”) rules and regulations could increase these uncertainties and costs. Recent patentPatent reform legislation in the United States and other countries, including the Leahy-Smith America Invents Act or the AIA,(“AIA”), signed into law on September 16, 2011, could increase those uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents. The AIA includes a number of significant changes to U.S. patent law. These include provisions that affect the way patent applications are prosecuted, redefine prior art and provide more efficient and cost-effective avenues for competitors to challenge the validity of patents. These include allowing third-party submission of prior art to the USPTO during patent prosecution and additional procedures to attack the validity of a patent in USPTO administered post-grant proceedings, including post-grant review, inter partes review, and derivation proceedings. For applications filed after March 15, 2013 that do not claim the benefit of applications filed before that date, the AIA transitioned the United States from a first to invent system to a first-inventor-to-file system in which, assuming that the other statutory requirements are met, the first inventor to file a patent application will be entitled to the patent on an invention regardless of whether a third party was the first to invent the claimed invention. The AIA and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications, our ability to obtain future patents, and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business, financial condition, results of operations and prospects.
The U.S. Supreme Court has ruled on several patent cases in recent years, either narrowing the scope of patent protection available in certain circumstances or weakening the rights of patent owners in certain situations.
Depending on future actions by the U.S. Congress, the U.S. courts, the USPTO and the relevant law-making bodies in other countries, the laws and regulations governing patents could change in unpredictable ways that would weaken our ability to obtain new patents or to enforce our existing patents and patents that we might obtain in the future.
Our in-licensed intellectual property has been discovered through government funded programs and thus may be subject to federal regulations such as ‘‘march-in’’ rights, certain reporting requirements and a preference for U.S.-based companies, and compliance with such regulations may limit our exclusive rights, and limit our ability to contract with non-U.S. manufacturers.*
Intellectual property rights that have been in-licensed pursuant to oura license agreement or the License Agreement,(the “License Agreement”) with The Washington University in St. Louis, Missouri or WUSTL,(“WUSTL”) have been generated through the use of U.S. government funding, and are therefore subject to certain federal regulations. As a result, the United States federal government may retain certain rights to intellectual property embodied in our current or future product candidates under the Bayh-Dole Act. These federal government rights include a ‘‘nonexclusive, nontransferable, irrevocable, paid-up license’’ to use inventions for any governmental purpose. The Bayh-Dole Act also provides federal agencies with ‘‘march-in rights.’’ March-in rights allow the government, in specified circumstances, to require the contractor or successors in title to the patent to grant a ‘‘nonexclusive, partially exclusive, or exclusive license’’ to a ‘‘responsible applicant or applicants’’ if it determines that (1) adequate steps have
not been taken to commercialize the invention, (2) government action is necessary to meet public health or safety needs or (3) government action is necessary to meet requirements for public use under federal regulations. If the patent owner refuses to do so, the government may grant the license itself.
The U.S. government also has the right to take title to these inventions if the licensor fails to disclose the invention to the government or fails to file an application to register the intellectual property within specified time limits. Intellectual property generated under a government funded program is also subject to certain reporting requirements, compliance with which may require us to expend substantial resources. In addition, the U.S. government requires that any products embodying any of these inventions or produced through the use of any of these inventions be manufactured substantially in the United States, and the License Agreement requires that we comply with this requirement. This preference for U.S. industry may be waived by the federal agency that provided the funding if the owner or assignee of the intellectual property can show that reasonable but unsuccessful efforts have been made to grant licenses on similar terms to potential licensees that would be likely to manufacture substantially in the United States or that under the circumstances domestic manufacture is not commercially feasible. This preference for U.S. industry may limit our ability to contract with non-U.S. product manufacturers for products covered by such intellectual property. To the extent any of our owned or future in-licensed intellectual property is also generated through the use of U.S. government funding, the provisions of the Bayh-Dole Act may similarly apply.
Issued patents covering our products and related technologies could be found invalid or unenforceable if challenged.
The issuance of a patent is not conclusive as to its inventorship, scope, validity or enforceability. Some of our patents or patent applications (including licensed patents) have been, are being or may be challenged at a future point in time in an opposition, nullification, derivation, reexamination, inter partes review, post-grant review or interference action in court or before patent offices or similar proceedings for a given period after allowance or grant, during which time third parties can raise objections against such grant. In the course of such proceedings, which may continue for a protracted period of time, the patent owner may be compelled to limit the scope of the allowed or granted claims thus attacked, or may lose the allowed or granted claims altogether. Any successful third-party challenge to our patents in this or any other proceeding could result in the unenforceability or invalidity of such patents, which may lead to increased competition to our business, which could harm our business. In addition, if the breadth or strength of protection provided by our patents and patent applications is threatened, regardless of the outcome, it could dissuade companies from collaborating with us to license, develop or commercialize current or future diagnostic tests.
We may not be aware of all third-party intellectual property rights potentially relating to our products. Publications of discoveries in the scientific literature often lag behind the actual discoveries, and patent applications in the United States and other jurisdictions are typically not published until approximately 18 months after filing or, in some cases (e.g., U.S. applications for which a request not to publish has been filed), not until such patent applications issue as patents. We might not have been the first to make the inventions covered by each of our pending patent applications and we might not have been the first to file patent applications for these inventions. To determine the priority of these inventions, we have and may have to participate in interference proceedings, derivation proceedings or other post-grant proceedings declared by the USPTO that could result in substantial cost to us. The outcome of such proceedings is uncertain. We can give no assurance that all of the potentially relevant art relating to our patents and patent applications has been found; overlooked prior art could be used by a third party to challenge the validity, enforceability and scope of our patents or prevent a patent from issuing from a pending patent application. As a result, we may not be able to obtain or maintain protection for certain inventions. No assurance can be
given that other patent applications will not have priority over our patent applications. In addition, changes to the patent laws of the United States allow for various post-grant opposition proceedings that have not been extensively tested, and their outcome is therefore uncertain. Therefore, the validity, enforceability and scope of our patents in the United States and other countries cannot be predicted with certainty and, as a result, any patents that we own or license may not provide sufficient protection against our competitors. Furthermore, if third parties bring these proceedings against our patents, we could experience significant costs and management distraction.
Our commercial success depends significantly on our ability to operate without infringing upon the intellectual property rights of third parties.
The life sciences industry is subject to rapid technological change and substantial litigation regarding patent and other intellectual property rights. Our potential competitors in both the United States and abroad, may have substantially greater resources and are likely to make substantial investments in patent portfolios and competing technologies, and may apply for or obtain patents that could prevent, limit or otherwise interfere with our ability to make, use and sell our products. Numerous third-party patents exist in fields relating to our products and technologies, and it is difficult for industry participants, including us, to identify all third-party patent rights relevant to our products and technologies. Moreover, because some patent
applications are maintained as confidential for a certain period of time, we cannot be certain that third parties have not filed patent applications that cover our products and technologies.
Patents could be issued to third parties that we may ultimately be found to infringe. Third parties may have or obtain valid and enforceable patents or proprietary rights that could block us from using our technology. Our failure to obtain or maintain a license to any technology that we require may materially harm our business, financial condition and results of operations. Furthermore, we would be exposed to a threat of litigation.
From time to time, we may be party to, or threatened with, litigation or other proceedings with third parties, including non-practicing entities, who allege that our products, components of our products, and/or proprietary technologies infringe, misappropriate or otherwise violate their intellectual property rights. The types of situations in which we may become a party to such litigation or proceedings include:
•we may initiate litigation or other proceedings against third parties seeking to invalidate the patents held by those third parties or to obtain a judgment that our products or technologies do not infringe those third parties’ patents;
•we may participate at substantial cost in International Trade Commission proceedings to abate importation of products that would compete unfairly with our products or technologies;
•if a competitor files patent applications that claim technology also claimed by us or our licensors, we or our licensors may be required to participate in interference, derivation or opposition proceedings to determine the priority of invention, which could jeopardize our patent rights and potentially provide a third party with a dominant patent position;
•if third parties initiate litigation claiming that our products or technologies infringe their patent or other intellectual property rights, we will need to defend against such proceedings;
•if third parties initiate litigation or other proceedings seeking to invalidate patents owned by or licensed to us or to obtain a declaratory judgment that their products, services, or technologies do not infringe our patents or patents licensed to us, we will need to defend against such proceedings;
•we may be subject to ownership disputes relating to intellectual property, including disputes arising from conflicting obligations of consultants or others who are involved in developing our products and technologies; and
•if a license to necessary technology is terminated, the licensor may initiate litigation claiming that our products or technologies infringe or misappropriate its patent or other intellectual property rights and/or that we breached our obligations under the license agreement, and we would need to defend against such proceedings.
These lawsuits and proceedings, regardless of merit, are time-consuming and expensive to initiate, maintain, defend or settle, and could divert the time and attention of managerial and technical personnel, which could materially adversely affect our business. Any such claim could also force us to do one or more of the following:
•incur substantial monetary liability for infringement or other violations of intellectual property rights, which we may have to pay if a court decides that the diagnostic test or technology at issue infringes or violates the third party’s rights, and if the court finds that the infringement was willful, we could be ordered to pay treble damages and the third party’s attorneys’ fees;
•stop manufacturing, offering for sale, selling, using, importing, exporting or licensing the diagnostic test or technology incorporating the allegedly infringing technology or stop incorporating the allegedly infringing technology into such test or technology;
•obtain from the owner of the infringed intellectual property right a license, which may require us to pay substantial upfront fees or royalties to sell or use the relevant technology and which may not be available on commercially reasonable terms, or at all;
•redesign our products and technologies so they do not infringe or violate the third party’s intellectual property rights, which may not be possible or may require substantial monetary expenditures and time;
•enter into cross-licenses with applicable third party, which could weaken our overall intellectual property position;
•lose the opportunity to license our technology to others or to collect royalty payments based upon successful protection and assertion of our intellectual property against others;
•find alternative suppliers for non-infringing technologies, which could be costly and create significant delay; or
•relinquish rights associated with one or more of our patent claims if our claims are held invalid or otherwise unenforceable.
Third parties may be able to sustain the costs of complex intellectual property litigation more effectively than we can because they have substantially greater resources. In addition, intellectual property litigation, regardless of its outcome, may cause negative publicity, adversely impact our business, cause delays, or prohibit us from marketing or otherwise commercializing our products and technologies. Any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise additional funds or otherwise have a material adverse effect on our business, results of operation, financial condition or cash flows.
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. There could also be public announcements of the results of hearings, motions or other interim proceedings or developments, which could have a material adverse effect on the price of our common stock. If securities analysts or investors perceive these results to be negative, it could have a material adverse effect on the price of our common stock. The occurrence of any of these events may have a material adverse effect on our business, results of operation, financial condition or cash flows.
We depend on information technology systems that we license from third parties. Any failure of such systems or loss of licenses to the software that comprises an essential element of such systems could significantly harm our business.*
We depend on information technology systems for significant elements of our operations, such as our laboratory information management systems,Laboratory Information Management System, including test validation, specimen tracking and quality control, our bioinformatics analytical software systems, and our test report generating systems and billing systems. Essential elements of these systems depend on software that we license from third parties. If we are unable to maintain the licenses to this software or our software providers discontinue or alter the programs on which we rely, it could render our test reports unreliable or hinder our ability to generate accurate test reports, among other things. Any of the foregoing could have a material adverse effect on our competitive position, business, financial conditions, results of operations and prospects.
We rely on licenses from third parties, and if we lose these licenses or are not able to obtain licenses to third-party technology on reasonable grounds or at all, then we may not be able to continue to commercialize existing diagnostic tests, be subjected to future litigation and may not be able to commercialize new diagnostic tests in the future.
We are party to certain royalty-bearing license agreements that grant us rights to use certain intellectual property, including patents and patent applications, in certain specified fields of use. Although we intend to develop products and technologies through our own internal research, we may need to obtain additional licenses from others to advance our research, development and commercialization activities. Our license agreements impose, and we expect that future license agreements will impose, various development, diligence, commercialization and other obligations on us.
In the future, we may identify third-party technology we may need, including to develop or commercialize new diagnostic tests or services. In return for the use of a third party’s technology, we may agree to pay the licensor royalties based on sales of our solutions. Royalties are a component of the cost of our products or services and affect our margins. We may also need to negotiate licenses to patents or patent applications before or after introducing a commercialized test. The in-licensing and acquisition of third-party intellectual property rights is a competitive area, and a number of more established companies are also pursuing strategies to in-license or acquire third-party intellectual property rights for technologies that we may consider attractive or necessary.
These established companies may have a competitive advantage over us due to their size, cash resources and greater clinical development and commercialization capabilities. Furthermore, companies that perceive us to be a competitor may be unwilling to assign or license rights to us. In addition, we expect that competition for the in-licensing or acquisition of third-party intellectual property rights for technologies that are attractive to us may increase in the future, which may mean fewer suitable opportunities for us as well as higher acquisition or licensing costs. We may not be able to obtain necessary or strategic licenses to patents or patent applications, and our business may suffer if we are unable to enter into these licenses on acceptable terms or at all, if any necessary licenses are subsequently terminated, if the licensors fail to abide by the terms of the licenses or fail to prevent infringement by third parties, or if the licensed patents or other rights are found to be invalid or unenforceable.
In spite of our efforts, our licensors might conclude that we have materially breached our obligations under such license agreements and might therefore terminate the license agreements, thereby removing or limiting our ability to develop and commercialize tests and technology covered by these license agreements. If these in-licenses are terminated, or if the underlying patents fail to provide the intended exclusivity, competitors or other third parties might have the freedom to seek regulatory approval of, and to market, tests identical to ours and we may be required to cease our development and
commercialization activities. For example, we license certain intellectual property from WUSTL that is incorporated into DecisionDx-UM. In 2018,2021, we provided more than 1,400over 1,600 test reports for DecisionDx-UM. If this license agreement were terminated, we would be unable to continue to issue test reports and thus sales of DecisionDx-UM. Any of the foregoing could have a material adverse effect on our competitive position, business, financial conditions, results of operations and prospects.
Moreover, disputes may arise with respect to any one of our licensing agreements, including:
•the scope of rights granted under the license agreement and other interpretation-related issues;
•the extent to which our products, technology and processes infringe on intellectual property of the licensor that is not subject to the licensing agreement;
•the sublicensing of patent and other rights under our collaborative development relationships;
•our diligence obligations under the license agreement and what activities satisfy those diligence obligations;
•the inventorship and ownership of inventions and know-how resulting from the joint creation or use of intellectual property by our licensors and us and our partners; and
•the priority of invention of patented technology.
If we do not prevail in such disputes, we may lose any of such license agreements.
In addition, the agreements under which we currently license intellectual property or technology from third parties are complex, and certain provisions in such agreements may be susceptible to multiple interpretations.
The resolution of any contract interpretation disagreement that may arise could narrow what we believe to be the scope of our rights to the relevant intellectual property or technology, or increase what we believe to be our financial or other obligations under the relevant agreement, either of which could have a material adverse effect on our business, financial condition, results of operations and prospects. Moreover, if disputes over intellectual property that we have licensed prevent or impair our ability to maintain our current licensing arrangements on commercially acceptable terms, we may be unable to successfully develop and commercialize the affected diagnostic tests, which could have a material adverse effect on our business, financial conditions, results of operations and prospects.
Our failure to maintain such licenses could have a material adverse effect on our business, financial condition and results of operations. Any of these licenses could be terminated, such as if either party fails to abide by the terms of the license, or if the licensor fails to prevent infringement by third parties or if the licensed patents or other rights are found to be invalid or unenforceable. Absent the license agreements, we may infringe patents subject to those agreements, and if the license agreements are terminated, we may be subject to litigation by the licensor. Litigation could result in substantial costs and be a distraction to management. If we do not prevail, we may be required to pay damages, including treble damages, attorneys’ fees, costs and expenses, royalties or, be enjoined from selling our products or services, including DecisionDx-UMDecisionDx-Melanoma and DecisionDx-Melanoma,DecisionDx-UM, which could adversely affect our ability to offer our products or services, our ability to continue operations and our financial condition.
We may not be able to protect our intellectual property rights throughout the world.
Filing, prosecuting and defending patents on our products in all countries throughout the world would be prohibitively expensive. The requirements for patentability may differ in certain countries, particularly developing countries, and the breadth of patent claims allowed can be inconsistent. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States, and we may encounter difficulties in protecting and defending such rights in foreign jurisdictions. Consequently, we may not be able to prevent third parties from practicing our inventions in all
countries outside the United States, or from selling or importing products made using our inventions in and into the United States or other jurisdictions. Competitors may use our technologies in jurisdictions where we have not obtained patent protection to develop their own tests or products and may also export infringing tests or products to territories where we have patent protection, but enforcement is not as strong as in the United States. These products may compete with our products. Our patents or other intellectual property rights may not be effective or sufficient to prevent them from competing.
Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of many other countries do not favor the enforcement of patents and other intellectual property protection, particularly those relating to life science technologies, which could make it difficult for us to stop the infringement of our patents in such countries. We do not have patent rights in certain
foreign countries in which a market may exist. Moreover, in foreign jurisdictions where we do have patent rights, proceedings to enforce our patent rights could result in substantial cost and divert our efforts and attention from other aspects of our
business, could put our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing, and could provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially meaningful. Accordingly, our efforts to enforce our intellectual property rights around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we develop or license. We may not be able to stop a competitor from marketing and selling in foreign countries tests, products and services that are the same as or similar to our products and technologies, in which case our competitive position in the international market would be harmed.
If we are unable to protect the confidentiality of our trade secrets, the value of our technology could be materially adversely affected and our business could be harmed.
In addition to pursuing patents on our technology, we also rely on trade secrets, including unpatented know-how, technology and other proprietary information, to maintain our competitive position. We take steps to protect our trade secrets, in part, by entering into agreements, including confidentiality agreements, non-disclosure agreements and intellectual property assignment agreements, with our employees, consultants, academic institutions, corporate partners and, when needed, our advisers. However, we cannot be certain that such agreements have been entered into with all relevant parties, and we cannot be certain that our trade secrets and other confidential proprietary information will not be disclosed or that competitors will not otherwise gain access to our trade secrets or independently develop substantially equivalent information and techniques. For example, any of these parties may breach the agreements and disclose our proprietary information, including our trade secrets, and once disclosed, we are likely to lose trade secret protection and may not be able to obtain adequate remedies for such breaches. 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. If we are required to assert our rights against such party, it could result in significant cost and distraction.
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.
We also seek to preserve the integrity and confidentiality of our confidential proprietary information by maintaining physical security of our premises and physical and electronic security of our information technology systems, but it is possible that these security measures could be breached. If any of our confidential proprietary information were to be lawfully obtained or independently developed by a competitor, absent patent protection, we would have no right to prevent such competitor from using that technology or information to compete with us, which could harm our competitive position.
We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed confidential information of third parties.
We do and may employ individuals who previously worked with universities or other companies, including potential competitors. We could in the future be subject to claims that we or our employees, consultants, or independent contractors have inadvertently or otherwise used or disclosed alleged trade secrets or other confidential information of current or former employers or competitors. Although we try to ensure that our employees, consultants and independent contractors do not use the intellectual property, proprietary information, know-how or trade secrets of others in their work for us, we may become subject to claims that we caused an individual to breach the terms of his or her non-competition or non-solicitation agreement, or that we or these individuals have, inadvertently or otherwise, used or disclosed the alleged trade secrets or other proprietary information of a current or former employer or competitor. Although, we are currently not subject to any such claims.
While we may litigate to defend ourselves against these claims, even if we are successful, litigation could result in substantial costs and could be a distraction to management and other employees. If our defenses to these claims fail, in addition to requiring us to pay monetary damages, a court could prohibit us from using technologies or features that are essential to our
products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the current or former employers. Therefore, we could be required to obtain a license from such third-party employer to commercialize our products or technology. Such a license may not be available on commercially reasonable terms or at all.
Moreover, any such litigation or the threat thereof may adversely affect our reputation, our ability to form strategic alliances or sublicense our rights to collaborators, engage with scientific advisors or hire employees or consultants, each of which would have an adverse effect on our business, results of operations and financial condition.
If our trademarks and trade names are not adequately protected, then we may not be able to build name recognition in our markets of interest and our business may be adversely affected.*
We have not yet registered certain of our trademarks in all of our potential markets, although we have registered DecisionDx,registrations for, among others, the DiffDx-Melanoma, DecisionDx-UM, DecisionDx-Melanoma, DecisionDx-SCC, MyPath Melanoma, TissueCypher and DecisionDx-MelanomaIDgenetix tests in the United States. Our current or future registered or unregistered trademarks or trade names may be challenged, infringed, circumvented or declared generic or descriptive determined to be infringing on other marks. We may not be able to protect our rights to these trademarks and trade names or may be forced to stop using these names, which we need for name recognition by potential partners or customers in our markets of interest. During trademark registration proceedings, we may receive rejections. Although we would be given an opportunity to respond to those rejections, we may be unable to overcome such rejections. In addition, in the USPTO and in comparable agencies in many foreign jurisdictions, third parties are given an opportunity to oppose pending trademark applications and to seek to cancel registered trademarks. Opposition or cancellation proceedings may be filed against our trademarks, and our trademarks may not survive such proceedings. In addition, third parties have used trademarks similar and identical to our trademarks in foreign jurisdictions and have filed or may in the future file for registration of such trademarks. If they succeed in registering or developing common law rights in such trademarks, and if we are not successful in challenging such third-party rights, we may not be able to use these trademarks to market our products in those countries. If we are unable to establish name recognition based on our trademarks and trade names, we may not be able to compete effectively and our business may be adversely affected. We may license our trademarks and trade names to third parties, such as distributors. Although these license agreements may provide guidelines for how our trademarks and trade names may be used, a breach of these agreements or misuse of our trademarks and tradenames by our licensees may jeopardize our rights in or diminish the goodwill associated with our trademarks and trade names.
We may be subject to claims challenging the inventorship of our patents and other intellectual property.
We or our licensors may be subject to claims that former employees, collaborators or other third parties have an interest in our owned or in-licensed patents, trade secrets or other intellectual property as an inventor or co-inventor. For example, we or our licensors may have inventorship disputes arise from conflicting obligations of employees, consultants or others who are involved in developing our products. Litigation may be necessary to defend against these and other claims challenging inventorship or our or our licensors’ ownership of our owned or in-licensed patents, trade secrets or other intellectual property. If we or our licensors fail in defending any such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights, such as exclusive ownership of, right to use, or right to exclude others from using, intellectual property that is important to our products. Even if we are successful in defending against such claims, litigation could result in substantial costs and be a distraction to management and other employees. Any of the foregoing could have a material adverse effect on our business, financial condition, results of operations and prospects.
In addition, while it is our policy to require our employees and contractors who may be involved in the development of intellectual property to execute agreements assigning such intellectual property to us, we may be unsuccessful in executing such an agreement with each party who in fact develops intellectual property that we regard as our own. Our assignment agreements may not be self-executing or may be breached, and we may be forced to bring claims against third parties, or defend claims they may bring against us, to determine the ownership of what we regard as our intellectual property.
Obtaining and maintaining our patent protection depends on compliance with various required procedures, document submissions, fee payments and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with these requirements.
Periodic maintenance fees, renewal fees, annuity fees and various other governmental fees on patents and/or applications must be paid to the USPTO and various governmental patent agencies outside of the United States at several stages over the lifetime of the patents and/or applications. We have systems in place to remind us to pay these fees, and we employ an outside firm and rely on our outside counsel to pay these fees due to non-U.S. patent agencies. The USPTO and various non-U.S. governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. We employ reputable law firms and other professionals to help us comply, and in many cases, an inadvertent lapse can be cured by payment of a late fee or by other means in accordance with the applicable rules. However, there are situations in which non-compliance can result in abandonment or lapse of the patent or patent application, resulting in
partial or complete loss of patent rights in the relevant jurisdiction, such as failure to respond to official actions within prescribed time limits, non-payment of fees and failure to properly legalize and submit formal documents. If we, or our licensors, fail to maintain the patents and patent applications covering our products and technologies, potential competitors may be able to enter the market without infringing our patents and this circumstance would have a material adverse effect on our business.
Patent terms may be inadequate to protect our competitive position on our products for an adequate amount of time.
Patents have a limited lifespan, and the protection patents afford is limited. In the United States, if all maintenance fees are timely paid, the natural expiration of a patent is generally 20 years from its earliest U.S. non-provisional filing date. Various extensions may be available, but the term of a patent, and the protection it affords, is limited. Even if patents covering our products are obtained, once the patent term has expired, we may be open to competition from competitive tests or products. Given the amount of time required for the development, testing and regulatory review of potential new tests or products, patents protecting such tests or products might expire before or shortly after such tests or products are commercialized. As a result, our owned and licensed patent portfolio may not provide us with sufficient rights to exclude others from commercializing tests or other products similar or identical to ours.
Risks Related to Employee Matters and Managing Growth and Other Risks Related to Our Business
We are highly dependent on the services of our key personnel.*
We are highly dependent on the services of our key personnel, including Derek J. Maetzold, our President and Chief Executive Officer. Although we have entered into agreements with themour key personnel regarding their employment, they are not for a specific term and each of may terminate their employment with us at any time, though we are not aware of any present intention of any of these individuals to leave us.
Our research and development programs and laboratory operations depend on our ability to attract and retain highly skilled scientists and technicians. We may not be able to attract or retain qualified scientists and technicians in the future due to the competition for qualified personnel among life science businesses, particularly near our sole laboratory facilityfacilities and office spaces located in Phoenix, Arizona.Arizona, Pittsburgh, Pennsylvania, San Diego, California and our corporate headquarters in Friendswood, Texas. This competition has become exacerbated by the increase in employee resignations currently taking place throughout the United States as a result of the COVID-19 pandemic, which is commonly referred to as the “great resignation.” We may also experience employee turnover as a result of the ongoing “great resignation.” In response to competition, rising inflation rates and labor shortages, we may need to adjust employee cash compensation, which would affect our operating costs and our margins, or equity compensation, which would affect our outstanding share count and cause dilution to existing stockholders. We also face competition from universities and public and private research institutions in recruiting and retaining highly qualified scientific personnel. We may have difficulties locating, recruiting or retaining qualified sales people.salespeople. Recruiting and retention difficulties can limit our ability to support our research and development and sales programs. All of our employees are at-will, which means that either we or the employee may terminate their employment at any time.
Our employees, clinical investigators, consultants, speakers, vendors and any current or potential commercial partners may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements and insider trading.*
We are exposed to the risk of fraud or other misconduct by our employees, clinical study investigators, consultants, speakers, vendors and any potential commercial partners. Misconduct by these parties could include intentional, reckless and/or negligent conduct or disclosure of unauthorized activities to us that violates: federal laws and regulations or those of comparable foreign regulatory authorities, including those laws that require the reporting of true, complete and accurate information; manufacturing standards; federal and state health and data privacy, security, fraud and abuse, government price reporting, transparency reporting requirements, and other healthcare laws and regulations in the United States and abroad; sexual harassment and other workplace misconduct; or laws that require the true, complete and accurate reporting of financial information or data. 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 have adopted a code of conduct applicable to all of our employees, as well as a disclosure program and other applicable policies and procedures, but it is not always possible to identify and deter employee misconduct, and the 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 significant civil, criminal and administrative penalties, damages, fines, disgorgement, individual imprisonment, exclusion from government funded healthcare programs, such as Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, additional integrity
reporting and oversight obligations, 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.
We may be unable to manage our future growth effectively, which could make it difficult to execute our business strategy.*
We have experienced significant revenue growth in a short period of time. We may not achieve similar growth rates in future periods. You should not rely on our operating results for any prior periods as an indication of our future operating performance. To effectively manage our anticipated future growth, we must continue to maintain and enhance our financial, accounting, human resources, laboratory operations, customer support and sales administration systems, processes and controls. Failure to effectively manage our anticipated growth could lead us to over-invest or under-invest in development, operational and administrative infrastructure, result in weaknesses in our infrastructure, systems, or internal controls, give rise to operational mistakes, losses,
loss of customers, productivity or business opportunities, and result in loss of employees and reduced productivity of remaining employees.
We also anticipate further growth in our business operations. ThisFor example, since May 2021, we have completed the acquisitions of Myriad MyPath Laboratory, Cernostics and AltheaDx, each of which we expect will contribute to our future growth. These acquisitions and other future growth could create strain on our organizational, administrative and operational infrastructure, including laboratory operations, quality control, customer service and sales organization management. We expect to increasecontinue increasing our headcount and to hire more specialized personnel in the future as we grow our business.business and expand our product offerings. We will need to continue to hire, train and manage additional qualified scientists, laboratory personnel, client and account services personnel, and sales and marketing staff and improve and maintain our technology to properlyeffectively manage our growth. If our new hires perform poorly, if we are unsuccessful in hiring, training, managing and integrating these new employees or if we are not successful in retaining our existing employees, our business may be harmed.
In addition, our anticipated growth could require significant capital expenditures and might divert financial resources from other projects such as the development of new diagnostic tests and services. As we commercialize additional diagnostic and prognostic tests, we may need to incorporate new equipment, implement new technology systems, or hire new personnel with different qualifications. Failure to manage this growth or transition could result in turnaround time delays, higher costs, declining quality, deteriorating customer service, and slower responses to competitive challenges. A failure in any one of these areas could make it difficult for us to meet market expectations for our products and could damage our reputation and the prospects for our business.
We may not be able to maintain the quality or expected turnaround times of our products, or satisfy customer demand as it grows. Our ability to manage our growth properly will require us to continue to improve our operational, financial and management controls, as well as our reporting systems and procedures. The time and resources required to implement these new systems and procedures is uncertain, and failure to complete this in a timely and efficient manner could adversely affect our operations. If our management is unable to effectively manage our anticipated growth, our expenses may increase more than expected, our revenue could decline or grow more slowly than expected and we may be unable to implement our business strategy. The quality of our products and services may suffer, which could negatively affect our reputation and harm our ability to retain and attract customers.
U.S. federal income tax reformWe may engage in strategic transactions, such as the acquisition of businesses, assets, products or technologies, which could be disruptive to our existing operations, divert the attention of our management team and adversely affect us.impact our liquidity, cash flows, financial condition and results of operations.*
OnFrom time to time, we may consider strategic opportunities and engage in transactions such as acquisitions of businesses, assets, products or technologies, as well as technology licenses or investments in complementary businesses. For example, in May 2021, December 22, 2017,2021 and April 2022, we completed the U.S. government enacted the TCJA that significantly revises the Internal Revenue Code of 1986, as amended, or the Code. The TCJA, among other things, contains significant changes to corporate taxation, including reductionacquisitions of the corporate tax rate from a top marginal rateMyriad MyPath Laboratory, Cernostics and AltheaDx, respectively. These and any other strategic acquisition transactions may entail numerous operational and financial risks, including:
•delays, difficulties and higher than expected costs associated with integration activities, such as those involving operational processes, regulatory and licensure compliance, personnel and information technology systems;
•disruption of 35%our existing business operations and diversion of management’s time, focus and attention;
•decreases in our liquidity and operating cash flows, increases in our overall operating costs, substantial amounts of amortization expense, increased capital expenditure requirements and non-recurring charges, including possibleimpairments of acquired assets and losses on the remeasurement of contingent consideration;
•incurrence of substantial debt or dilutive issuances of equity securities, the assumption of additional liabilities and exposure to a flat rateunknown liabilities;
•inability to retain key personnel of any acquired businesses; and
•failure to realize any of the tax deduction for interest expenseanticipated revenues, synergies, efficiencies or other benefits of a transaction within our estimated time frame or at all.
With regard to 30% of adjusted earnings (except for certain small businesses), limitationour acquisitions of the deductionMyriad MyPath Laboratory, Cernostics and AltheaDx, actual results may differ materially from our plans and expectations. For example, there can be no assurances regarding our ability to successfully scale and integrate the MyPath Melanoma, TissueCypher and IDgenetix tests into our commercial offerings and the ability of the combined strengths of Castle, the Myriad MyPath Laboratory, Cernostics or AltheaDx to position us for net operating losses generated after December 31, 2017continued growth and success as a leader in the diagnostics space. Further, there are inherent execution and business risks associated with managing the integration and growth objectives of more than one acquisition at the same time and such circumstances may have the effect of heightening the operational and financial risks related to 80%acquisitions noted above and the other risks described in this “Risk Factors” section.
We are unable to predict the timing, size or nature of current year taxable income and elimination of net operating loss carrybacks, one time taxation of offshore earnings at reduced rates regardless ofany future transactions, whether they are repatriated, elimination of U.S. taxwill be completed or financed on foreign earnings (subject to certain important exceptions), immediate deductions for certain new investments instead of deductions for depreciation expense over time, and modifyingfavorable terms, if at all, or repealing many business deductions and credits. We do not expect the TCJA to have a material impact to our current projection of minimal cash taxes for the near future.
However, we continue to examinewhat the impact that the TCJA may haveof those transactions might be on our financial results, including if such transactions are not effectively and profitably integrated into our business. Our failure to successfully complete the integration of any business in the longer term. Accordingly, notwithstanding the reduction in the corporate income tax rate, the overall impact of the TCJA is uncertain andthat we acquire could have an adverse effect on our prospects, business andactivities, cash flows, financial condition, could be adversely affected. In addition, itresults of operations and stock price. Additionally, our ability to successfully integrate, manage and derive financial and other benefits from any acquired business, asset, product or technology is uncertain if and to what extent various states will conform to the TCJA. The impact of the TCJA on holders of our common stock is also uncertain and could be adverse. We urge prospective investors to consult with their legal and tax advisors with respect to the TCJA and the potential tax consequences of investing in or holding our common stock.unproven.
Our ability to use net operating lossesloss carryforwards and certain other tax attributes to offset future taxable income may be subject to limitations.
As of December 31, 2018,2021, we had federal net operating loss (“NOL”) carryforwards of approximately $62.2 million. These$99.4 million, of which $43.5 million will begin to expire in 2030 if not utilized to offset taxable income, and $55.9 million may be carried forward indefinitely. Also, as of December 31, 2021, we had state net operating loss carryforwards couldof $67.5 million, which begin to expire unused and be unavailablein 2028 if not utilized to offset future income tax liabilities.state taxable income.
Under the TCJA,legislation known as the Tax Cuts and Jobs Act of 2017 (“TCJA”), as modified by the CARES Act, federal net operating losses incurredNOLs generated in 2018 and in futuretaxable years beginning after December 31, 2017 may be carried forward indefinitely, but the deductibility of such federal net operating lossesNOL carryforwards in taxable years beginning after December 31, 2020 is limited.limited to 80% of taxable income. It is uncertain if and to what extent various states will conform to the TCJA. TCJA or the CARES Act.
In addition, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, and corresponding provisions of state law, if a corporation undergoes an ‘‘ownership change’’ (which is generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), the corporation’s ability to use its pre-change net operating lossNOL carryforwards and other pre-change tax attributes to offset its post-change income or taxes may be limited. We have experienced an ownership changechanges in the past and we may also experience additional ownership changes in the future as a result of subsequent shifts in ourour stock ownership, some of which may be outside of our control. If an ownership change occurs and our ability to use our net operating loss
NOL carryforwards is materially limited, it would harm our future operating results by effectively increasing our future tax obligations. In addition, at the state level, there may be periods during which the use of NOL carryforwards is suspended or otherwise limited, which could accelerate or permanently increase state taxes owed.
Our business could be negatively impacted by cyber security threats.
We are increasingly dependent uponIf our information technology systems infrastructureor data, or those of third parties upon which we rely, are or were compromised, we could experience adverse consequences resulting from such compromise, including but not limited to regulatory investigations or actions; litigation; fines and data to operatepenalties; disruptions of our business. business operations; reputational harm; loss of revenue or profits; loss of customers or sales; and other adverse consequences.
In the ordinary course of business, we collect, storeProcess proprietary, confidential, and transmit confidentialsensitive information (including but not limited to intellectual property, proprietary business information and personal information). We manage and maintain our applications and information utilizing a combination of on-site systems, managed data centers, and cloud-based data centers, and we are increasingly dependent upon information technology systems, infrastructure and information to operate our business.
It is critical that we do so in a secure manner to maintain the confidentiality, availability and integrity of such confidential information. We also have outsourced elements of our operations to third parties, including third-party service providers and technologies to help operate critical business systems to Process proprietary, confidential and sensitive information, and as a result we manage a number of third-party contractors who have access to our proprietary, confidential and sensitive information. Our ability to monitor these third parties’ cybersecurity information security practices is limited, and these third parties may not have adequate information security measures in place.
Cyberattacks, malicious internet-based activity, and online and offline fraud are prevalent, continue to increase, and are becoming increasingly difficult to detect. Threat actors, personnel (such as through theft or misuse), hacktivist, sophisticated
nation-states, and nation-state-supported actors now engage and are expected to continue to engage in cyber-attacks, including without limitation nation-state actors for geopolitical reasons and in conjunction with military conflicts and defense activities.During times of war and other major conflicts, we and the third parties upon which we rely may be vulnerable to a heightened risk of these attacks, including cyber-attacks that could materially disrupt our systems and operations, supply chain, and ability to produce, sell and distribute our goods and services. Despite the implementation of security measures given their sizedesigned to protect against a security incident, we and complexity and the increasing amounts of confidential information that they maintain, our internal information technology systems and those of our contractors and consultants are potentially vulnerable to breakdown or other damage or interruption froma variety of evolving threats including but not limited to service interruptions, system malfunction, natural disasters, terrorism, war, andpublic health crises, telecommunication and electrical failures, malware (including as well as security breaches from inadvertent or intentional actions by our employees, contractors, consultants, business partners, and/or other third parties, or from cyber-attacks bya result of advanced persistent threat intrusions), malicious third parties (including the deployment of harmful malware,code, ransomware, supply chain attacks, denial-of-service attacks (such as credential stuffing), social engineering and other meansattempts to affect service reliability and threaten the confidentiality, integrity and availability of information), which may compromise our system infrastructure orproprietary, confidential and sensitive information. In particular, ransomware attacks have become increasingly prevalent and severe and can lead to significant interruptions in our operations, loss of data leakage. Toand income, reputational harm, and diversion of funds.Extortion payments may alleviate the extentnegative impact of a ransomware attack, but we may be unwilling or unable to make such payments due to, for example, applicable laws or regulations prohibiting such payments. Supply-chain attacks have also increased in frequency and severity, and we cannot guarantee that anythird parties and infrastructure in our supply chain or our third-party partners’ supply chains have not been compromised or that they do not contain exploitable defects or bugs that could result in a breach of or disruption to our information technology systems (including our services) or the third-party information technology systems that support us and our services. Future or past business transactions (such as acquisitions or integrations) could expose us to additional cybersecurity risks and vulnerabilities, as our systems could be negatively affected by vulnerabilities present in acquired or integrated entities’ systems and technologies. Any of the previously identified or similar threats could cause a disruption or security breach were toincident, which could result in aunauthorized, unlawful, or accidental loss of, or damage to, our data or applications, or inappropriatemodification of, destruction of, alteration of, encryption of, disclosure of, confidentialaccess to, or proprietary information, we could incur liability and reputational damage and the further development and commercializationacquisition of our productsinformation and could be delayed.interrupt our ability to provide our services.
While we have not experienced any such system failure, accident or material security breachincident to date, we cannot assureassure you that our data protection efforts and our investment in information technology have or will prevent significant breakdowns, data leakages, breachessecurity incidents, and we may be unable in the future to detect vulnerabilities in our information technology systems because such threats and techniques change frequently, are often sophisticated in nature, and may not be detected until after a security incident has occurred. Applicable data privacy and security obligations may require us to notify relevant stakeholders of security incidents, including affected individuals, the Secretary of the HHS, states Attorneys General and others.Such disclosures are costly, and the disclosures or failure to comply could lead to adverse consequences.
If we or a third party upon whom we rely experience a security incident or are perceived to have experienced a security incident, we may experience government enforcement actions, additional reporting requirements and/or oversight, restrictions on Processing data (including personal information), litigation, indemnification obligations, negative publicity, reputational harm, monetary fund diversions, interruptions in our operations, and other cyber incidents that could have a material adverse effect uponharms.Such consequences may disrupt our operations (including our ability to conduct our analyses, provide test results, bill payors or patients, process claims and appeals, provide customer assistance, conduct research and development activities, collect, process, and prepare company financial information, provide information about our products and other patient and physician education and outreach efforts through our website, and manage the administrative aspects of our business), damage our reputation, negatively impact our ability to grow our business, operations or financial condition.and others. For example, we maintain a tumor specimen database comprised of over 38,00060,000 samples.Some of these samples some of which were used to develop and validate DecisionDx-Melanoma, someand, of whichthose, some are currently being used to improve onupon the test and some of which will be used in the future. If we were to lose this database, our ability to further validate, improve and therefore maintain and grow sales of DecisionDx-Melanoma could be significantsignificantly impaired.
Furthermore, significant disruptionsOur contracts may not contain limitations of liability, and there can be no assurance that the limitations of liability in our internal information technology systemscontracts would be enforceable or security breaches could result in the loss, misappropriation, and/adequate or unauthorized access, use,would otherwise protect us from liabilities or disclosure of, or the prevention of access to, confidential information (including trade secrets or other intellectual property, proprietary business information, and personal information), which could result in financial, legal, business, and reputational harm to us. For example, any such event that leads to unauthorized access, use, or disclosure of personal information, including personal information related to our patient samples or employees, could harm our reputation directly, compel usdamages if we fail to comply with federal and/or state breach notification laws and foreign law equivalents, subject us to mandatory corrective action, and otherwise subject us to liability under laws and regulations that protect theapplicable privacy and security obligations. We cannot be sure that our insurance coverage will be adequate or sufficient to protect us from or adequately mitigate liabilities or damages with respect to claims, costs, expenses, litigation, fines, penalties, business loss, information loss, regulatory actions or material adverse impacts arising out of personal information, which could result in significant legalour privacy and financial exposure and reputational damagessecurity practices, Processing or security incidents we may experience, or that could potentially have an adverse effectsuch coverage will continue to be available on our business.commercially reasonable terms or at all.
Product or professional liability lawsuits against us could cause us to incur substantial liabilities and could limit our commercialization of our products.
We face an inherent risk of product and professional liability exposure related to our products. The marketing, sale and use of our products could lead to the filing of product liability claims were someone to allege that our products identified or reported inaccurate or incomplete information, or otherwise failed to perform as designed. We may also be subject to liability for errors
in, a misunderstanding of or inappropriate reliance upon, the information we provide in the ordinary course of our business activities.
If we cannot successfully defend ourselves against claims that our products caused injury or otherwise failed to function properly, we could incur substantial liabilities. Regardless of merit or eventual outcome, product liability claims may result in:
•decreased demand for our current tests any tests that we may develop, and the inability to commercialize such tests;
•injury to our reputation and significant negative media attention;
•reluctance of experts willing to conduct our clinical studies;
•initiation of investigations by regulators;
•significant costs to defend the related litigation and diversion of management’s time and our resources;
•substantial monetary awards to study subjects or patients;
•product recalls, withdrawals or labeling, or marketing or promotional restrictions; and
•loss of revenue.
We currently carry product liability insurance. However, the amount of this insurance may not be adequate to cover all liabilities that we may incur. Insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost or in an amount adequate to satisfy any liability that may arise.
International expansion of our business exposes us to business, regulatory, political, operational, financial, and economic risks associated with doing business outside of the United States.*
WeWhile we currently do not accept orders from customers outside of the United States, but our long termhistorical business strategy incorporateshas been directed toward customers within the United States. Our long-term business strategy contemplates potential international expansion. Doing business internationally involves a number of risks, including:
•multiple, conflicting and changing laws and regulations such as privacy regulations, tax laws, export and import restrictions, economic sanctions and embargoes, employment laws, regulatory requirements and other governmental approvals, permits and licenses;
•limits in our ability to penetrate international markets if we are not able to perform tests locally;
•logistics and regulations associated with shipping tissue samples, including infrastructure conditions and transportation delays;
•difficulties in staffing and managing foreign operations;
•failure to obtain regulatory approvals for the commercialization of our products in various countries;
•complexities and difficulties in obtaining intellectual property protection and enforcing our intellectual property;
•complexities associated with managing multiple payor reimbursement regimes, government payors, or patient self-pay systems;
•financial risks, such as longer payment cycles, difficulty collecting accounts receivable, the impact of local and regional financial crises on demand and payment for our products and exposure to foreign currency exchange rate fluctuations;
•natural disasters, political and economic instability, including wars, terrorism, and political unrest, outbreak of disease, boycotts, curtailment of trade and other business restrictions; and
•regulatory and compliance risks that relate to maintaining accurate information and control over sales and distributors’ activities that may fall within the purview of the U.S. Foreign Corrupt Practices Act or FCPA,(“FCPA”) its books and records provisions, or its anti-bribery provisions.
Additionally, financial markets around the world experienced volatility following the invasion of Ukraine by Russia in February 2022. In response to the invasion, the United States, United Kingdom and EU, along with others, imposed significant new sanctions and export controls against Russia, Russian banks and certain Russian individuals and may implement additional sanctions or take further punitive actions in the future. The full economic and social impact of the sanctions imposed on Russia (as well as possible future punitive measures that may be implemented), as well as the counter measures imposed by Russia, in addition to the ongoing military conflict between Ukraine and Russia, which could conceivably expand into the surrounding region, remains uncertain; however, both the conflict and related sanctions have resulted and could continue to result in disruptions to trade, commerce, pricing stability, credit availability, and/or supply chain continuity, in both Europe and globally,
and has introduced significant uncertainty into global markets. While we do not operate in Russia, Ukraine or Eastern Europe, as the adverse effects of this conflict continue to develop and potentially spread, both in Europe and throughout the rest of the world, our business and results of operations may be adversely affected, particularly to the extent this conflict escalates to involve additional countries, further economic sanctions or wider military conflict. Any of these factors could significantly harm our future international expansion and operations and, consequently, our revenue and results of operations.
Requirements associated with being a public company will continue to increase our costs significantly, as well as divert significant company resources and management attention.*
We are subject to the reporting requirements of the Exchange Act or the other rules and regulations of the SEC orand any securities exchange relating to public companies. Sarbanes-Oxley, as well as rules subsequently adopted by the SEC and Nasdaq to implement provisions of Sarbanes-Oxley, impose significant requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Further, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, the SEC has adopted additional rules and regulations in these areas, such as mandatory ‘‘say on pay’’ voting requirements that willnow apply to us whensince we cease to beare no longer an emerging growth company.company effective December 31, 2021. Stockholder activism, the current political environment and the current high level of government intervention and regulatory reform may lead to substantial new regulations and disclosure obligations, which may lead to additional compliance costs and impact the manner in which we operate our business in ways we cannot currently anticipate. Compliance with the various reporting and other requirements applicable to public companies requires considerable time and attention of management. We cannot assure you that we will satisfy our obligations as a public company on a timely basis.
We expect the rules and regulations applicable to public companies to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly. We were previously afforded exemptions from certain public company reporting requirements as a result of our status as an emerging growth company. Effective December 31, 2021, we ceased to be an emerging growth company. If we are unable to comply with these requirements diverton a timely basis or if the attention of our management and personnel is diverted from other business concerns, theyit could have a material adverse effect on our business, financial
condition and results of operations. The increased costs will increase our net loss or decrease our net income, or increase our net loss, and may require us to reduce costs in other areas of our business or increase the prices of our products. In addition, as a public company,we expand, it may be more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified personnel to serve on our board of directors, our board committees or as executive officers.
If we fail to comply with environmental, health and safety laws and regulations, we could become subject to fines or penalties or incur costs that could have a material adverse effect on the success of our business.
We, and the third parties with whom we share our facilities, are subject to numerous environmental, health and safety laws and regulations, including those governing laboratory procedures and the handling, use, storage, treatment and disposal of hazardous materials and wastes. Each of our operations involve the use of hazardous and flammable materials, including chemicals and biological and radioactive materials. Our operations also produce hazardous waste. We generally contract with third parties for the disposal of these materials and wastes. We cannot eliminate the risk of contamination or injury from these materials. We could be held liable for any resulting damages in the event of contamination or injury resulting from the use of hazardous materials by us or the third parties with whom we share our facilities, and any liability could exceed our resources. We also could incur significant costs associated with civil or criminal fines and penalties.
Although we maintain workers’ compensation insurance to cover us for costs and expenses we may incur due to injuries to our employees resulting from the use of hazardous materials, this insurance may not provide adequate coverage against potential liabilities. We do not maintain insurance for environmental liability or toxic tort claims that may be asserted against us in connection with our storage or disposal of biological, hazardous or radioactive materials.
In addition, we may incur substantial costs in order to comply with current or future environmental, health and safety laws and regulations. These current or future laws and regulations may impair our research and development. Failure to comply with these laws and regulations also may result in substantial fines, penalties or other sanctions.
Our business could be adversely impacted by inflation.*
In 2021, the rate of inflation in the United States began to increase and has since risen to levels not experienced in over 40 years. We are experiencing inflationary pressures, primarily in personnel costs, and we anticipate impacts on other cost areas within the next twelve months. The extent of any future impacts from inflation on our business and our results of operations will be dependent upon how long the elevated inflation levels persist and the extent to which the rate of inflation further increases, if at all, neither of which we are able to predict. If elevated levels of inflation were to persist or if the rate of inflation were to accelerate, the purchasing power of our cash and cash equivalents may be diminished, our expenses could increase
faster than anticipated and we may utilize our capital resources sooner than expected. Further, given the complexities of the reimbursement landscape in which we operate, our payors may be unwilling or unable to increase reimbursement rates to compensate for inflationary impacts. As such, the effects of inflation may adversely impact our results of operations, financial condition and cash flows.
Our business could be adversely affected by natural disasters, public health epidemics and other events beyond our control.*
Although we maintain crisis management plans, our business operations are subject to interruption by natural disasters and other events and catastrophes beyond our control, including, but not limited to, earthquakes, floods, fires, tornadoes, hurricanes, power or other utility outages, telecommunications failures and public health crises. Further, outbreaks of epidemic diseases, such as the COVID-19 pandemic discussed above, or Russia’s invasion of Ukraine in February 2022, or the fear of such events, could provoke responses, including government-imposed travel restrictions that could impede the mobility and effectiveness of our sales force, disrupt our operations or those of our suppliers and service providers. The ultimate impact of any of these or similar events is highly uncertain and could have a material adverse impact on our operations.
Risks Related to Ownership of Our Common Stock
The stock price of our common stock may be volatile or may decline regardless of our operating performance, and you may lose all or part of your investment.*
The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:
•our operating performance and the performance of other similar companies;
•our success in marketing and selling our products;
•reimbursement determinations by third-party payors and reimbursement rates for our products;
•changes in our projected operating results that we provide to the public, our failure to meet these projections or changes in recommendations by securities analysts that elect to follow our common stock;
•regulatory or legal developments in the United States and other countries;
•the level of expenses related to product development and clinical studies for our products;
•our ability to achieve product development goals in the timeframetimeframes we announce;
•announcements of clinical study results, regulatory developments, acquisitions, strategic alliances or significant agreements by us or by our competitors;
•the success or failure of our efforts to acquire, license or develop additional tests;
•recruitment or departure of key personnel;
the economy as a whole•general economic conditions and market conditions inspecific to our industry;
•interest rates and the rate of inflation;
•the extent and duration of the impacts on our operations of general political and economic conditions, including the COVID-19 pandemic, the invasion of Ukraine by Russia, economic slowdowns, recessions or market corrections, the duration and effects of elevated inflation, rising interest rates and tightening of credit markets resulting from the pandemic, the conflict or another cause;
•trading activity by a limited number of stockholders who together beneficially own a significant percentage of our outstanding common stock;
the expiration of market standoff or contractual lock-up agreements;
•the size of our market float; and
•any other factors discussed in this Quarterly Report on Form 10-Q.
For example, following our April 4, 2022 announcement of our entry into a definitive agreement to acquire AltheaDx, our stock price decreased 16.5% the next day and experienced further declines in the days that followed. In addition, the stock market in general, and diagnostic and life sciences companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our securities, regardless of our actual operating performance. In the past, stockholders of other companies have filed securities class action litigation following periods of market volatility. If we were to become involved in securities litigation, it could subject us to substantial costs, divert resources and the attention of management from our business and adversely affect our business.
If there are substantial sales of shares of our common stock, the price of our common stock could decline.*
The price of our common stock could decline if there are substantial sales of our common stock, particularly sales by our directors, executive officers and significant stockholders, or if there is a large number of shares of our common stock available for sale and the market perceives that sales will occur. As of August 30, 2019, we had 17,069,094 shares of common stock outstanding. Of these shares, only the 4,600,000 shares sold in the IPO are currently freely tradable, without restriction, in the public market. All of our other outstanding shares of common stock are currently restricted from resale as a result of market standoff and lock-up agreements and will become available to be sold on January 21, 2020, which is 181 days after the date of the underwriting agreement we entered into in connection with the IPO. Shares held by directors, executive officers and other affiliates are subject to volume limitations under Rule 144 under the Securities Act of 1933, as amended, or the Securities Act.
Certain of our stockholders have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or our stockholders, subjectstockholders. We filed such a registration statement in January 2022 to market standoffregister the resale of shares of our common stock issuable in connection with our acquisition of Cernostics in December 2021. In June 2022, we filed a registration statement to register the resale of shares of our common stock that were issued and lockup agreements.that may be issuable in connection with our acquisition of AltheaDx in April 2022. We have registered shares of common stock that we have issued and may issue under our employee equity incentive plans. As a result, these shares will be able to be sold freely in the public market upon issuance, subject to existing market standoff or lock-up agreements. SVB Leerink LLC and Robert W. Baird & Co. Incorporated, as the representatives of the underwriters in the IPO may, in their discretion, permit our stockholders to sell shares prior to the expiration of the restrictive provisions contained in those lock-up agreements.issuance.
The market price of the shares of our common stock could decline as a result of the sale of a substantial number of our shares of common stock in the public market or the perception in the market that the holders of a large number of shares intend to sell their shares.
We have broad discretion in the use of working capital and may not use it effectively or in ways that increase our share price.*
We cannot specify with any certainty the particular uses of working capital, but we currently expect such uses will include: funding selling and marketing activities, including expansion of our sales force to support the ongoing commercialization of current and future products; research and development related to the continued support of our current products, as well as the development of our product pipeline; and other general corporate purposes, including acquisitions and the additional costs associated with being a public company. The failure by our management to apply our working capital effectively could adversely affect our business and financial condition. Pending its use, we may invest working capital in a manner that does not produce income or that loses value. These investments may not yield a favorable return to our investors.
If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.*
The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our common stock or publish inaccurate or unfavorable research about our business, our common stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our common stock could decrease, which might cause our common stock price and trading volume to decline.
Our disclosure controls and procedures may not prevent or detect all errors or acts of fraud.*
We are subject to the periodic reporting requirements of the Exchange Act. We designed our disclosure controls and procedures to reasonably assure that information we must disclose in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. We believe that any disclosure controls and procedures or internal controls and procedures, no matter how well-conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. For example, our directors or executive officers could inadvertently fail to disclose a new
relationship or arrangement causing us to fail to make any related party transaction disclosures. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by an unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected. In addition, we do not have a risk management program or processes or procedures for identifying and addressing risks to our business in other areas.
We have and may continue to enter into related party transactions that create conflicts of interest, or the appearances of conflicts of interest, which may harm our business and cause our stock price to decline.*
We have entered into related party transactions that create conflicts of interest between our interests and the interests of our directors and executive officers. For example, we employ three children and a brother-in-law of Derek J. Maetzold, our President and Chief Executive Officer, three children and a son-in-law of Kristen M. Oelschlager, our Chief Operating Officer, and the son of Tobin W. Juvenal, our Chief Commercial Officer, in each case in non-officer positions. Additionally, Derek J. Maetzold and Daniel M. Bradbury, the chairperson of our board of directors, each served on the board of directors of AltheaDx,
a commercial-stage molecular diagnostics company that we acquired in April 2022. Further, each of the following individuals was a direct or indirect beneficial owner of AltheaDx securities and received consideration in the transaction: Mr. Bradbury; Mr. Maetzold; Thomas Sullivan, John Maetzold and Peter Maetzold, immediate family members of Mr. Maetzold; Frank Stokes, our Chief Financial Officer; Tobin Juvenal, our Chief Commercial Officer; Kristen Oelschlager, our Chief Operating Officer; and Joshua Albers and Allysa Topel, immediate family members of Ms. Oelschlager.
These types of related party arrangements are an emerging growth companyrequired to be disclosed in our annual proxy statement and/or in the notes to our consolidated financial statements based on certain criteria. We may engage in other transactions in the future involving our executive officers, directors and their family members and/or entities which they control or are affiliated, which could cause individuals in our management to seek to advance their economic interests or the economic interests of certain related parties above ours. Although we have a written policy on related party transactions that involves independent review and oversight by the audit committee of our board of directors, there can be no assurances that conflicts of interest will not exist, or that we will be able to adequately address or mitigate any actual or perceived conflicts of interest, and stockholders, analysts, proxy advisory firms, the news media and other parties may view these transactions as representing conflicts of interest or as otherwise inappropriate, which may result in negative public perception and reputational harm, and could impair our ability to enter into new customer relationships or attract and retain employees. Potential, perceived and actual conflicts of interest could cause investors to question the independence of our management, the adequacy and effectiveness of our disclosure controls and procedures or the integrity of our corporate governance procedures and compensation practices, which could have a material adverse effect on the trading price of our common stock and our business, financial condition and results of operations.
We are a smaller reporting company and we cannot be certain if the reduced reportingscaled disclosure requirements applicable to emerging growthsmaller reporting companies will make our common stock less attractive to investors.*
We are an emerging growth companyEffective as defined in the JOBS ACT, and we intend to take advantage of some of the exemptions from reporting requirements that are applicable to other public companies that are not emerging growth companies, including:
being permitted to provide only two years of audited financial statements, in addition to any required unaudited interim financial statements, with correspondingly reduced ‘‘Management’s Discussion and Analysis of Financial Condition and Results of Operations’’ disclosure;
not being required to comply with the auditor attestation requirements in the assessment of our internal control over financial reporting;
not being required to comply with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements;
reduced disclosure obligations regarding executive compensation; and
not being required to hold a non-binding advisory vote on executive compensation or obtain stockholder approval of any golden parachute payments not previously approved.
In addition, as an emerging growth company the JOBS Act allows us to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We have elected to use this extended transition period under the JOBS Act. We may take advantage of these reporting exemptions until we are no longer an emerging growth company. We will remain an emerging growth company until the earlier of (1) the last day of the fiscal year (a) following the fifth anniversary of the completion of the IPO, or July 29, 2024, (b) in whichJune 30, 2022, we have total annual gross revenue of at least $1.07 billion or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700 millionrequalified as of the prior June 30th and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.
We are also a smaller reporting company as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an emerging growth company. We may take advantage of certain of the scaled disclosures available to smaller reporting companies beginning with this Quarterly Report on Form 10-Q and will be able to take advantage of these scaled disclosures for so long as the market value of our voting and non-voting common stock held by non-affiliates is less than $250.0 million measured on the last business day of our second fiscal quarter, or our annual revenue is less than $100.0 million during the most recently completed fiscal year and the market value of our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.
We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions.scaled disclosures. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
We do not intend to pay dividends for the foreseeable future.
We have never declared nor paid cash dividends on our capital stock. We currently intend to retain any future earnings to finance the operation and expansion of our business, and we do not expect to declare or pay any dividends in the foreseeable future. In addition, the terms of the 2018 LSA precludes us from paying dividends without prior consent. Consequently, stockholders must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investment.
The concentration of our stock ownership will likely limit your ability to influence corporate matters, including the ability to influence the outcome of director elections and other matters requiring stockholder approval.*
Based upon shares outstanding as of AugustJune 30, 2019,2022, our executive officers, directors and the known holders of more than 5% of our outstanding common stock, in the aggregate, beneficially owned approximately 37% 27%of our common stock. As a result, these stockholders, acting together, will have significant influence over all matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate actions might be taken even if other stockholders oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.
Delaware law and provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make a merger, tender offer or proxy contest difficult, thereby depressing the trading price of our common stock.*
Provisions of our amended and restated certificate of incorporation and amended and restated bylaws may delay or discourage transactions involving an actual or potential change in our control or change in our management, including transactions in which stockholders might otherwise receive a premium for their shares or transactions that our stockholders might otherwise deem to be in their best interests. Therefore, these provisions could adversely affect the price of our common stock. Among other things, our amended and restated certificate of incorporation and amended and restated bylaws:
•permit our board of directors to issue up to 10,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate (including the right to approve an acquisition or other change in our control);
•provide that the authorized number of directors may be changed only by resolution of the board of directors;
•provide that the board of directors or any individual director may only be removed with cause and the affirmative vote of the holders of at least 66-2/3% of the voting power of all of our then outstanding common stock;
•provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;
•divide our board of directors into three classes;
•require that any action to be taken by our stockholders must be effected at a duly called annual or special meetingmeetings of stockholders and not be taken by written consent;
•provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide notice in writing in a timely manner and also specify requirements as to the form and content of a stockholder’s notice;
•do not provide for cumulative voting rights (therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose);
•provide that special meetings of our stockholders may be called only by the chairmanchairperson of the board, our Chief Executive Officer or by the board of directors pursuant to a resolution adopted by a majority of the total number of authorized directors;
•provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware (or, if and only if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, any state court located within the State of Delaware or, if and only if all such state courts lack subject matter jurisdiction, the federal district court for the District of Delaware) will be the sole and exclusive forum for the following types of actions or proceedings under Delaware statutory or common law: (i) any derivative action or proceeding brought on our behalf; (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any of our current or former directors, officers or other employees to us or our stockholders; (iii) any action or proceeding asserting a claim against us or any of our current or former directors, officers or other employees, arising out of or pursuant to any provision of the Delaware General Corporation Law, our certificate of incorporation or our bylaws; (iv) any action or proceeding to interpret, apply, enforce or determine the validity of our certificate of incorporation or our bylaws; (v) any action or proceeding as to which the Delaware General Corporation Law confers jurisdiction to the Court of Chancery of the State of Delaware; and (vi) any action asserting a claim against us or any of our directors, officers or other employees governed by the internal affairs doctrine, in all cases to the fullest extent permitted by law and subject to the court’s having personal jurisdiction over the indispensable parties named as defendants; provided these provisions of our amended and restated certificate of incorporation and amended and restated bylaws will not apply to
suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the federal courts have exclusive jurisdiction; and
•provide that unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act, subject to and contingent upon a final adjudication in the State of Delaware of the enforceability of such exclusive forum provision.
The amendment of any of these provisions, with the exception of the ability of our board of directors to issue shares of preferred stock and designate any rights, preferences and privileges thereto, would require approval by the holders of at least 66-2/3% of our then-outstanding common stock.
In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law. These provisions may prohibit large stockholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time. A Delaware corporation may opt out of this provision by express provision in its original certificate of incorporation or by amendment to its certificate of incorporation or bylaws approved by its stockholders. However, we have not opted out of this provision.
These and other provisions in our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirorsacquirers to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including delay or impede a merger, tender offer or proxy contest involving our company. The existence of these provisions could negatively affect the price of our common stock and limit opportunities for you to realize value in a corporate transaction.
Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware is the exclusive forum for certain disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.*
Our amended and restated certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware (or, if and only if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, any state court located within the State of Delaware or, if and only if all such state courts lack subject matter jurisdiction, the federal district court for the District of Delaware) will be the sole and exclusive forum for the following types of actions or proceedings under Delaware statutory or common law: (i) any derivative action or proceeding brought on our behalf; (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any of our current or former directors, officers or other employees to us or our stockholders; (iii) any action or proceeding asserting a claim against us or any of our current or former directors, officers or other employees arising out of or pursuant to any provision of the Delaware General Corporation Law, our amended and restated certificate of incorporation or amended and restated bylaws; (iv) any action or proceeding to interpret, apply, enforce or determine the validity of our amended and restated certificate of incorporation or our amended and restated bylaws; (v) any action or proceeding as to which the Delaware General Corporation Law confers jurisdiction to the Court of Chancery of the State of Delaware; and (vi) any action asserting a claim against us or any of our directors, officers or other employees that is governed by the internal affairs doctrine, in all cases to the fullest extent permitted by law and subject to the court’s having personal jurisdiction over the indispensable parties named as defendants; provided these provisions would not apply to suits brought to enforce a duty or liability created by the Exchange Act, or any other claim for which the federal courts have exclusive jurisdiction. In addition,This provision would not apply to suits brought to enforce a duty or liability created by the Exchange Act. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated certificate of incorporation and amended and restated bylaws provide that unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act, subject to and contingent upon a final adjudication in the State of Delaware of the enforceability of such exclusive forum provision. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring a claim in a venue other than those designated in the exclusive forum provisions. In such instance, we would expect to vigorously assert the validity and enforceability of the exclusive forum provisions of our amended and restated certificate of incorporation. This may require significant additional costs associated with resolving such action in other jurisdictions and there can be no assurance that the provisions will be enforced by a court in those other jurisdictions.
These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees and may discourage these types of lawsuits. Furthermore, the enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that a court could find these types of provisions to be inapplicable or unenforceable. If a court were to find the choice of forum provisions contained in our amended and restated certificate of incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Recent Sales of Unregistered Equity Securities
During the six months ended June 30, 2019, we granted stock options to purchase an aggregate of 510,355 shares of our common stock at a weighted-average exercise price of $3.46 per share, to certain of our employees, consultants and directors in connection with services provided to us by such persons. During the six months ended June 30, 2019, options to purchase 276,237 shares have been exercised for aggregate consideration of approximately $418,000 and options to purchase 10,698 shares have been canceled. The offers, sales and issuances of the foregoing stock options were deemed to be exempt from registration under the Securities Act in reliance on either Rule 701 in that the transactions were under compensatory benefit plans and contracts relating to compensation as provided under Rule 701 or Section 4(a)(2) in that the issuance of securities to the accredited investors did not involve a public offering. The recipients of such securities were our employees, directors or bona fide consultants and received the securities under our 2008 Stock Plan and our 2018 Equity Incentive Plan.
Use of Proceeds from IPO of Common Stock
On July 29, 2019, we completed the IPO, pursuant to which we issued and sold 4,600,000 shares of our common stock, including 600,000 shares associated with the full exercise of the underwriters’ option to purchase additional shares, at a price to the public of $16.00 per share.
The offer and sale of all of the shares of our common stock in the IPO were registered under the Securities Act pursuant to our Registration Statements on Form S-1, as amended (File Nos. 333-232369 and 333-232796), which were declared or became effective on July 24, 2019. SVB Leerink LLC and Robert W. Baird & Co. Incorporated acted as joint book-running managers for the IPO and as representatives of the underwriters. Canaccord Genuity LLC and BTIG, LLC acted as co-managers for the IPO.
We received gross proceeds from the IPO of $73.6 million, or net proceeds of $66.0 million after deducting $5.2 million in underwriting discounts and commissions and $2.4 million of offering expenses. None of the underwriting discounts and commissions or offering expenses were incurred or paid, directly or indirectly, to any of our directors or officers or their associates or to persons owning 10% or more of our common stock or to any of our affiliates.
There has been no material change in our planned use of the net proceeds from the IPO as described in the Prospectus.final prospectus filed with the SEC on July 26, 2019, relating to our Registration Statements on Form S-1 (File Nos. 333-232369 and 333-232796).
Since the effective date of our registration statement through June 30, 2022, we have not used any of the net proceeds from the IPO. Pending such uses, we have invested, and plan to continue to invest, the balance of the net proceeds from the IPO in cash and cash equivalent securities or highly liquid investment securities.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
None.
Item 6. Exhibits.
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Exhibit Number | | Description of document |
3.12.1#+ | | Agreement and Plan of Merger, dated October 18, 2021, by and among the Registrant, Space Merger Sub, Inc., Cernostics, Inc., and Shareholder Representative Services LLC, incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K, as amended, originally filed with the SEC on December 6, 2021. |
2.2#+ | | |
3.1 | | |
3.2 | | |
4.1 | | |
10.1#4.2 | | |
31.1*10.1# | | |
31.1* | | |
31.2* | | |
32.1** | | |
32.2** | | |
101.INS* | | Inline XBRL Instance Document.Document—the instance document does not appear in the Interactive Data File as its XBRL tags are embedded within the Inline XBRL document. |
101.SCH* | | Inline XBRL Taxonomy Extension Schema Document.Schema. |
101.CAL* | | Inline XBRL Taxonomy Extension Calculation Linkbase Document.Linkbase. |
101.DEF* | | Inline XBRL Taxonomy Extension Definition Linkbase Document.Linkbase. |
101.LAB* | | Inline XBRL Taxonomy Extension Label Linkbase Document.Linkbase. |
101.PRE* | | Inline XBRL Taxonomy Extension Presentation Linkbase Document.Linkbase. |
104* | | Cover Page Interactive Data File (embedded within the Inline XBRL and contained in Exhibit 101). |
______________
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# | Certain portions of this exhibit (indicated by “[***]”) have been omitted as we have determined (i) the omitted information is not material and (ii) the omitted information would likely cause harm to us if publicly disclosed. |
* Filed herewith
** Furnished herewith.
# Schedules and exhibits to this exhibit have been omitted pursuant to Item 601(a)(5) of Regulation S-K. A copy of any omitted schedule or exhibit will be furnished to the SEC upon request; provided, however, that we may request confidential treatment pursuant to Rule 24b-2 of the Exchange Act for any schedule or exhibit so furnished.
+ Pursuant to Item 601(b)(2) of Regulation S-K, certain portions of this exhibit have been omitted (indicated by “[***]”) because we have determined that the information is not material and is the type that we treat as private or confidential. In addition, certain schedules and exhibits have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule or exhibit will be furnished to the SEC upon request; provided, however, that we may request confidential treatment pursuant to Rule 24b-2 of the Exchange Act for any schedule or exhibit so furnished.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | | CASTLE BIOSCIENCES, INC. |
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Date: | August 8, 2022 | | By: | /s/ Derek J. Maetzold |
| | | | Derek J. Maetzold President and Chief Executive Officer (Principal Executive Officer) |
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Date: | August 8, 2022 | | CASTLE BIOSCIENCES, INC. |
By: | | | | |
Date: | September 3, 2019 | | By: | /s/ Derek J. Maetzold |
| | | | Derek J. Maetzold
President and Chief Executive Officer
(Principal Executive Officer)
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| | | | |
Date: | September 3, 2019 | | By: | /s/ Frank Stokes |
| | | | Frank Stokes Chief Financial Officer
(Principal Financial and Accounting Officer)
|