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Table of Contents

As filed with the Securities and Exchange Commission on January 23, 2013

Registration No. 333-184121

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 4

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

AutoGenomics, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   3826   80-0252299

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

2980 Scott Street

Vista, California 92081

(760) 477-2248

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

 

 

Fareed Kureshy

President and Chief Executive Officer

AutoGenomics, Inc.

2980 Scott Street

Vista, California 92081

(760) 477-2248

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

 

 

Copy to:

 

Todd A. Hentges

Timothy R. Rupp

Bingham McCutchen LLP

600 Anton Boulevard, 18th Floor

Costa Mesa, CA 92626-7653

(714) 830-0600

 

Charles S. Kim

Sean M. Clayton

Cooley LLP

4401 Eastgate Mall

San Diego, CA 92121-1909

(858) 550-6000

 

 

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

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

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

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

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

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

 

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

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of Each Class of

Securities to be Registered

 

Proposed Maximum

Aggregate Offering Price (1) (2)

  Amount of
Registration Fee (3)

Common Stock, $0.01 par value

  $75,900,000   $8,936

 

 

(1) Estimated solely for the purpose of computing the amount of the registration fee, in accordance with Rule 457(o) promulgated under the Securities Act of 1933.
(2) Includes offering price of shares that the underwriters have the option to purchase to cover overallotments, if any.
(3) Calculated pursuant to Rule 457(o) under the Securities Act of 1933, as amended, based on an estimate of the proposed maximum aggregate offering price. $7,449 of this amount was previously paid.

 

 

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.

 

 

 


Table of Contents

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

 

SUBJECT TO COMPLETION, DATED JANUARY 22, 2013

Preliminary Prospectus

6,000,000 Shares

 

LOGO

Common Stock

 

 

We are offering 6,000,000 shares of our common stock. This is our initial public offering, and no public market currently exists for our common stock. We expect the initial public offering price to be between $9.00 and $11.00 per share. We have applied to list our common stock on the NASDAQ Global Market under the symbol “AGMX.”

We are an “emerging growth company,” as defined under federal securities laws, and have elected to comply with certain reduced public company reporting requirements available to such companies.

Investing in our common stock involves a high degree of risk. Please read “Risk Factors” beginning on page 20.

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

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discounts and commissions

   $         $     

Proceeds, before expenses, to us

   $         $     

Delivery of the shares of common stock is expected to be made on or about                    , 2013. We have granted the underwriters an option for a period of 30 days to purchase, on the same terms and conditions set forth above, up to an additional 900,000 shares of our common stock to cover overallotments. If the underwriters exercise the option in full, the total underwriting discounts and commissions payable by us will be $         and the total proceeds to us, before expenses, will be $        .

 

 

Leerink Swann

 

 

Stephens Inc.      Mizuho Securities

 

Cantor Fitzgerald & Co.

The date of this prospectus is                    , 2013.


Table of Contents

LOGO

 

Not all products have received all necessary domestic or international regulatory approvals or clearances for commercial sale. The vast majority of products sold by AutoGenomics are offered for sale to allow for the collection of research data, and may only be used for clinical purposes by laboratories certified under the Clinical Laboratory Improvements Amendments of 1988 and that have incorporated the products into laboratory-developed tests pursuant to guidelines issued by the College of American Pathologists. The FDA has not adopted these guidelines and AutoGenomics is not permitted to represent these products as in vitro diagnostic products.


Table of Contents

Table of Contents

 

Prospectus Summary

     1   

Risk Factors

     20   

Special Note Regarding Forward-Looking Statements

     46   

Market, Industry and Other Data

     47   

Use of Proceeds

     48   

Dividend Policy

     49   

Capitalization

     50   

Dilution

     52   

Selected Financial Data

     54   

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

     56   

Business

     87   

Management

     122   

Executive Compensation

     128   

Principal Stockholders

     144   

Certain Relationships and Related Persons Transactions

     146   

Description of Capital Stock

     150   

Shares Eligible for Future Sale

     154   

Material United States Federal Income Tax Consequences to Non-U.S. Holders

     157   

Underwriting

     161   

Legal Matters

     167   

Experts

     167   

Where You Can Find More Information

     167   

Index to Financial Statements

     F-1   

INFINITI, BioFilmChip, Intellipac and QMatic are our trademarks. All other service marks, trademarks and trade names referred to in this prospectus are the property of their respective owners.

Neither we, nor the underwriters, have authorized anyone to provide you with additional or different information than that contained in this prospectus and any free writing prospectus prepared by or on behalf of us or to which we have referred you. We take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock.

Until                     , 2013 (25 days after the date of this prospectus), all dealers that buy, sell or trade in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.


Table of Contents

Prospectus Summary

This summary highlights certain information contained in this prospectus. Because this is only a summary, it does not contain all of the information that may be important to you. For a more complete understanding of the information that you may consider important in making your investment decision, we encourage you to read this entire prospectus. Among the other information in this prospectus, you should carefully consider the information set forth under the heading “Risk Factors” and our financial statements and accompanying notes included elsewhere in this prospectus. Unless the context requires otherwise, the words “we,” “us,” “our,” “Company” and “AutoGenomics” refer to AutoGenomics, Inc.

Our Company

We design, develop, manufacture and market the INFINITI molecular diagnostics system. The system includes an extensive and expanding menu of genetic tests and a family of highly automated analyzers. Our products are sold to reference laboratories, hospital laboratories and specialty clinics that produce genetic test results in a broad range of market segments, including personalized medicine, women’s health, oncology and infectious disease. Genetic tests are performed on our INFINITI analyzer utilizing our high-margin and test-specific consumables, which include our proprietary BioFilmChip microarrays and our proprietary Intellipac Reagent Management Modules. In the United States, we market and sell our genetic tests that have been cleared by the U.S. Food and Drug Administration, or FDA, for use in the indications specified in those clearances. The remainder of our genetic tests are marketed and sold on a research use only, or RUO, basis. Our RUO tests may be used for clinical purposes in the United States only by customers that are certified under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, and that have incorporated our test into the customer’s laboratory-developed tests, or LDTs, pursuant to guidelines issued by the College of American Pathologists. Our INFINITI analyzers are capable of both mid- to high-volume testing and generating many different laboratory results from one patient sample at the same time, which is commonly referred to as multiplexing, while providing a high level of accuracy and reproducibility. Our INFINITI system is easy to use, as it eliminates the need for multiple, specialized instruments and automates many of the discrete processes of traditional genetic testing.

As of December 31, 2012, we offered 53 tests for use on our INFINITI analyzers, and had more than 15 additional tests in development. Our current and in-development tests are focused on the areas of personalized medicine (including pain management, mental health and cardiovascular health assessment), women’s health, oncology, infectious disease, genetic disorders, newborn screening and blood banking, which we believe represent large and growing market opportunities in genetic testing. We believe the depth and breadth of our test menu is a significant competitive advantage that will allow laboratories to utilize laboratory space, labor and capital investment more efficiently to conduct additional molecular diagnostic tests. The proprietary design of our INFINITI system allows us to introduce new and enhanced tests to our genetic test menu without the need to modify our INFINITI analyzers. We intend to increase the number of tests offered in each of our target market segments, which will further increase the utility of our INFINITI system to our customers. Our internal test development efforts are generally driven by our customers’ current and anticipated needs, our analysis and projections for the molecular diagnostics market, and our ability to leverage our core competencies such as automation and multiplexing. We have entered into, and expect to continue to enter into, collaborative relationships with leading research and academic institutions for the development of additional or enhanced tests to further increase the depth and breadth of our genetic test menu. Since the initial launch of our INFINITI system in 2007 we have introduced more than five new or enhanced tests per year.

We have received FDA 510(k) clearance for our INFINITI Analyzer and five of our genetic tests, and we have submitted an additional notification to the FDA for 510(k) clearance of our UGT1A1 test. We are finalizing the protocol for a clinical trial necessary to support a premarket approval application, or PMA, for our HPV-HR tests and intend to commence this clinical trial in 2013. The balance of our tests are currently offered for sale in

 

 

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the United States under the RUO designation. These RUO tests are labeled “For Research Use Only. Not for use in diagnostic procedures.” as required by FDA regulations. We are not permitted to market these products for in vitro diagnostic use, and must maintain distribution controls to assure that these products are not used for diagnostic purposes. We therefore train our personnel to only market these products to laboratories for research or investigational use in the collection of research data, and to not promote any off-label uses of our products. Internationally, we have obtained a Conformité Européenne, or CE, mark for our INFINITI Analyzer, our INFINITI Plus Analyzer and a total of 22 of our tests. This designation is supported by completed clinical and validation studies that demonstrate the analytical performance of each CE marked test. The CE mark facilitates the marketing and sale of our CE marked analyzers and tests in the European Union and the European Economic Area as well as certain other international markets.

Sales of products for which we have received 510(k) clearance accounted for 13%, 8% and 4% of our net revenue for 2010, 2011 and the first nine months of 2012, respectively. The balance of our product sales for those same periods, representing 87%, 92% and 96% of our net revenue for 2010, 2011 and the first nine months of 2012, respectively, were derived from sales of RUO products. These products are offered for sale to allow for the collection of research data, and may only be used in the United States for clinical purposes by laboratories and other facilities certified under CLIA that have incorporated these products into their LDTs pursuant to guidelines issued by the College of American Pathologists. We believe that nearly all of our RUO product sales are incorporated into LDTs. In order to develop an LDT utilizing our products, these certified laboratories and other facilities must develop and validate a test protocol that includes specimen collection, DNA extraction, PCR amplification, hybridization and detection, and data analysis, interpretation and reporting. Our products provide components that can be used by these certified laboratories and other facilities for the PCR amplification, hybridization and detection portions of these LDTs. We sell each of these components individually, as ordered by the customer in its discretion, and not as a kit or system. The validation process engaged in by these certified laboratories and other facilities can involve validation of the sample collection and extraction process, establishing limits of detection and analytical sensitivity, testing for specificity and cross-reactivity, including interfering substances, validation for assay accuracy, precision and reproducibility, and establishing reportable ranges of test results for the test system and reference values that will be measured against as controls. This validation process also requires verifying the result from the LDT against known standard samples or the results of a high-standard laboratory testing method such as sequencing, and can involve the testing of a large number of patient samples. Depending on the availability of patient samples, this process may take from several weeks to several months or more to complete, and thus requires a significant investment by the customer. This validation process must be completed for each of our RUO genetic test components that a customer wishes to incorporate into one of its LDTs.

We believe that all sales of our RUO products in the United States are to customers that are either certified in the manner described above and have incorporated our products into their LDT’s, or that use such products for research only. The FDA has not adopted these guidelines and we are not permitted to represent our RUO products as in vitro diagnostic products. Our decision to seek FDA approvals or clearances domestically, and CE marking internationally, for our genetic tests is made on a test-by-test basis, and is based on a variety of factors, including:

 

   

the regulatory environment for the use of genetic tests, in particular the FDA’s requirements and limitations on marketing RUO tests, which may not be marketed as in vitro diagnostic products;

 

   

the demand by our existing and target customers, as expressed to us, for particular genetic tests that have received regulatory approvals or clearances;

 

   

the competitive environment for the use of genetic tests that have received regulatory approvals or clearances versus similar tests that have not; for example, certain of our competitors provide FDA cleared or approved tests in the area of HPV testing, and to compete with those competitors we intend to obtain FDA clearance or approval for certain of our HPV tests as well; and

 

 

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the size of the available market for the particular test, given the relatively significant expense and time required to obtain regulatory approvals or clearances.

For those of our tests for which we have not obtained FDA regulatory clearance or approval, we experience delays of anywhere from a few weeks to several months or more in obtaining revenue from customers that desire to utilize our RUO test consumables during the period of time that the customer is developing its own LDT that incorporates our RUO test.

We believe that we are in compliance with existing FDA rules and regulations governing our business, including those governing the marketing and sale of RUO tests; however, a significant change in existing laws, or their enforcement, may require us to change our business model or our business practices to maintain compliance with these laws. For instance, in June 2011 the FDA issued a Draft Guidance entitled “Commercially Distributed In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only: Frequently Asked Questions,” which, if enforced, would limit our marketing of RUO tests to general discovery laboratories and would require us to halt sales to clinical laboratories that validate and use our RUO tests as part of their LDTs. The FDA has generally exercised its enforcement discretion to not enforce applicable regulations with respect to LDTs. However, the FDA has indicated, since 2010, that it intends to reconsider its policy regarding enforcement and to begin drafting an oversight framework for such tests. If the FDA imposes significant changes to the regulation or enforcement of LDTs, including our RUO tests that are used as LDTs, it may require us to suspend sales of our RUO tests, which together represented 96% of our net revenues for the nine months ended September 30, 2012, and it would require us to seek FDA clearance or approval for our RUO tests, which would in turn require significant time and capital investments on our part and reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations or financial condition. We have not undertaken any specific efforts to comply with this draft guidance. If we were to voluntarily elect to comply with this draft guidance, we would be required to seek regulatory approval for all of our RUO tests that are sold in the United States, which would require significant time and capital investments on our part, significantly reduce our revenues until we obtain regulatory approvals, and significantly increase our capital costs, which could in turn adversely affect our business, prospects, results of operations or financial condition during the affected fiscal periods. Our management currently believes that finalization or enforcement of this draft guidance in its present form is unlikely given the significant adverse effect it would have on a variety of industry participants, and on the ability of physicians to provide effective healthcare.

We believe that compared to traditional genetic testing methods our INFINITI system can significantly improve laboratory productivity, workflow and throughput while reducing the cost per reportable result. We believe that these and other attributes of our INFINITI system decrease the cost and complexity of genetic testing and reduce the need for specialized laboratory personnel, training, equipment and facilities. Our INFINITI system has been designed to enable our customers to start performing, or to more cost-effectively perform, molecular diagnostic tests, which we believe will facilitate acceptance and adoption of our INFINITI system.

We experienced meaningful revenue growth in the first nine months of 2012, with net revenue of $14.5 million during this period, $13.2 million of which was derived from consumables sales, as compared to net revenue of $7.5 million and $8.0 million for fiscal years 2010 and 2011, respectively, of which $3.9 million and $6.8 million was derived from consumables sales, respectively. We expect to continue to generate the substantial majority of our net revenue through the sale of our genetic test consumables for the foreseeable future. As of December 31, 2012, we had 191 INFINITI analyzers placed with customers.

Market Opportunity

Industry Background

Molecular diagnostic testing is used to measure or detect genetic biomarkers associated with a predisposition to, or the presence of, a particular disease or condition, or other genetic variance such as drug

 

 

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response. The information provided by molecular diagnostic testing may enable physicians to achieve better patient outcomes and better contain health care costs through, for example, earlier diagnosis of disease, improved monitoring of disease progression and more personalized treatment. According to Kalorama Information, an independent market research firm, the global molecular diagnostics market is expected to grow from an estimated $4.8 billion in 2010 to $8.1 billion in 2015, which represents a compound annual growth rate of approximately 11%, a rate we believe will be greater than the growth of the overall diagnostics market.

Current practices in developing and running molecular diagnostic tests typically involve manual and complex procedures that require significant expertise, time and expense. We believe the resource and time constraints of traditional testing methods have limited the growth of the molecular diagnostics market, and that the recent availability of more automated and integrated testing methods will result in accelerated use of molecular diagnostic testing. The growth of the molecular diagnostics market will also depend on increasing physician education regarding the use of genetic testing and greater coverage of tests by insurance carriers. Growing understanding of the utility of genetic information for the diagnosis and treatment of disease, as well the increase in identification of new biomarkers, may lead to increased growth in the molecular diagnostics market.

Our Target Markets

We believe there are additional factors that will continue to drive growth in the molecular diagnostics market segments we target, including:

 

   

Personalized Medicine and Companion Diagnostics. The matching of treatment options to a patient’s specific genetic profile has emerged as an important trend in medicine because the efficacy and side-effect profile of certain treatments can be predicted by the presence or absence of specific genetic markers in a particular patient. Better targeted and more effective pharmacogenomic-based treatments have the potential to improve healthcare outcomes and lower healthcare costs. As of December 31, 2012, we offered 23 genetic tests for use in the area of personalized medicine and companion diagnostics, three of which have received FDA 510(k) clearance.

 

   

Pain Management. Pharmacogenomics is playing an integral role in the administration and management of pain medication, as gene mutations can be key factors in determining whether specific pain medications will be effective, or will otherwise result in adverse side effects. As of December 31, 2012, we offered five RUO genetic tests for use in the area of pain management.

 

   

Mental Health. Mental health represents a major component of overall pharmaceutical sales. According to the Centers for Disease Control and Prevention, or CDC, as much as 11% of the U.S. population is taking antidepressants at a given time, while as many as 23% of women between the age of 40 and 59 are on psychiatric medication. As of December 31, 2012, we offered 11 genetic tests for use in the area of mental health, two of which have received FDA 510(k) clearance.

 

   

Cardiovascular Health Assessment. According to the World Health Organization, or WHO, cardiovascular diseases were responsible for 30% of global deaths in 2008. It is estimated that by 2030, 23.6 million people will die from some form of cardiovascular disease. In addition to the increasing prevalence of cardiovascular diseases, the information generated by molecular diagnostic testing is becoming increasingly important for determining the predisposition and treatment of cardiovascular diseases. As of December 31, 2012, we offered 16 genetic tests for use in the area of cardiovascular health assessment, five of which have received FDA 510(k) clearance.

 

   

Women’s Health. We believe the women’s health diagnostics market will continue to grow and represent a substantial market opportunity. Non-molecular tests are commonly employed in this market, but the use of molecular diagnostics is expanding significantly due to increased applications,

 

 

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better performance and better clinical discriminatory capabilities. As of December 31, 2012, we offered 15 RUO genetic tests for use in the area of women’s health.

 

   

Cancer and Companion Diagnostics. Because of the high cost of many cancer therapeutics, and the varied levels of efficacy and toxicity across different patients, tests to diagnose or direct the treatment of, or to determine the predisposition to, various forms of cancer are becoming increasingly important. As of December 31, 2012, we offered 23 RUO genetic tests for use in the area of cancer and companion diagnostics.

 

   

Infectious Diseases. According to the WHO, infectious diseases caused approximately 20% of all recorded deaths in 2008. Within this group, HIV, tuberculosis, or TB, and respiratory infections were the top three contributors to overall mortality in adults aged 15-59, at 35%, 21% and 10%, respectively. Molecular diagnostic testing offers advantages in identifying infectious disease pathogens compared to traditional testing methods. As of December 31, 2012, we offered 15 RUO genetic tests for use in the area of infectious diseases.

 

   

Genetic Disorders. Genetic and inherited disease testing is a cornerstone of molecular diagnostic testing. Molecular diagnostic tests offer significant advantages over prior, often subjective, forms of diagnosis. As of December 31, 2012, we offered six RUO genetic tests for use in the area of genetic disorders; however, we did not have any material sales or net revenue from sales of genetic tests in the area of genetic disorders during the year ended December 31, 2012.

 

   

Newborn Screening. Many common newborn screening panels require the identification of multiple (often five or more) genetic markers which makes traditional testing impractical. Classic testing algorithms are limited in that they utilize subjective analysis of a newborn’s parental health history with little to no genetic evaluation. Targeted genetic evaluation can inform the clinician if the newborn is at risk for developing the disease in question. As of December 31, 2012, we offered four RUO genetic tests for use in the area of newborn screening; however, we did not have any material sales or net revenue from sales of genetic tests in the area of newborn screening during the year ended December 31, 2012.

 

   

Blood Banking. As genetic testing products have become more prevalent, more accurate and more cost-effective, the use of genetic tests in screening in the blood banking market has grown, and is expected to continue to grow. As of December 31, 2012, we did not offer any tests for use in the area of blood banking, and did not have any sales or net revenue in the blood banking market during the year ended December 31, 2012.

As is noted in the tables appearing in “Business — Our Current Test Menu”, many of our 53 genetic tests may be utilized in more than one of our target markets, resulting in particular genetic tests being counted multiple times in the information presented above.

The Limitations of Traditional Testing Methods

Traditional testing platforms to detect genetic biomarkers have a number of drawbacks, which we believe have significantly limited their use, including:

 

   

High cost per reportable result;

 

   

Impractical for use by smaller reference labs, hospitals and specialty clinics;

 

   

Limited testing menu;

 

   

Inability to multiplex;

 

   

Limited automation and throughput capability;

 

   

Need for specialized labor; and

 

 

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Inaccurate results and challenges with reproducibility.

These limitations have created the need in the molecular diagnostics market for a highly integrated system to perform a large menu of automated, cost-effective and easy to use tests with a high degree of accuracy and reproducibility.

The AutoGenomics Solution

Our INFINITI system has been designed to enable a broad range of reference laboratories, hospital laboratories and specialty clinics to start performing, or to more cost-effectively perform, molecular diagnostic testing, which we believe will drive adoption and use of our INFINITI system as well as expand the potential of the molecular diagnostic testing market.

To use our system, an operator loads the prepared test samples into an INFINITI analyzer, along with the specific BioFilmChip and Intellipac Reagent Management Module, for the desired test. Once the INFINITI analyzer is loaded and the test is initiated, no further action by the operator is required. After the test is completed, the system generates an electronic report that can be transmitted directly to a laboratory information system.

Our INFINITI system has a number of key advantages, including:

 

   

Enhanced cost-efficiency. Our system eliminates the need for complex protocols and manual intervention once a test is initiated, which is intended to reduce the laboratory’s cost of testing by simplifying workflow and reducing the need for highly skilled technicians.

 

   

Ability to decentralize molecular diagnostics. We believe that medium-sized reference laboratories, hospital laboratories and specialty clinics are increasingly seeking to add or expand molecular diagnostics capabilities to treat patients more efficiently and provide a more comprehensive offering, lower the cost of providing healthcare, and participate in the value provided by diagnostic testing. We believe that this trend is being facilitated in part by new technologies like ours that are more automated, easier to use, more cost-effective and require less bench space in a laboratory than traditional genetic testing methods.

 

   

Broad menu of tests. As of December 31, 2012, we offered 53 tests as part of our INFINITI system, of which five have received FDA clearance. The balance of our tests are sold on an RUO basis. We believe that this represents one of the broadest available test menus on a single system. We believe that the depth and breadth of our test menu is a strong competitive advantage that will allow our customers to utilize laboratory space, labor and capital investment more efficiently. We also believe that our offering of five FDA cleared tests is comparable to similar testing system offerings of our competitors, which we believe based on publicly available information ranges from zero to seven FDA-cleared tests. As we increase the number of tests available for use on our INFINITI system, laboratories using our system will be able to broaden their molecular diagnostics offerings without significant additional capital investment or operator training.

 

   

Ability to multiplex. Many diseases and patient responses to therapy are caused by multiple genetic mutations that necessitate testing for multiple biomarkers to diagnose those diseases or to predict and/or monitor therapy response. Our INFINITI system is able to detect up to 1,024 individual features of biochemical sensors within a single microarray, which reduces the amount of sample needed, reduces the time required to run the test, and often reduces the need for multiple tests.

 

   

Multiple patient array technology. Our proprietary multiple patient array, or MPA, technology is designed to test up to eight patient samples on a single microarray. This significantly enhances throughput by up to

 

 

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300% while reducing cost per sample by up to 75% as compared to our single patient microarrays. Our MPA technology is particularly well suited for addressing high volume test markets such as HPV and TB.

 

   

Better workflow. Our broad offering of INFINITI analyzers combined with the integrated, “load and go” design of the INFINITI system is designed to address our target customers’ varied throughput and workflow requirements. We believe that we can substantially increase a laboratory’s workflow by enabling them to perform their tests on our highly integrated and automated system that has the ability to multiplex and run high volume MPAs. The INFINITI system can run multiple different tests simultaneously which reduces or eliminates the need for laboratories to run tests in batches.

 

   

Increased accuracy of results. Human handling of samples is the most common cause of contamination in existing technologies. By reducing the risk of human error and contamination, we believe that our INFINITI system can provide more accurate and more reproducible test results compared to other, less automated systems. In addition, where certain systems only use target or signal amplification (e.g., polymerase chain reaction, or PCR, amplification), we believe that our combined target and signal amplification technologies can increase the sensitivity and specificity over these widely used stand-alone amplification methods.

Our Products

Our INFINITI Analyzers

Our INFINITI system includes a family of analyzers, each of which is designed to address customer-specific needs based on the customer’s productivity, workflow and throughput requirements. Our INFINITI analyzers integrate and automate the discrete processes of sample handling, reagent management, hybridization, detection, results analysis and reporting in a self-contained system. They have been designed to operate on a “load and go” basis, which means that to run a genetic test, an operator loads prepared samples into the INFINITI analyzer along with the BioFilmChip microarrays and the Intellipac Reagent Management Modules specific to that test. From the perspective of the operator, the test protocols are substantially identical for all of our genetic tests, which eliminates the need to retrain operators when additional tests are added. After the test is completed, the INFINITI analyzer generates an electronic report that can be transmitted directly to a laboratory information system. Our BioFilmChips and Intellipac Reagent Management Modules are test-specific, but are not analyzer-specific, so all of our INFINITI analyzers use substantially the same consumables.

The following table illustrates the test capabilities of our different INFINITI analyzers:

 

Analyzer

  

Capacity per run

  

Patient results *

INFINITI

   24 samples    up to 96 per day

INFINITI PLUS

   48 samples    up to 192 per day

INFINITI PLUS 96 (in beta testing)

   96 samples    up to 288 per day

INFINITI HTS (in beta testing)

   384 samples    up to 1,152 per day

 

* numbers presented are based on average time to complete an HPV-HR Quad test run

Selected Key Tests

We have a demonstrated track record of successfully developing genetic tests that leverage our core competencies and that address current and anticipated customer needs. We believe that by offering a wide variety of tests for each of our target market segments, we will provide significant value to our customers in these areas

 

 

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by allowing them to consolidate multiple testing platforms, expand their testing capabilities, increase workflow, reduce costs, and limit additional investment in equipment, personnel and training. Some of our key test offerings in our focus market segments currently include:

 

   

HPV. We have developed four HPV tests, which are designed for screening and/or genotyping and each of which addresses a different segment of the HPV testing market. Our tests include our HPV-HR Quad and HPV-HR Hex tests, designed to screen for and genotype 14 high-risk types of HPV simultaneously, our HPV Quad test, designed to screen for 13 high-risk and two low-risk types of HPV and our HPV Genotyping test, designed to identify 26 types of HPV. Our HPV-HR Quad, HPV-HR Hex and HPV Quad tests are designed to allow a laboratory to test samples from four to six different patients simultaneously on a single BioFilmChip. We believe our tests offer several competitive advantages: consolidation of multiple testing steps, better automation, reduction of sample requirements and enhanced accuracy and reproducibility. We plan to seek a PMA for our HPV-HR tests and 510(k) clearance for our HPV Genotyping test. Our HPV-HR Quad, HPV Quad and HPV Genotyping tests have been CE marked.

 

   

Other STDs. We have launched a variety of panels consisting of tests that our customers use to identify numerous organisms associated with sexually transmitted diseases, or STDs. Our panels are designed to screen for multiple STDs in a single sample.

 

   

Breast Cancer. We have developed tests such as our CHEK-2 and the Breast Cancer Panel-AJ tests, which are designed to identify individuals at greater risk for breast cancer, and our CYP450 2D6T test, which is designed to determine if a woman will benefit from tamoxifen, a frequently prescribed drug for the prevention of breast cancer recurrence.

 

   

Colorectal Cancer. We have developed KRAS and KRAS-BRAF tests, which enable laboratories to identify certain genetic mutations associated with poor response to anti-epidermal growth factor receptor, or EGFR, therapies.

 

   

Personalized Medicine. One of our leading personalized medicine offerings is our CYP450 2C19 Panel test, which is designed to enable laboratories to identify certain gene variants that affect the metabolism and efficacy of the anticoagulant drug Plavix (clopidogrel). Our other leading tests in this area currently include our CYP450 2C19 Plus, Warfarin and CYP450 2D6I tests, which are designed to enable laboratories to identify certain gene variants associated with responsiveness to certain medications for psychiatric disorders, the oral anticoagulant Warfarin and certain antidepressants and cancer drugs, respectively.

 

   

Infectious Disease. Our Multidrug Resistance Tuberculosis (MDR-TB) test is a multiplexed test that can identify Mycobacterium tuberculosis infections (as opposed to nontuberculous mycobacterium infections) while simultaneously determining resistance to the three front-line TB treatments: rifampin, isoniazid and pyrazinamide.

 

   

Genetic Disorders. Our Familial Mediterranean Fever (FMF) panel multiplexes multiple markers into a single test that allows simultaneous identification of the five most common FMF variations as well as eight other variations spanning 14 ethnicities.

 

   

Newborn Screening. Our Ashkenazi Jewish Panel is capable of simultaneously detecting 31 genetic variants that account for eight diseases commonly found among those of Ashkenazi Jewish descent.

 

   

Blood Banking. We have several tests for blood typing and infectious disease screening currently in development that are intended to take advantage of our multiplexed automation capabilities.

 

 

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BioFilmChip

Our proprietary BioFilmChip microarrays consist of multiple layers of a hydro-gel matrix coated on polyester film sandwiched between a plastic base and a reaction body to form a microarray. Our microarrays are printed with 36 to 1,024 individual features of biochemical sensors depending on the requirements of the test. These spotted microarrays are then packaged into specifically designed magazines and are used on all of our INFINITI analyzers.

Intellipac Reagent Management Module

Our proprietary Intellipac Reagent Management Modules hold the reagent needed to run our specific genetic tests. Our reagent module is designed to communicate all relevant information about a test to the INFINITI analyzer without any intervention from the operator, saving time and reducing errors. A read-write memory chip embedded in the module saves test-specific information on the module, including reagent identification, expiration dates, lot number, amount of reagent remaining for future tests, specific instructions for test processing, the time last used and the serial number for the instrument.

Our Strategy

Our objective is to become a leading provider of genetic tests to a broad array of customers within our target market segments. We believe our INFINITI system will allow us to achieve this objective by facilitating molecular diagnostic testing by reference laboratories, hospital laboratories and specialty clinics. To achieve our objective, we intend to:

 

   

Capitalize on the capabilities of our INFINITI system to increase penetration within our target market segments. We believe that our INFINITI system’s high level of automation, ability to multiplex and broad test menu are attractive to our target customers in our target market segments as our genetic tests provide an easy to use solution with greater breadth of diagnostic information at a lower cost per reported result than many competing systems.

 

   

Develop and launch new and enhanced tests. We believe that developing a broad menu of genetic tests to run on our system will increase the value of our INFINITI system, drive additional placements of our INFINITI analyzers and increase our consumables sales. We believe that the depth and breadth of our test menu is a significant competitive advantage that will allow customers to increase their ability to conduct molecular testing and utilize laboratory space, labor and capital investment more efficiently, as well as generate supplementary revenue. In addition, the depth and breadth of our test menu diversifies our revenue so that we are not dependent on the performance of any single test. The majority of tests that we offer, are developing and intend to develop have established market demand and reimbursement by public and private payors.

 

   

Target molecular diagnostic laboratories with high potential utilization of our INFINITI system. We believe that our INFINITI system’s automation, broad genetic test menu and family of analyzers designed to address various throughput requirements will generate demand from both larger reference laboratories seeking a more flexible and efficient molecular diagnostic platform and from smaller reference laboratories, hospital laboratories and specialty clinics for whom it has not previously been cost-effective to develop their own tests.

 

   

Expand our domestic sales force and international distribution of our products. We are marketing and selling the INFINITI system in the United States through our own sales and marketing organization and believe there is a meaningful opportunity to further penetrate existing markets and customers as well as enter new markets by expanding our U.S. sales force. We also plan to expand our global distribution networks to address increasing international demand in addition to driving increased utilization with our existing distributors.

 

 

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Pursue regulatory clearances, approvals and certifications for products and facilities, as necessary. We have received FDA 510(k) clearance for our INFINITI Analyzer and five of our genetic tests, and we have submitted an additional notification to the FDA for 510(k) clearance of our UGT1A1 test. We are finalizing the protocol for a clinical trial necessary to support a PMA application to the FDA for our HPV-HR tests and intend to commence the clinical trial in 2013. We intend to seek regulatory clearance or approval, as necessary, for our tests.

 

   

Align with key opinion leaders at leading institutions and increase scientific awareness of our products. We align with key opinion leaders at leading institutions and clinical research laboratories to help to increase awareness of our system, to demonstrate its benefits relative to existing technologies and to accelerate its adoption in the molecular diagnostics market. We also seek to increase awareness of our products through participation at trade shows, academic conferences, online webinars and hospital-based grand, or teaching, rounds. In addition, our INFINITI system has been discussed in several published peer review articles.

Risks Affecting Us

Our business is subject to numerous risks, as more fully described in the section entitled “Risk Factors” elsewhere in this prospectus, including the following:

 

   

There is limited information available to evaluate our business, as we have a limited operating history and limited current revenue;

 

   

We have a long history of losses and negative cash flows and may not be able to maintain profitability in the current fiscal year or in future fiscal periods;

 

   

The vast majority of our net revenue (96% for the nine month period ended September 30, 2012) is derived from the sale of products designated for research use only; changes in RUO regulations or the FDA’s enforcement discretion with respect to RUO regulations, or violations of these regulations by us, could significantly limit our ability to sell our products to our target customers, or otherwise require us to obtain regulatory approvals for our products at considerable time and expense;

 

   

Some of our existing indebtedness will come due and be payable in the immediate future, and we do not have the resources to satisfy this indebtedness absent the completion of this offering;

 

   

After completing this offering, we may not be able to meet our cash requirements without obtaining additional capital, and if we are unable to do so, we may have to curtail or cease operations;

 

   

Our financial results depend on commercial acceptance of the INFINITI system and its tests and the development of additional tests;

 

   

We currently derive a significant portion of our revenue from a few customers;

 

   

Many of our competitors are large and well capitalized, and we face significant competition;

 

   

The molecular research use and diagnostic market may fail to fully develop, or we may fail to capture a significant share of that market;

 

   

If the medical relevance of the biomarkers targeted by our tests is not demonstrated or is not recognized by others, we may experience reduced demand for our products;

 

   

We have identified material weaknesses and significant deficiencies in our internal controls; and

 

   

Our success will depend in part on our ability to operate without infringing or misappropriating the proprietary rights of others, on our ability to own or license patents that are adequate to reduce competition and on our ability to license intellectual property from third parties for certain tests and manufacturing processes needed for our business.

 

 

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Corporate Information

We were incorporated as Neuron Technologies, Incorporated in California in April 1999, and changed our name to AutoGenomics, Incorporated in August 2000. We subsequently changed our name to AutoGenomics, Inc. in October 2002. We reincorporated in Delaware in November 2008. Our principal executive offices are located at 2980 Scott Street, Vista, California, 92081. Our telephone number is (760) 477-2248. Our website address is www.autogenomics.com. Information contained in or that can be accessed through our website is not incorporated by reference into this prospectus and should not be considered to be part of this prospectus.

We are an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012. As an emerging growth company, we are eligible to comply with less stringent disclosure requirements than those applicable to larger, more established companies. 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 this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period. We refer to the Jumpstart Our Business Startups Act of 2012 herein as the “JOBS Act,” and references herein to “emerging growth company” shall have the meaning associated with it in the JOBS Act.

Recent Financial Results

We are finalizing our financial results as of and for the year ended December 31, 2012. Complete financial information and operating data as of and for such period are not available, and we believe that this data will not be available prior to the completion of this offering; however, based on the preliminary information and data available, our management estimates that for the three months ended December 31, 2012, our net revenue will range between $4.0 million and $4.2 million, as compared to net revenue of $2.8 million for the three months ended December 31, 2011, and as compared to net revenue of $5.8 million for the three months ended September 30, 2012; and our loss from operations will range between $1.3 million and $1.6 million, as compared to a loss from operations of $0.8 million for the three months ended December 31, 2011, and as compared to income from operations of $1.5 million for the three months ended September 30, 2012. Taken together with the statement of operations financial data for the nine months ended September 30, 2012 included elsewhere in this prospectus, these estimates would result in income from operations for the year ended December 31, 2012 to range between $1.7 million and $2.0 million, as compared to losses from operations of $6.8 million and $16.5 million for the years ended December 31, 2011 and 2010, respectively.

Net revenue during the three months ended December 31, 2012 was impacted positively as compared to the three months ended December 31, 2011 primarily due to increases in INFINITI analyzer and consumables sales, and was impacted negatively as compared to the three months ended September 30, 2012 by decreased sales of consumables to a key customer, partially offset by increased sales of INFINITI analyzers. We believe the decrease in sales of consumables to this key customer was the result of this customer having increased its purchases of equivalent products from one of our competitors in October and November 2012. We have taken steps to recapture purchases by this key customer and we believe that the recent volume decrease was temporary, as consumables sales to this customer began to increase in December 2012; however, we can provide no assurance that either sales volume or net revenue from this key customer will return to levels we observed in the third quarter of 2012, or that either or both will not decrease further, in future quarters.

Income/(loss) from operations during the three months ended December 31, 2012 was impacted positively as compared to the three months ended December 31, 2011 primarily due to increases in INFINITI analyzer and consumables sales and higher gross margins resulting from a shift in product sales mix that reflected increased

 

 

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sales of consumables as compared to sales of INFINITI analyzers, and was impacted negatively as compared to the three months ended September 30, 2012 primarily as a result of significantly lower gross profit from decreased consumable sales to a key customer, a significant increase in operating expenses associated with the estimated accounts receivable reserve described below, and lower gross margins resulting from a shift in product sales mix that reflected increased sales of INFINITI analyzers as compared to sales of consumables.

We are unable to estimate with reasonable specificity our net income/(loss) and net income/(loss) per share attributable to common stockholders (basic and diluted) for the three months, and for the year, ended December 31, 2012, primarily due to the impact on such financial measures of certain non-cash charges that we expect to take during these periods, the determination of which have not yet been made. These determinations include the impact on our financial results for the three months, and for the year, ended December 31, 2012 of:

 

   

Our exchange in November 2012 of subordinated promissory notes for 4,287,074 shares of Series NC convertible preferred stock, which we anticipate will be treated as an exchange of debt for what we currently estimate to be equity of equal value based on the fair value of the debt and equity on the exchange date. If we were to determine in connection with finalizing our financial results for the three months, and for the year, ended December 31, 2012, that the Series NC convertible preferred stock was not issued at fair value on the issue date, but rather at a discount, then we would be required to recognize a non-cash charge for the three months, and for the year, ended December 31, 2012 in an amount equal to the amount of that discount, which would increase our net loss for that period. For example, if we were to determine that the fair value of the Series NC convertible preferred stock at the date of issue was $2.00 per share (rather than the $1.75 per share that we currently estimate), then the discount on the date of issue would be $0.25 per share ($1.1 million in the aggregate), and if we were to determine that the fair value of the Series NC convertible preferred stock at the date of issue was $2.50 per share (rather than the $1.75 per share that we currently estimate), then the discount on the date of issue would be $0.75 per share ($3.2 million in the aggregate). This discount would then increase our net loss for the three months, and for the year, ended December 31, 2012.

 

   

The issuance in November 2012 of common stock warrants in connection with the exchange of debt for Series NC convertible preferred stock, the fair value of which we anticipate will be recognized as a charge against the proceeds of the Series NC convertible preferred stock, with an offsetting charge against additional paid in capital, and which will not affect our income statement. The fair value of these issued common stock warrants will be determined using the Black-Scholes valuation model. We estimate that this charge against proceeds and against additional paid in capital will range between $1.7 million and $2.2 million.

 

   

Our exchange in November 2012 of subordinated promissory notes and warrants to purchase common stock for new subordinated promissory notes with extended maturity dates and warrants to purchase common stock, which we anticipate will be recorded in our financial statements for the three months, and the year, ended December 31, 2012 as an extinguishment of debt in accordance with FASB ASC 470-50, and which we anticipate will be recorded at fair value on the exchange date as calculated using future discounted cash flows, and the issuance in November 2012 of common stock warrants in connection with the exchange of debt for new debt with extended maturity dates, the fair value of which we anticipate will be recorded as a discount to the new debt and will be amortized over the three year term of the new debt using the effective interest method. The fair value of these issued common stock warrants will be determined using the Black-Scholes valuation model. We estimate that the result of this exchange and accounting treatment will result in a non-cash charge in a range between $0.2 and $0.5 million for the three months, and for the year, ended December 31, 2012. This non-cash charge, once determined, will be recognized in each of our fiscal quarters going forward for the entire three-year term of the new debt. If the offering referred to in this prospectus is consummated and our outstanding promissory note indebtedness is paid in full from the proceeds of this offering, as is

 

 

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expected, then the remaining unamortized portion of this non-cash charge will be recognized in the same fiscal quarter that our outstanding promissory note indebtedness is paid in full.

In addition, we expect to recognize the deferred costs we incurred in connection with our November 2012 debt-to-equity exchange transaction, which we estimate were approximately $0.3 million, as a non-cash charge for the three months, and for the year, ended December 31, 2012, and we expect to recognize the deferred costs we incurred in connection with our November 2012 debt-for-debt exchange transaction, which we estimate were approximately $0.7 million, as a non-cash charge over the three year term of the new debt, which we estimate will result in a non-cash charge of $0.1 million for the three months, and for the year, ended December 31, 2012. If the offering referred to in this prospectus is consummated and our outstanding promissory note indebtedness is paid in full from the proceeds of this offering, as is expected, then the remaining unamortized portion of these deferred costs will be recognized as a non-cash charge in the same fiscal quarter that our outstanding promissory note indebtedness is paid in full.

Each of these above non-cash items, when determined, will impact our net income/(loss) and net income/(loss) per share attributable to common stockholders (basic and diluted) for the three months, and for the year, ended December 31, 2012. If we were to determine that each of the above non-cash items were to be at the low end of the estimated ranges and examples presented above, based on the preliminary information and data available, and using our estimated range of loss from operations for the same period described above, our management estimates that for the three months ended December 31, 2012, our net loss would range between $1.9 million and $2.2 million, as compared to a net loss of $1.9 million for the three months ended December 31, 2011, and as compared to net income of $0.7 million for the three months ended September 30, 2012. Taken together with the statement of operations financial data for the nine months ended September 30, 2012 included elsewhere in this prospectus, these estimates would result in net income for the year ended December 31, 2012 to range between $1.1 million and $1.4 million, as compared to net losses of $10.0 million and $19.7 million for the years ended December 31, 2011 and 2010, respectively. If we were to determine that each of the above non-cash items were to be at the top end of the estimated ranges and examples presented above, based on the preliminary information and data available, and using our estimated range of loss from operations for the same period described above, our management estimates that for the three months ended December 31, 2012, our net loss would range between $5.4 million and $5.7 million, as compared to a net loss of $1.9 million for the three months ended December 31, 2011, and as compared to net income of $0.7 million for the three months ended September 30, 2012. Taken together with the statement of operations financial data for the nine months ended September 30, 2012 included elsewhere in this prospectus, these estimates would result in a net loss for the year ended December 31, 2012 to range between $2.4 million and $2.7 million, as compared to net losses of $10.0 million and $19.7 million for the years ended December 31, 2011 and 2010, respectively.

As of December 31, 2012, approximately $1.1 million in accounts receivable from a key customer were past due 90 days or more. We have not finalized our assessment of the collectability of these receivables; however, for the purposes of the estimates provided above, we have reserved this entire past due amount. If we determine that we are able to reduce this reserved amount, it would have a positive impact on our income/(loss) from operations, as well as our net income/(loss) and our net income/(loss) per share attributable to common stockholders (basic and diluted), for the three months, and the year, ended December 31, 2012.

The preliminary financial data and accounting treatment information above has been prepared by, and is the responsibility of, our management. Our independent registered public accounting firm has not audited, reviewed, compiled, or performed any procedures with respect to this preliminary financial data and accounting treatment information and does not express an opinion or any other form of assurance with respect thereto. Because the three months ended December 31, 2012 has recently ended, the unaudited net revenue, income/(loss) from operations and net income/(loss) information presented above for the three months and year ended December 31, 2012 has not yet been subject to our normal quarterly financial closing processes, reflects estimates based only

 

 

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upon preliminary information available to us as of the date of this prospectus, and is not a comprehensive statement of our financial results for the three months, or for the year, ended December 31, 2012. We believe that our financial statements and operating data as of and for the three months and the year ended December 31, 2012 will not be available until after this offering is completed and may differ from the unaudited net revenue, income/(loss) from operations and net income/(loss) information we have provided. Such differences may be material. Accordingly, the net revenue, income/(loss) from operations and net income/(loss) information and accounting treatment information presented should not be viewed as a substitute for full interim financial statements prepared in accordance with GAAP, and undue reliance should not be placed on these preliminary estimates. These preliminary estimates are not necessarily indicative of any future period and should be read together with “Risk Factors,” “Special Note Regarding Forward-looking Statements,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Selected Financial Data” and our financial statements and related notes included elsewhere in this prospectus.

 

 

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The Offering

 

Common stock to be offered by us

6,000,000 shares

 

Common shares to be outstanding immediately after this offering

16,746,791 shares

 

Overallotment option

We have granted the underwriters an option for 30 days from the date of this prospectus to purchase up to 900,000 additional shares of our common stock at the initial public offering price to cover overallotments.

 

Use of proceeds

We anticipate that we will use the net proceeds from this offering to (i) repay the principal and interest under our outstanding promissory notes, (ii) fund the expansion of our sales force, enhance our international distributor network, and increase our marketing and promotional activity and business development efforts, (iii) support a PMA for our HPV-HR tests and 510(k) and CE mark studies and submissions for several tests associated with women’s health and personalized medicine, (iv) fund research and development activities to add new or enhanced tests to our menu, (v) fund the expansion of our manufacturing capacity and efficiency, including purchasing automation equipment, (vi) satisfy outstanding accounts payable to advisors and service providers incurred in connection with certain of our prior capital raising activities conducted from 2008 through 2010, and (vii) make payment of past due amounts owed to our landlord. We anticipate that we will use the remainder of the net proceeds from this offering for additional working capital and general corporate purposes. See “Use of Proceeds.”

 

NASDAQ Global Market listing

We have applied to list our common stock on the NASDAQ Global Market under the symbol “AGMX.”

 

Risk factors

Investing in our common stock involves a high degree of risk. You should carefully read and consider the information set forth under the heading “Risk Factors” and all other information set forth in this prospectus before deciding to invest in our common stock.

 

 

The number of shares of common stock outstanding after this offering is based on the following as of December 31, 2012: 2,855,771 shares of common stock, and 1,579,227 shares of Series A Convertible Preferred Stock, 4,468,369 shares of Series B Convertible Preferred Stock, 6,417,680 shares of Series C Convertible Preferred Stock, 3,423,258 shares of Series D Convertible Preferred Stock, 732,555 shares of Series E Convertible Preferred Stock and 4,287,074 shares of Series NC Convertible Preferred Stock which will convert into an aggregate of 7,891,020 shares of common stock in connection with the completion of this offering, and excludes as of that date:

 

   

1,549,720 shares of common stock issuable upon exercise of options outstanding at a weighted average exercise price of $5.16 per share;

 

   

465,328 and 82,500 shares of common stock reserved for future issuance under our 2008 Equity Incentive Plan and 2008 Employee Stock Purchase Plan, respectively; and

 

   

warrants to purchase 3,372,711 shares of common stock at a weighted average exercise price of $6.08 per share and warrants to purchase 371,300 shares of our preferred stock which will become warrants to purchase 133,488 shares of common stock at a weighted average exercise price of $10.78 per share in connection with the completion of this offering.

 

 

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Unless otherwise indicated, all information in this prospectus assumes an initial public offering price of $10.00 per share, the midpoint of the range on the cover page of this prospectus, and gives effect to the 1-for-0.33 reverse split of our common stock that we effected in January 2013.

Effective immediately prior to the completion of this offering, each outstanding share of our Series A Convertible Preferred Stock will convert into 0.6600 shares of our common stock, each outstanding share of our Series B, Series C and Series E Convertible Preferred Stock will convert into 0.3595 shares of our common stock, each outstanding share of our Series D Convertible Preferred Stock will convert into 0.3674 shares of our common stock and each outstanding share of our Series NC Convertible Preferred Stock will convert into 0.3300 shares of our common stock. The conversion into common stock of our Series C, Series E and Series NC Convertible Preferred Stock is predicated on the offering referred to in this prospectus resulting in net proceeds to us of $25 million or more. Our outstanding warrants to purchase our convertible preferred stock will automatically become exercisable for shares of our common stock in connection with the completion of this offering.

Except as otherwise indicated, all information in this prospectus assumes:

 

   

no issuance of any options under our 2008 Equity Incentive Award Plan after December 31, 2012 and no exercise of any outstanding warrants or options after December 31, 2012; and

 

   

no exercise by the underwriters of their overallotment option.

As of December 31, 2012, we had outstanding total indebtedness and accrued interest under promissory notes of approximately $17.5 million, of which approximately $2.3 million in principal amount was in payment default. In November 2012, the holders of $7.5 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes with rates of interest ranging from six percent to 12% that were then past due or scheduled to come due in the immediate future surrendered their right to payment of those promissory notes in exchange for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock. In connection with this surrender and issuance, these noteholders surrendered warrants for the purchase of an aggregate of 637,813 shares of our common stock with exercise prices ranging from $5.24 per share to $15.15 per share in exchange for warrants of a like tenor for the purchase of an aggregate of 637,813 shares of our common stock with exercise prices of $4.55 per share that are exercisable through November 2017. Also in November 2012, the holders of $14.4 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes with rates of interest ranging from six percent to 13% that were then past due or scheduled to come due in the immediate future surrendered their right to payment of those promissory notes in exchange for new promissory notes in aggregate principal amount of $14.4 million with eight and one-half percent rates of interest and November 2015 maturity dates. In connection with this surrender and issuance, these noteholders surrendered warrants for the purchase of an aggregate of 1,156,013 shares of our common stock with exercise prices ranging from $5.24 per share to $15.15 per share in exchange for warrants of a like tenor for the purchase of an aggregate of 1,734,020 shares of our common stock with exercise prices of $5.30 per share that are exercisable through November 2017. As of November 27, 2012, after giving effect to these actions, we had outstanding total indebtedness and accrued interest under promissory notes of approximately $17.4 million, of which approximately $2.9 million was past due or scheduled to come due in the immediate future, and outstanding warrants to purchase an aggregate of 3,372,711 shares of our common stock.

On December 28, 2012, Tregale Group Ltd, the holder of approximately $2.2 million in principal amount under our promissory notes that had been in default beginning in the first quarter of 2012, filed a request for judicial intervention and motion for summary judgment in lieu of complaint, demanding payment of the principal and interest outstanding under its promissory notes as well as reimbursement of certain legal and other expenses. See “Business—Legal Proceedings” elsewhere in this prospectus. In January 2013, we issued and sold a

 

 

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subordinated promissory note in the amount of $2.4 million to one of our existing investors, who is a holder of more than 5% of our capital stock. This promissory note has a maturity date of March 31, 2013, an annual interest rate of 8.5%, and is prepayable at any time without premium or penalty. We used the proceeds of this sale to retire the outstanding principal and interest owed to Tregale Group Ltd under our outstanding promissory notes, and are negotiating with Tregale Group Ltd with respect to the reimbursement of its legal and other expenses, and the dismissal of the lawsuit.

 

 

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Summary Financial Data

The following tables provide our summary financial data and should be read in conjunction with our audited financial statements, the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The summary statement of operations data for each of the years ended December 31, 2010 and 2011 were derived from our audited financial statements appearing elsewhere in this prospectus. The summary statement of operations data for the nine months ended September 30, 2011 and September 30, 2012 and the summary balance sheet data as of September 30, 2012 were derived from our unaudited financial statements. The unaudited financial data, in management’s opinion, have been prepared on the same basis as the audited financial statements and related notes included elsewhere in this prospectus, and include all adjustments, consisting only of normal recurring adjustments, that our management considers necessary for a fair presentation of the information for the periods presented. The results of operations for the nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012 or any other period.

 

     Years ended December 31,     Nine months ended September 30,  
     2010     2011               2011                          2012             
                 (unaudited)  
     (in thousands, except share and per share data)  

Statement of operations data:

        

Net revenue

   $ 7,504      $ 8,005      $ 5,166      $ 14,473   

Cost of sales

     7,666        6,019        4,378        5,035   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit/(loss)

     (162     1,986        788        9,438   

Operating expenses

        

Research and development

     3,560        2,768        2,146        1,724   

General and administrative

     5,376        3,360        2,587        2,775   

Sales and marketing

     4,717        2,672        2,023        1,655   

Impairment of film coating equipment

     981        —          —          —     

Initial public offering costs - terminated offering

     1,752        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     16,386        8,800        6,756        6,154   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income/(loss) from operations

     (16,548     (6,814     (5,968     3,284   

Interest expense, net

     (4,109     (3,626     (2,598     (1,913

Other income/(expense), net

     36        (2     —          5   

Change in fair value of warrant liabilities

     926        445        434        (170
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss)

     (19,695     (9,997     (8,132     1,206   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss) per share attributable to common stockholders

        

Basic

   $ (7.63   $ (3.79   $ (3.09   $ 0.45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

         $ 0.13   
        

 

 

 

Shares used to compute net income/(loss) per share attributable to common stockholders

        

Basic

     2,581,708        2,634,385        2,633,929        2,651,833   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

           9,148,420   
        

 

 

 

 

 

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     As of September 30, 2012  
     Actual     Pro forma (1)     Pro forma
as adjusted (2)
 
     (unaudited)  
     (in thousands)  

Balance sheet data:

      

Cash and cash equivalents

   $ 294      $ 294      $ 36,727   

Current assets

     7,104        7,104        43,537   

Total assets

     9,826        9,826        46,259   

Total debt (3)

     20,784        17,057        —     

Convertible preferred stock (4)

     47,432        —          —     

Total stockholders’ equity/(deficit)

     (77,080     (22,140     31,510   

 

(1) On a pro forma basis after giving effect to the restructuring of debt described in note (3) below, which occured in November 2012, and the conversion of all outstanding shares of convertible preferred stock into common stock, including our Series NC Convertible Preferred Stock, which will occur immediately prior to the completion of this offering.
(2) On a pro forma as adjusted basis after giving effect to (i) the conversion of all outstanding shares of convertible preferred stock into common stock, (ii) the sale of 6,000,000 shares of our common stock in this offering at an assumed initial offering price of $10.00 per share, the midpoint of the range on the cover page of this prospectus, and after deducting underwriting discounts and commissions and our estimated offering expenses and (iii) the application of $17.7 million of the net proceeds of this offering to repay the principal and interest under our outstanding promissory notes. A $1.00 increase or decrease in the assumed initial public offering price of $10.00 per share would increase or decrease, as applicable, the net proceeds to us from this offering by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and our estimated offering expenses.
(3) Amounts include principal only of promissory notes payable. The summary unaudited pro forma, and pro forma as adjusted, balance sheet data as of September 30, 2012 give effect to the exchange, in November 2012, of $22.0 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock and $14.4 million in aggregate principal amount of new promissory notes due November 2015.
(4) Our convertible preferred stock has been classified as temporary equity on our balance sheets instead of in stockholders’ deficit due to the possibility of the occurrence of certain change in control events that are outside of our control, including our sale or transfer of control, which trigger the rights of holders of the convertible preferred stock to force redemption. Accordingly, these shares are considered contingently redeemable. We have adjusted the carrying values of the convertible preferred stock to their liquidation values at each period end.

 

 

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Risk Factors

Before deciding to invest in our common stock, you should carefully consider each of the following risk factors and all of the other information set forth in this prospectus. The following risks and the risks described elsewhere in this prospectus, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” could materially harm our business, financial condition, future results and cash flow. If that occurs, the trading price of our common stock could decline, and you could lose all or part of your investment. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business.

Risks Relating to Our Business

Because we have a limited operating history and limited current revenue, there is limited information available to evaluate our business.

We have a limited operating history upon which one can evaluate our business and our products. As an early commercial-stage company in the rapidly evolving market for molecular diagnostics, we face numerous risks and uncertainties. Based on our limited operating experience, we may not be able to effectively:

 

   

drive adoption of our system;

 

   

attract and retain customers for our products;

 

   

demonstrate the commercial viability of our tests;

 

   

comply with evolving regulatory requirements applicable to products that are intended for research use only;

 

   

obtain regulatory approvals to market and sell our products;

 

   

anticipate and adapt to changes in the molecular diagnostics market;

 

   

focus our research and development efforts in areas that generate appropriate returns on these efforts;

 

   

maintain and develop strategic relationships with vendors and manufacturers to acquire necessary materials and the production of our products;

 

   

implement an effective marketing strategy to promote awareness of our products;

 

   

scale our manufacturing capacity to meet potential demand;

 

   

avoid infringement and misappropriation of third-party intellectual property;

 

   

obtain licenses on commercially reasonable terms to third-party intellectual property;

 

   

obtain valid and enforceable patents that give us a competitive advantage;

 

   

protect our proprietary technology;

 

   

provide appropriate levels of customer support for our products;

 

   

protect our operations from any equipment- or software-related system failures;

 

   

develop and operate computer systems and related infrastructure that are adequate to manage our growth and provide our services effectively; and

 

   

attract, retain and motivate qualified personnel.

Our operations are subject to many of the risks inherent in the growth of a new business. The likelihood of our success must be evaluated in light of the challenges, expenses, difficulties, complications and delays frequently encountered in the operation of a new business. We cannot assure you that we will achieve anticipated revenue growth and maintain profitability in the current or future fiscal years. Our failure to meet any of these goals could have a material adverse effect on us and may force us to reduce or cease our operations.

 

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We have a long history of operating losses and negative cash flows and we may not be able to maintain profitability.

We have incurred substantial costs to develop our technology. As of September 30, 2012, we had an accumulated deficit of $92.4 million. We expect to continue to spend substantial financial and other resources on conducting clinical studies and trials, seeking regulatory approvals, servicing our existing indebtedness, introducing new products, expanding our sales and marketing activities, developing our technology and manufacturing capabilities, engaging in laboratory testing and manufacturing new products. As a result, we will need to generate significant revenue to maintain profitability.

Our ability to generate significant revenue will depend on our ability to successfully implement our business strategies and address the risks and uncertainties facing us, and we cannot assure you that we will be successful in these efforts. Even if we do address these risks successfully and implement our business strategies, we may not generate sufficient revenue to maintain profitability. We cannot assure you that we would be able to increase profitability on a quarterly or annual basis in the future.

Our operating results may be variable and unpredictable.

Due to the nature of the molecular diagnostic testing market and facets of our business, our revenue and operating results may be difficult to predict and may vary significantly from period to period. The sales cycles for our products may be lengthy, which may make it difficult for us to accurately forecast revenue in a given period. Specifically, initial sales of our consumable products are often dependent on completing customer validation processes that may be time-consuming and unique to each customer. In addition to its length, the sales cycle associated with our products is subject to a number of significant risks, including the budgetary constraints of our customers, their inventory management practices and possibly internal acceptance reviews and the timing of FDA approval and review, all of which are beyond our control. Sales of our products will also involve the purchasing decisions of reference laboratories, hospital laboratories and specialty clinics, which can require many levels of pre-approvals, further lengthening sales time. These purchasing decisions are subject to a number of significant risk factors beyond their and our control and are difficult for us to predict. For example, reference laboratories, hospitals and specialty clinics may purchase fewer of our consumable products due to a decline in the volumes of tests needed at these facilities. As a result, we may expend considerable resources on unsuccessful sales efforts or we may not be able to complete sales as anticipated. In addition, a significant percentage of our revenue is generated from a few customers. Changes in ordering volume from one or more of these customers could materially impact our operating results. For example, in the fourth quarter of 2012, one of our key customers decreased its ordering volumes, which resulted in substantially lower net revenues compared to the prior quarter. Our international sales are also difficult to predict because they depend upon the activities of our distributors, over which we have limited control.

Our revenue and operating results may also vary due to the evolving mix between sales of our INFINITI analyzers and consumables and the introduction of new or enhanced tests. Changes in the relative mix of our INFINITI analyzers and consumables sales can have a significant impact on our gross margin, as consumable sales typically have significantly higher margins than those of INFINITI analyzer sales. Further, our revenue and operating results are difficult to predict because many of our tests have only recently been launched and we do not have sufficient history to forecast revenue reliably for those tests. The difficulty in accurately forecasting, and any period-to-period variations in, our revenue and operating results may cause our stock price to fluctuate significantly in the future.

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

As of December 31, 2011 and September 30, 2012, we did not have sufficient working capital to fund our planned operations through December 31, 2012 without additional financing. These conditions raise substantial doubt about our ability to continue as a going concern. Accordingly, the report of our independent registered

 

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public accounting firm on our audited financial statements included in this prospectus contains an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern; however, the audited financial statements have been prepared assuming that we will continue as a going concern, which contemplates the recovery of our assets on rental or loan to our customers and the satisfaction of our liabilities in the normal course of business.

After completion of this offering, we may not be able to meet our cash requirements without obtaining additional capital from external sources, and if we are unable to do so, we may have to curtail or cease operations.

We anticipate that our current cash and cash equivalents and cash provided by this offering and our operating activities will be sufficient to meet our currently estimated cash requirements for at least the next 12 months; however, we expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure, commercialization, training and support, manufacturing and research and development activities. We operate in a market that makes our prospects difficult to evaluate, and we may need additional financing to execute on our current or future business strategies. The amount of additional capital we may need to raise depends on many factors, including:

 

   

the level of research and development investment required to maintain and improve our technology, including efforts to expand our molecular diagnostic test menu, to fund clinical studies and clinical trials of our tests and to invest in the development of new products;

 

   

the amount of future cash provided by or used in operating activities;

 

   

the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

 

   

our need or decision to acquire or license complementary technologies or acquire complementary businesses; and

 

   

changes in regulatory policies or laws that affect our operations.

We have a history of operating losses and negative cash flows since our inception and we may not be able to maintain profitability. We cannot be certain that additional capital will be available when and as needed or that our actual cash requirements will not be greater than anticipated. If we require additional capital at a time when investment in diagnostics companies, or in the marketplace in general, is limited due to the then-prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter. If we are unable to raise additional capital, we may be required to curtail some or all of our operations, including commercialization and research and development efforts, and forced to forego otherwise valuable business opportunities. Any failure to raise additional capital when needed could have a material adverse effect on us. In addition, if we raise additional funds through the issuance of common stock, preferred stock or convertible securities, the percentage ownership of our stockholders could be significantly diluted, and any preferred stock or convertible securities may have rights, preferences or privileges senior to those of common stockholders. If we obtain additional debt financing, a substantial portion of our operating cash flow or other cash resources may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we may be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us.

We conduct business in a heavily regulated industry, and any changes in regulations or the FDA’s enforcement discretion, or violations of regulations by us, could adversely affect our business, prospects, results of operations or financial condition.

The clinical laboratory testing 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 particular, the laws and regulations governing the marketing of molecular research use or diagnostic products for use as laboratory-

 

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developed tests are extremely complex and in many instances there are no significant regulatory or judicial interpretations of these laws and regulations. While we believe that we are currently in material compliance with applicable laws and regulations as historically enforced by the FDA, we cannot assure you that the FDA or other regulatory agencies would agree with our determination, and a determination that we have violated these laws, or a public announcement that we are being investigated for possible violations of these laws, could adversely affect our business, prospects, results of operations or financial condition.

In addition, a significant change in any of these laws may require us to change our business model in order to maintain compliance with these laws. For instance, in June 2011 the FDA issued a Draft Guidance entitled “Commercially Distributed In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only: Frequently Asked Questions,” which, if enforced, would limit our marketing of research use only, or RUO, tests to general discovery laboratories and would require us to halt sales to clinical laboratories that validate and incorporate our RUO tests as laboratory developed tests, or LDTs. The FDA has generally exercised its enforcement discretion to not enforce applicable regulations with respect to LDTs. However, the FDA has indicated, since 2010, that it intends to reconsider its policy regarding enforcement and to begin drafting an oversight framework for such tests. Sales of RUO products accounted for 87%, 92% and 96%, respectively, of our net revenue for 2010, 2011 and the first nine months of 2012, respectively. Accordingly, if the FDA imposes significant changes to the regulation or enforcement of LDTs, including our RUO tests that are incorporated into LDTs, it could reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations or financial condition.

Our existing indebtedness could adversely affect our ability to continue operations and to raise additional capital to fund our operations, and could prevent us from meeting our obligations.

As of December 31, 2012, the principal amount of our total indebtedness was approximately $17.0 million and there was approximately $0.5 million in accrued and unpaid interest on this principal amount. As of December 31, 2012, we were in default on approximately $2.3 million in aggregate principal amount of and accrued interest on our indebtedness. Absent the completion of this offering, we do not have sufficient cash to satisfy our debt obligations. We are required pursuant to the terms of substantially all of our indebtedness to use at least 50% of the net proceeds of this offering to repay that indebtedness.

Our outstanding debt and related debt service obligations that remain after this offering, if any, could have important adverse consequences to us, including:

 

   

heightening our vulnerability to downturns in our business, our industry or the general economy and restricting us from making improvements to our products, acquiring complementary technology or businesses, or exploring other business opportunities;

 

   

requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and future business opportunities;

 

   

limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and general corporate or other purposes;

 

   

limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who have greater capital resources; and

 

   

subjecting us to financial and other restrictive covenants in our indebtedness, the failure with which to comply could result in an event of default.

If our cash flows and capital resources continue to be insufficient to fund our existing and future debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital

 

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or restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. Failure to pay our indebtedness on time would constitute an event of default under the agreements governing such indebtedness, and could constitute an event of default under the agreements governing our other indebtedness. Future events of default under such agreements would give rise to these creditors’ ability to accelerate the applicable debt obligations and/or seek other remedies against us, which could have a material adverse effect on us. We intend to use a portion of the proceeds of this offering to pay down our outstanding indebtedness. See “Use of Proceeds”.

Our past inability to pay our indebtedness and trade payables when due could adversely affect our reputation and business prospects.

We have in the past been in default on a substantial amount of indebtedness owed to various persons due to our inability to repay our indebtedness by their applicable maturity dates. We have also periodically been unable to timely pay various trade payables, including amounts owed to our suppliers, services providers and landlord. On November 1, 2012, we went into default on certain of our payment obligations to our landlord. In December 2012, we entered into an amendment to our lease with our landlord which provides that our past due amounts owed to the landlord, which total $1.1 million, must be paid by February 4, 2013. If we do not complete the offering referred to in this prospectus prior to February 4, 2013, we will be unable to satisfy this payment obligation, we will be in default under the lease, and our landlord will have the right to elect any or all of the remedies available to it under the lease and applicable law, including the termination of the lease and our eviction from our Vista, CA facility. In December 2012, we were sued for repayment by the holder of $2.2 million in past due principal under our outstanding promissory notes. See “Business—Legal Proceedings”. These events may have a negative impact on our reputation and perceived credit-worthiness, and make it more difficult for us to maintain existing relationships and enter into new relationships with suppliers and service providers, or to obtain future financing, particularly debt financing. In addition, concerns about our long-term ability to continue operations may deter potential customers from investing the time and resources necessary to install our INFINITI analyzers and use our system to conduct genetic testing. To the extent that our reputation has been harmed from our past failure to timely pay our debt and trade payables, it may take us many years to repair our reputation. In the meantime, we may receive less favorable terms from our suppliers and service providers, find it more difficult to obtain financing, and face challenges convincing customers to invest in the long-term use of the INFINITI system.

Our financial results depend on commercial acceptance of the INFINITI system, its menu of tests and the development of additional tests and other products.

Our future depends on the success of the INFINITI system, which depends primarily on its acceptance by reference laboratories, hospitals and specialty clinics as a reliable, accurate and cost-effective replacement for traditional molecular diagnostic testing methods. Many reference laboratories and hospitals already use molecular diagnostics testing instruments in which they have made substantial investments, and may be reluctant to change their current procedures for performing such analyses. In addition, many laboratories currently rely on their own LDTs. These laboratories, hospitals and specialty clinics may be reluctant to discontinue using their own LDTs due to the time and expense already invested in developing and validating these tests and their familiarity with these tests compared to the INFINITI system. If we are unable to displace molecular diagnostic testing instruments and LDTs currently in use, our market opportunity will be limited and we may not be able to achieve significant sales of our products.

We continue to seek to develop additional tests for our INFINITI system as well as additional products (such as our INFINITI PLUS 96 and INFINITI HTS analyzers, both of which are currently in the beta testing phase) to respond to what we perceive to be the needs of reference laboratories, hospital laboratories and specialty clinics; however, we cannot guarantee that we will be able to develop enough additional tests or other products in a timely manner or in a manner that is cost-effective or at all. The development of new or enhanced tests and other products is a complex and uncertain process requiring the accurate anticipation of technological and market trends, as well as precise technological execution. We are currently not able to estimate when or if we will be able to develop, obtain

 

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licenses to third-party intellectual property on commercially acceptable terms for, obtain regulatory approval or clearance for, commercialize or sell, additional tests or enhance existing products. If we are unable to increase sales of our INFINITI system or to successfully develop, obtain licenses to third-party intellectual property on commercially acceptable terms for, obtain regulatory approval or clearance for and commercialize, additional tests or other products, our revenue, prospects and ability to maintain profitability would be impaired.

Because we derive a significant portion of our revenue from a few customers, our business, financial condition and results of operations could be materially adversely affected by the loss of one or more of these customers, a significant decline in sales to one or more of these customers or a delay in collection of payments from one or more of these customers.

We have in the past derived, and expect to continue to derive, a significant portion of our revenue from a few major customers. For fiscal years 2010 and 2011, we had two and three customers, respectively, that each represented between 12% and 14% of our revenue in each year. For the nine months ended September 30, 2012, we had two customers that each represented more than 17% of our revenue, one of whom represented 47% of our revenue during such period. Our continued business relationship with these major customers, and the amount of purchases and timing of payment by these major customers, may be impacted by several factors beyond our control, including product offerings by our competitors, pricing pressures or the financial health of these customers. The loss of any of these major customers, or a significant decline in sales to or a delay in collection of payments from any of these customers, would materially adversely affect our business, financial condition and results of operations. For example, in the fourth quarter of 2012, one of our key customers decreased its ordering volumes, which resulted in substantially lower net revenues compared to the prior quarter.

Our business may suffer if we have difficulty acquiring and retaining customers.

A large part of our business strategy depends on our ability to place our INFINITI analyzers with customers that are high-volume users of genetic tests in our areas of focus to drive sales of our consumable products. We may not succeed in acquiring and retaining a sufficiently large customer base for our INFINITI system in order to execute on our strategy. If we are unable to establish a sufficient installed base of INFINITI analyzers or if customers with which we place INFINITI analyzers do not use them, we may not be able to generate revenue or successfully implement our business strategy. In addition, if we are unable to bring our products to market as quickly as anticipated or to acquire and develop our customer base as quickly as we have projected, our ability to generate revenue could be materially adversely impacted.

Failure by our customers or distributors to pay for products we have sold to them could have a material adverse effect on our financial condition and results of operations.

In certain cases, we may not be able to recognize revenue on sales even though we may have delivered products to our customers or distributors. For example, we have in the past sold, and may continue to sell, our INFINITI analyzers to certain of our international distributors where our ability to collect payment was not reasonably assured. Although our customers and distributors are required to pay us for the products that we sell to them, from time to time certain of our customers and distributors have not paid us or have delayed payment. In particular, some of our distributors experience long delays in receiving reimbursement from foreign government payors and healthcare providers, which in turn causes them to withhold payment to us. As of December 31, 2011 and September 30, 2012, approximately $0.2 million of our accounts receivable were 90 days or more past due. As of December 31, 2012, approximately $1.1 million of our accounts receivable were 90 days or more past due. In the past we have deferred, and in the future we may be required to defer, the recognition of revenue where the collection of payment is not reasonably assured until such payment is received. Deferring the recognition of revenue could negatively impact our results of operations for any period in which the related sales occurred. Although we have reserved for or deferred the recognition of revenue related to the amount of all late payments on our balance sheets, we also may incur unexpected costs or losses resulting from these sales in the event of any delays or failures to make payment for the related products. If we are unable to collect payment from our customers or distributors for

 

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products we have sold to them, we may never be able to recover our costs to manufacture and sell such products, which could have a material adverse effect on our financial condition and results of operations.

If our customers are unwilling or unable to validate the INFINITI system or follow required protocols, our business could be harmed.

In most cases, we are dependent on our customers to validate our INFINITI system and the associated tests we offer. These test validation processes are done on a test-by-test basis and can take anywhere from several weeks to several months or more to complete, and we do not generate revenue from these customers for sales of the tests being validated during these processes. Individual laboratories have their own validation procedures and protocols that our system and tests must pass and we cannot predict how long each validation process will take or whether laboratories will be willing or able to validate our INFINITI system. To the extent that any laboratories are unwilling or unable to validate our INFINITI system, we will not be able to generate meaningful revenue from sales to these laboratories.

Proper use of the INFINITI system also requires our customers to follow certain sample collection and other protocols. If we are unable to develop these protocols or if, despite our efforts, customers do not follow the required protocols, the INFINITI system may not generate a result or a correct result. With respect to international customers, we are generally dependent on our distributors to provide support services. Failure by our customers to follow required protocols may lead to a perception, even if unfounded, that the INFINITI system does not function properly. Such perceptions could damage our reputation and brand and reduce the frequency that our customers use the INFINITI system and purchase our consumable products.

Many of our competitors are large and well capitalized, and we face significant competition.

We face, and will continue to face, significant competition from organizations such as large in vitro diagnostics companies that compete directly or indirectly with us in the general molecular diagnostics market. We compete in an industry characterized by: (i) rapid technological change, (ii) evolving industry standards and regulatory requirements, (iii) emerging competition and (iv) new product introductions. Our competitors may develop and commercialize products and technologies that may mitigate any advantages our products may currently have and that may compete successfully with our products and technologies. Since several potentially competing companies and institutions have greater financial resources, more established brand names and larger existing customer bases than we do, they may be able to: (a) provide broader services and product lines, (b) make greater investments in research and development, (c) undertake more extensive sales efforts and marketing campaigns and (d) adopt more aggressive pricing policies than we are able. Some of our competitors are also our suppliers, and there can be no assurance that these suppliers will continue to provide us products at competitive prices or at all. Many of our competitors have also been able to enter into long-term, exclusive agreements with major potential customers, such as large reference labs, oftentimes by offering favorable pricing and other terms. Until these agreements expire, our ability to place our analyzers with and sell our testing consumables to these customers will be limited. Even after exclusive agreements expire, we may not be able to compete with the terms offered by our competitors in their efforts to extend exclusive relationships with these major potential customers. In addition, we compete against companies on the basis of the relative regulatory status of their and our products. Some of our competitors may have already received regulatory approval and conducted extensive clinical trials for tests we seek to sell. For example, other companies have received approval of PMAs from the FDA for HPV screening tests. We expect that it may take us several years to receive approval of a PMA for our HPV-HR tests, if at all. Any tests that we offer on an RUO basis may be at a competitive disadvantage to similar tests offered by others that have received FDA clearances or approvals.

We face competition from enhanced or alternative technologies and products.

We expect to continue to face competition from enhanced or alternative technologies and products. One or more of our competitors could develop a product that is superior to a product we offer or intend to offer or our technology and products may be rendered obsolete or uneconomical by advances in existing technologies. At least two of our competitors currently offer on a commercial basis self-contained, integrated systems for molecular

 

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diagnostic testing that are similar in many ways to our products. If we are unable to keep pace with technological advances in the molecular diagnostics market, our business, financial condition and results of operations may suffer.

Our business may be materially adversely affected if the molecular research use and diagnostics market fails to develop or if we fail to capture a significant share of the market.

Our business may suffer if the market for research use and molecular diagnostics products fails to develop or develops more slowly than expected. Our revenue is dependent on the acceptance of molecular research use and diagnostics products by laboratories, hospitals and specialty clinics and on the expanded use of molecular diagnostic testing by physicians and hospitals. Even if we are successful in gaining acceptance of our products in laboratories, hospitals and specialty clinics, our revenue may be limited if physicians and hospitals curtail or do not expand the use of molecular diagnostic testing. Barriers to the adoption of widespread genetic testing include the need to increase physician education on molecular research use and diagnostic testing and to keep physicians up-to-date on new and emerging technologies, as well as overcoming coverage denials from insurance companies generally. Moreover, we rely in part on reference laboratories to drive demand for molecular diagnostic testing with physicians and hospitals and to provide this education. Reference laboratories are private, commercial facilities that conduct high-volume routine and specialty testing and which are relied upon for testing by many physicians and hospitals. If these laboratories are unsuccessful in their efforts to drive demand for testing, or if laboratories that use our INFINITI system lose market share to other laboratories that use competing molecular diagnostics products, our growth potential will be limited. Even if the market does develop, we cannot assure you that we will be successful in capturing a significant share of it by expanding the sale of our products at the prices we currently project. In the event that the market in general, or our market share in particular, does not grow as we expect, our business may be materially adversely affected.

We have limited experience pricing and marketing our products and we may not be able to appropriately adjust our pricing and marketing efforts in response to changes in the market.

We intend to generate revenue from one-time sales of our INFINITI analyzers and recurring sales of consumables, including our BioFilmChips and Intellipac Reagent Management Modules. We have limited experience marketing and pricing molecular research use and diagnostics products. As such, we cannot assure you that our expectations as to pricing and marketing of these products are appropriate. The molecular research use and diagnostics market is also rapidly evolving due to, among other things, regulatory changes and the introduction of new technologies. If we are unable to appropriately adjust our pricing and marketing efforts in response to this changing environment, we may lose market share by pricing our products too high or lose potential revenue by pricing our products lower than required to maintain or grow our market share. Our failure to price and market our products appropriately could impact our ability to attract and retain customers in the molecular research use and diagnostics market, or to establish and maintain recurring revenue streams on acceptable terms. In light of these factors, we cannot assure you that we will be able to attract a sufficient number of customers or generate sufficient revenue to support our operations.

We are subject to risks relating to the placement of INFINITI analyzers under our domestic placement plans.

In the United States, we offer the INFINITI analyzer through direct sale, monthly rental plans and our domestic placement plan. As of December 31, 2012, we had 191 INFINITI analyzers placed with customers, 48 of which were placed with customers under domestic placement plans. Under our domestic placement plan, an INFINITI analyzer is placed at the customer’s location at no direct cost to the customer with the intent of generating recurring demand for our high-margin testing consumables, including our test-specific BioFilmChips and Intellipac Reagent Management Modules. The customers under our domestic placement plans are required by the terms of the plans to purchase minimum amounts of consumables; however, in some cases, customers have not met this requirement. We have the right to reclaim an INFINITI analyzer placed with a customer pursuant to a domestic placement plan if the customer does not purchase the minimum amount of consumables. During the years ended December 31, 2010, 2011 and 2012, we reclaimed 27, 18, and 16 INFINITI analyzers,

 

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respectively, either because the customer failed to purchase the minimum amount of consumables or otherwise elected not to retain the INFINITI analyzer at the end of the term of the applicable domestic placement plan. We bear the costs of producing these INFINITI analyzers and rely on the revenue from the sale of consumables to recoup our costs. As a result, we could expend significant resources to produce INFINITI analyzers for our domestic placement plans and not generate enough revenue from the sale of consumables to recoup our costs, in which case our business could be materially adversely affected.

The spending policies of our customers have a significant effect on the demand for our products.

Our targeted customers include reference laboratories, hospital laboratories and specialty clinics, and their spending policies can have a significant effect on the demand for our products. These policies are based on a wide variety of factors, including governmental regulation or price controls, reimbursement policies, the resources available for purchasing diagnostic tests, the spending priorities among various types of diagnostic tests and the policies regarding capital expenditures during recessionary periods. Any decrease in spending by reference laboratories, hospital laboratories or specialty clinics could cause our revenue to decline. As a result, we are subject to significant volatility in revenue. Therefore, our operating results can be materially affected by the spending policies and priorities of our customers, over which we have little control.

We rely on the innovation and resources of larger industry participants and public programs to advance genetic research, establish the medical relevance of biomarkers, and educate physicians and clinicians on molecular diagnostics.

The link between the genetic variations that our products detect and the underlying disease states or response to medications is not always fully medically validated, and our current and future products may involve biomarkers whose medical relevance is unproven. Additionally, the availability of validated biomarkers is dependent on significant investment in genetic research, often funded through public programs for which there are no assurances of ongoing support. Should any government limit patent rights to specific genetic information, private investment in this area could also be significantly curtailed. In addition, the adoption of molecular diagnostics is dependent to a great extent on the education and training of physicians and clinicians. We do not have the resources to undertake such training, and we are relying on larger industry participants and professional medical colleges to establish, communicate and educate physicians and clinicians regarding the use and application of molecular diagnostics.

We have identified material weaknesses and significant deficiencies in our internal controls, and we cannot provide assurances that these weaknesses and deficiencies will be effectively remediated or that additional material weaknesses and significant deficiencies will not occur in the future. If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results, prevent fraud, or file our periodic reports in a timely manner, which may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price.

We have historically operated as a private company and the number and qualifications of our finance and accounting staff have not been consistent with those of a public company. We also currently do not have an internal audit function. Further, we have in the past been required to expend significant time and resources to improve our internal controls over financial reporting. For example, in the first and second quarter of 2010, we identified material weaknesses and significant deficiencies in our internal controls under the standards established by the Public Company Accounting Oversight Board, or PCAOB, with respect to (i) revenue recognition as it relates to properly recording negotiated terms and conditions in customer agreements that deviate from our standard terms and conditions, (ii) the misapplication of generally accepted accounting principles, or GAAP, with respect to the timing of the recognition of revenue for product sales characterized by multiple deliverables or additional elements, and (iii) our financial statement closing process and errors in calculating and allocating the fair value of the warrants and the amortization of the related interest expense related to our accounting for warrants issued with our promissory notes. In response to the identification of these material weaknesses, we terminated one of our sales

 

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personnel that had contributed to the failure to communicate negotiated terms and conditions, revised our sales and revenue recognition policies and procedures and trained our personnel with respect to the revised policies and procedures, and amended our code of ethics and required all of our employees to certify compliance with this code.

Furthermore, in connection with the audits of our financial statements for the years ended December 31, 2010 and 2011, and the review of our financial statements for the period ended September 30, 2012, both our independent registered public accounting firm and our management discovered several conditions that we deemed to again be material weaknesses and significant deficiencies in our internal controls, as follows:

 

   

We noted several issues related to effective oversight by management primarily attributed to lack of significant prior audit experience and expertise relating to complex accounting issues (such as debt and equity accounting and valuation). A lack of sufficient controls over debt/equity accounting and recordkeeping of equity and debt holders’ transactions resulted in material adjustments.

 

   

We lacked a comprehensive, consistent and supportable methodology to capture the cost of manufacturing our inventory, specifically as it relates to labor and overhead charges and inventory reserves. In addition, updates to our costing system were not performed timely to ensure accurate recordkeeping.

 

   

A lack of qualified accounting and finance resources as well as effective oversight by those in charge of governance resulted in insufficient controls over timely financial statement preparation and review as well as the inability to timely and accurately account for complex transactions. A lack of technical knowledge and expertise attributed to non-compliance with certain GAAP accounting disclosure requirements.

 

   

The design of monitoring controls used to assess the design and operating effectiveness of our internal controls is inadequate. We also do not have an adequate internal process to report deficiencies in internal control to management on a timely basis.

We believe that we have taken actions that have substantially remediated the material weaknesses and significant deficiencies identified in 2010 other than with respect to our financial statement closing process, with respect to which we have continued to experience material weaknesses. In an attempt to remediate our closing process weaknesses, and in response to the identification of our more recent material weaknesses and significant deficiencies, we (i) have hired two new employees to augment our accounting staff, and intend to hire additional finance and accounting personnel, in addition to providing more resources and/or assistance on equity accounting and other complex GAAP accounting matters, and have engaged a third party finance specialist to perform certain accounting functions for us, (ii) have established a series of internal controls over critical financial processes designed to ensure the proper oversight, accuracy and timeliness of entries made by our finance personnel and to ensure that periodic financial reporting is completed within requisite timeframes, and (iii) will seek to establish better operating controls and involve our board of directors in our internal controls process, which will involve establishing formal procedures to communicate deficiencies in internal controls on a timely basis, and encourage our board of directors to more actively participate in guiding management as it relates to internal controls matters. However, we cannot assure you that our internal controls over financial reporting, as modified, will enable us to identify or avoid material weaknesses or significant deficiencies in the future. Regardless, following the completion of this offering 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.

Growth in our business could strain our managerial, operational, manufacturing, customer support, sales, financial and information systems resources.

The anticipated future growth necessary to expand our operations will place a significant strain on our managerial, operational, manufacturing, sales, financial and information systems resources. These increased demands could cause us to operate our business less effectively, which in turn could cause deterioration in the financial performance of our business. To increase revenues and achieve growth, we will need to expand our sales efforts and continue to improve and develop our products. The future growth of our business will also

 

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require us to expand our customer support resources, including adding additional personnel for customer training and technical product support. If our customer support infrastructure does not keep pace with future growth of our customer base, we may lose customers and our reputation and future sales potential may be harmed. In addition, we expect that we will need to improve our financial and managerial controls, reporting systems and procedures, and that we also will need to expand, train and manage our workforce. We may be unable to hire, train and retain a sufficient number of qualified personnel or successfully manage our growth. This growth may also place increased burdens on our international distributors, increase the complexities we face related to international sales and increase our inventory-related risk. Future growth will also make it difficult for us to adequately predict the expenditures we will need to make in the future.

If we do not make the necessary capital or other expenditures to accommodate our anticipated growth, or if we are unable to manage our growth effectively, our business, financial condition and results of operations will suffer. We cannot anticipate all of the demands that our expanding operations will impose on our business, personnel, systems and controls and procedures, and our failure to appropriately address such demands could have a material adverse effect on us.

The loss of the services of one or more of our key personnel or failure to attract and retain other highly qualified personnel in the future could adversely affect operations and result in a loss of revenue.

We are dependent on the continued services and performance of senior management and educated, technically-trained personnel. We currently do not have employment or severance agreements with any of these persons. Certain of the members of our senior management, including certain of our named executive officers, are at or close to traditional retirement age in the United States. Our business depends and will depend in the future on the ability to identify, attract, hire, train, retain and motivate senior management and other highly skilled technical, managerial, marketing and customer service personnel. Competition for such personnel is intense, and we cannot assure you that we will be able to successfully attract and retain sufficiently qualified personnel in the future. While we do not currently expect any of our senior management or other technically-trained personnel to retire or otherwise cease employment with us in the near-term, we will need to effectively plan for management succession to maintain effective leadership and continuity in our business. The failure to attract and retain necessary senior management and technically-trained personnel and to successfully plan for management succession could adversely affect our business and result in a loss of revenue.

Our failure to comply with regulatory requirements or receive any required regulatory clearance or approval for our products or operations in the United States or abroad would adversely affect our revenue and potential for future growth.

As a manufacturer of molecular research use and diagnostics products, our products are medical devices that are subject to extensive regulation in the United States by the FDA, and by respective authorities in foreign countries where we do business. The FDA regulates virtually all aspects of a medical device’s design and testing, manufacture, safety, labeling, storage, recordkeeping, reporting, clearance and approval, promotion and distribution. The FDA also regulates the export of medical devices to foreign countries. Failure to comply with the regulatory requirements of the FDA and other applicable U.S. regulatory requirements may subject a company to administrative or judicially imposed sanctions ranging from warning letters to criminal penalties or product withdrawal or recall. Unless an exemption applies, a medical device must receive either clearance or premarket approval from the FDA before it can be marketed in the United States. The FDA’s 510(k) clearance process for Class II devices usually takes from three to twelve months, but may take significantly longer. The premarket approval process for Class III devices generally takes from one to three years from the time the application is filed with the FDA, but also can be significantly longer. Premarket 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 premarket approval process.

 

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Medical devices may only be marketed for the indications for which they are approved or cleared. We may be required to obtain additional new premarket approvals, premarket approval supplements or 510(k) clearances to market additional products or for new indications for or modifications to our existing products. We cannot be certain that we would obtain additional premarket approvals or 510(k) clearances in a timely manner or at all. We have modified various aspects of our devices in the past and we determined that new approvals, supplements or clearances were not required. The FDA may not agree with our decisions not to seek approvals, supplements or clearances for particular device modifications. If the FDA requires us to obtain premarket approvals, supplement approvals, or 510(k) clearances for any modification to a previously cleared or approved device, we may be required to cease manufacturing and marketing the modified device or to recall such modified device until we obtain FDA clearance or approval and we may be subject to significant regulatory fines or penalties. In addition, we cannot assure you that the FDA will clear or approve such submissions in a timely manner, if at all.

The vast majority of the tests that we currently sell, which together represented 87%, 92% and 96% of our net revenue for 2010, 2011 and the first nine months of 2012, respectively, have not been cleared or approved for clinical use by the FDA. These tests are labeled “For Research Use Only. Not for use in diagnostic procedures.” as required by FDA regulations. These RUO tests are marketed to allow for the collection of research data and may only be used for clinical purposes by laboratories certified under the Clinical Laboratory Improvements Amendments of 1988, or CLIA, that have incorporated our RUO tests into their own laboratory-developed tests pursuant to guidelines issued by the College of American Pathologists. In order to develop an LDT utilizing our products, these certified laboratories and other facilities must develop and validate a test protocol that includes specimen collection, DNA extraction, PCR amplification, hybridization and detection, and data analysis, interpretation and reporting. We provide components that can be used by these certified laboratories and other facilities for the PCR amplification, hybridization and detection portions of these LDTs. We sell each of these components individually, as ordered by the customer in its discretion, and not as a kit or system. The validation process engaged in by these certified laboratories and other facilities can involve validation of the sample collection and extraction process, establishing limits of detection and analytical sensitivity, testing for specificity and cross-reactivity, including interfering substances, validation for assay accuracy, precision and reproducibility, and establishing reportable ranges of test results for the test system and reference values that will be measured against as controls. This validation process also requires verifying the result from the LDT versus known standard samples or the results of a high-standard laboratory testing method such as sequencing, and can involve the testing of a large number of patient samples. Depending on the availability of patient samples, this process may take from several weeks to several months or more to complete. The FDA has not adopted these guidelines and we are not permitted to represent our RUO products as effective in vitro diagnostic products. On December 4, 2009, the FDA issued a letter to us indicating that certain of our promotional materials for our RUO tests may include diagnostic/clinical claims which may cause these products to be in vitro diagnostic tests for clinical use for which FDA clearance or approval is required. In addition, the FDA noted that the allegations in its letter may not constitute an exhaustive list of potential violations and noted that we are required to comply with the RUO requirements for all of our products that have not received FDA clearance or approval. We responded to the FDA’s allegations in a letter dated December 14, 2009 and believe that we have taken appropriate action to modify and revise the promotional materials in light of the FDA’s concerns. However, the FDA has not responded to our submission and has not confirmed its agreement with our approach. If the FDA does not agree with our approach, it could require that we take additional steps, initiate enforcement action or require that we recall or withdraw certain or all of our RUO products from the market. Our failure to comply with the FDA’s regulatory requirements, obtain FDA clearance or approvals of new or existing products or product modifications or enhancements that we develop in the future, any limitations imposed by the FDA on such products’ development or use, or the costs of obtaining FDA clearance or approvals could have a material adverse effect on our business, particularly given the proportion of our business that is reliant upon RUO products.

In many of the foreign countries in which we market our products, including those countries in the European Union, we are subject to extensive regulations similar to those of the FDA. As discussed under “Business — Government Regulation,” there are additional regulatory requirements outside of the United States, including certifications, registrations or approvals that may require third-party certification of compliance with ISO

 

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13485:2003, a quality management system standard developed by the International Organization for Standardization, or ISO. This certification must be satisfied in order for us to market our products in those jurisdictions. If we fail to satisfy such requirements or obtain the requisite certifications, registrations or approvals in these countries, it could have a material adverse effect on our international operations.

If the FDA or another regulatory agency determines that we have promoted off-label use of our products, or are not in compliance with restrictions on the marketing of products labeled for research use only, we may be subject to various penalties, including civil or criminal penalties.

The FDA and other regulatory agencies actively enforce regulations prohibiting the promotion of a medical device for a use that has not been cleared or approved by the FDA. Use of a device outside its cleared or approved indications is known as “off-label” use. If the FDA or another regulatory agency determines that our promotional materials or training constitutes promotion of an off-label use, it could require us to modify our training or promotional materials or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and criminal penalties.

As required by the FDA, we have a policy in place requiring that our labeling and marketing practices comply with FDA regulations for products labeled for research use only. We also have a policy in place to refrain from making statements that could be considered off-label promotion of our products. Although our policy is to refrain from making statements that could be considered off-label promotion of our products or outside of the restrictions for products labeled for research use only, the FDA or another regulatory agency could conclude that we have engaged in off-label promotion or marketing of products labeled for research use only. If the FDA disagrees with the marketing of these products, we may be subject to a variety of enforcement actions ranging from public warning letters, fines, injunctions, consent decrees and civil penalties to suspension or delayed issuance of approvals, seizure or recall of our products, total or partial shutdown of production, withdrawal of approvals or clearances already granted, and criminal prosecution. In addition, the off-label use of our products or the use of our products labeled for research use only for clinical purposes may increase the risk of injury to patients, and, in turn, the risk of product liability claims. Product liability claims are expensive to defend and could divert our management’s attention and result in substantial damage awards against us.

We may fail to receive favorable clinical results from the diagnostic tests currently in development that require clinical trials, and even if we receive favorable clinical results, we may still fail to receive the necessary clearances or approvals to market these tests.

We are investing in the research and development of new products to expand the menu of testing options for the INFINITI system. To commercialize our products, we are required to undertake time-consuming and costly development activities, sometimes including clinical trials for which the outcome is uncertain. We are in the process of finalizing the protocol for a clinical trial necessary to support a PMA application to the FDA for our HPV-HR tests and intend to commence the clinical trial in 2013 once the protocol is complete. As discussed under “Use of Proceeds,” we intend to use a portion of the net proceeds of this offering to fund the clinical trial. We do not know whether clinical trials of our HPV-HR tests or any other pre-clinical or clinical trials will begin on time or be completed on schedule, if at all. The commencement and completion of clinical trials can be delayed for a number of reasons, including delays related to:

 

   

obtaining sufficient funding for the clinical trial;

 

   

satisfying regulatory requirements to commence a clinical trial;

 

   

reaching agreement on acceptable terms with prospective clinical research organizations, or CROs, clinical investigators and trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs, clinical investigators and trial sites;

 

   

obtaining institutional review board approval to initiate and conduct a clinical trial at a prospective site;

 

   

identifying, recruiting and training suitable clinical investigators; and

 

   

identifying, recruiting and enrolling subjects to participate in clinical trials.

 

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Clinical trials may also be delayed, halted or repeated as a result of ambiguous or negative interim results or unforeseen complications in testing. In addition, a clinical trial may be suspended or terminated by us, the FDA, the institutional review board overseeing the clinical trial at issue, any of our clinical trial sites with respect to that site, or other regulatory authorities due to a number of factors, including:

 

   

failure by us, our employees, our CROs or their employees to conduct the clinical trial in accordance with all applicable FDA or other regulatory requirements or our clinical protocols;

 

   

inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

 

   

lack of adequate funding to continue the clinical trial, including the incurrence of unforeseen costs due to enrollment delays, requirements to conduct additional trials and studies and increased expenses associated with the services of our CROs and other third parties;

 

   

lack of effectiveness of any product candidate during clinical trials;

 

   

slower than expected rates of subject recruitment and enrollment rates in clinical trials;

 

   

failure of our CROs or other third-party contractors to comply with all contractual requirements or to perform their services in a timely or acceptable manner; or

 

   

unfavorable results from ongoing clinical trials and pre-clinical studies.

Clinical investigations of in vitro diagnostic tests, including our products and product candidates, typically are exempt from the investigational device exemption, or IDE, requirements. Thus, we do not need the FDA’s prior approval to conduct clinical trials of our products, provided the testing is non-invasive, does not require an invasive sampling procedure that presents a significant risk, does not intentionally introduce energy into the subject and is not used as a diagnostic procedure without confirmation of the diagnosis by another, medically established diagnostic device or procedure. The FDA requires each sponsor of a clinical trial to make this determination in the first instance, but the FDA can review any decision. If the FDA disagrees with our decision not to submit an IDE for the clinical trials we are currently conducting, the agency may retroactively require us to submit an IDE and halt the clinical trial until the IDE is approved.

Products that appear promising during early development and preclinical studies may, nonetheless, fail to demonstrate the results needed to support regulatory approval or commercial viability. Even if we receive favorable clinical results, we may still fail to obtain the necessary FDA clearance and approvals. Any such failure, or any material delay in obtaining the necessary clearance or approvals, could materially adversely affect our business, financial condition and results of operations.

Our products are subject to recalls even after receiving FDA clearance or approval, or after affixing the CE marking, which would harm our reputation and business.

We are subject to medical device reporting regulations (e.g., MDR, vigilance reporting) that require us to report to the FDA or governmental authorities in other countries if our products cause or contribute to a death or serious injury, or malfunction in a way that would be reasonably likely to contribute to death or serious injury if the malfunction were to recur. The FDA and similar governmental authorities in other countries have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacturing. To date, we have not conducted a product recall. A government mandated, or voluntary, recall by us could occur as a result of component failures, manufacturing errors or design defects, including defects in labeling. Any recall would divert managerial and financial resources and could harm our reputation with customers. There can be no assurance that there will not be product recalls in the future or that such recalls would not have a material adverse effect on our business.

If we fail to comply with the FDA’s Quality System regulation and similar requirements in other jurisdictions, our manufacturing could be delayed, and our product sales and profitability could suffer.

Our manufacturing processes are required to comply with the FDA’s Quality System regulation, which covers the procedures concerning (and documentation of) the design, testing, production processes, controls,

 

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quality assurance, labeling, packaging, storage and shipping of our devices. We also are subject to similar requirements in other jurisdictions and to state requirements and licenses applicable to manufacturers of medical devices. In addition, we must engage in extensive recordkeeping and reporting and must make available our manufacturing facilities and records for periodic unscheduled inspections by governmental agencies, including the FDA, state authorities and comparable agencies in other countries. Moreover, failure to pass a Quality System regulation inspection or to comply with these and other applicable regulatory requirements could result in disruption of our operations and manufacturing delays. Failure to take adequate corrective action could result in, among other things, significant fines, suspension of approvals, seizures or recalls of products, operating restrictions and criminal prosecutions. Any failure to comply with applicable requirements could adversely affect our product sales and profitability.

The California Department of Health Services, Food and Drug Branch audited our quality system in 2007. That audit resulted in two observations related to CAPA documentation and failure to make instructions available to employers to define how an activity is to be carried out. We responded to those observations on October 16, 2007 and have not received any further correspondence. The FDA also audited our quality system in April 2009. This audit resulted in a Form 483 notice of inspectional observations that identified eight deficiencies relating primarily to CAPA documentation. On April 30, 2009, we formally addressed the observations from the audit. On September 22, 2009, we received a copy of the establishment inspection report, or EIR, from the FDA District Director for the audit conducted in April 2009. Although we have addressed the audit observations from this audit, we cannot assure you that the FDA will not raise issues relating to our activities as a result of this or any other audit.

We may not be able to compete effectively if we are unable to protect our proprietary rights.

Our success depends in part on our ability to protect our intellectual property rights, which involve complex legal, scientific, and factual questions and uncertainties. We rely upon patent, trade secret, copyright and contract laws to protect proprietary technology and trademark law to protect brand identities. We cannot be certain that we have taken adequate steps to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to ours. We also cannot be certain that we have taken adequate steps to protect our inventions through patents or our brand identities through trademarks. To date we have not sought trademark protection for our brand identities in countries outside of the United States, and this may adversely affect our ability to prevent unauthorized use of these brand identities after we, or our distributors, have expended resources to increase their recognition. Our success depends in part on our ability to obtain and maintain patent protection for our products and their use, maintain trade secret protection and operate without infringing upon the proprietary rights of others. Our policy is to protect our proprietary technology through patents, where appropriate, and in other cases, through trade secrets. In addition, we rely on the licenses of patents of third parties. We cannot assure you that any patent applications filed by, assigned to, or licensed to us will be granted, that any patents issued to or licensed by us will provide us with any competitive advantages or adequate protection for inventions, that any patents issued to or licensed by us will not be challenged, invalidated, held to be unenforceable, or circumvented by others or that issued patents, or patents that may be issued, will provide protection against competitive products or otherwise be commercially valuable.

If we fail to obtain and/or maintain sufficient patent protection for our products, our ability to realize a competitive advantage for these products could be materially affected, which may have a material adverse effect on our results of operations. In particular, if we fail to obtain and/or maintain patent protection, competitors may be able to produce products that would be directly competitive with our products using similar or identical processes with impunity. Moreover, should any government or court limit or alter patent rights relating to specific genetic information or diagnostic methods, our business could be materially and adversely affected.

Patent law relating to the scope of claims in the fields of healthcare and biosciences generally, and molecular diagnostics in particular, is evolving and our patent rights are subject to this uncertainty. For example, on March 29, 2010, the U.S. District Court in New York invalidated seven patents held by Myriad Genetics

 

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related to the genes BRCA1 and BRCA2. Mutations in these genes have been associated with breast cancer, indicating that such patents “are directed to a law of nature and were therefore improperly granted”; however, that decision was overruled by the Federal Circuit, Association for Molecular Pathology v. USPTO, Fed. Cir., No. 2010-1406, 8/16/2012, which held that isolated BRCA1/2 DNA molecules used for diagnosing increased breast and ovarian cancer risk are eligible for patent protection under 35 U.S.C. §101. If patents covering naturally occurring genes are invalidated, it could adversely impact the scope of our patent protection relating to naturally occurring genes and certain aspects of their diagnostic methods.

Our patent rights on our products might conflict with the patent rights of others, whether existing now or in the future. We cannot assure you that the inventors of the patents and applications that we own and license were the first to invent or the first to file on the claimed inventions, and if others were determined to be the first inventors, such determination could materially reduce or even eliminate the value of such patents. We also cannot assure you that a third party does not have or will not obtain patents that dominate the patents we own or license now or in the future. Consequently, we could be subject to charges of patent infringement. The defense and prosecution of patent claims are both costly and time-consuming even if the outcome is ultimately in our favor. An adverse outcome could subject us to significant liabilities to third parties, require disputed rights to be licensed from third parties or require us to cease selling the affected products. As our products are distributed in the marketplace, we expect to face opposition to our intellectual property by competitors. If we face opposition to our intellectual property, we likely will incur substantial costs defending our patents.

Additionally, we rely on trade secrets and proprietary know-how, which we seek to protect, in part, by confidentiality agreements with our collaborators, employees and consultants. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any such breach or that our trade secrets will not otherwise become known or be independently developed by competitors.

Our success will depend partly on our ability to operate without infringing or misappropriating the proprietary rights of others.

The in vitro diagnostics industry has a history of patent litigation and likely will continue to experience patent litigation suits. A third party could claim that we are infringing a patent, which could prevent us from selling our INFINITI analyzers and tests, or from developing new technologies we expect to utilize or products we expect to sell. We may be sued for infringing or misappropriating the proprietary rights of others. We may have to pay substantial damages, including treble damages and the opposing party’s attorney fees, for past infringement if it is determined that our products or their use infringe on a third party’s proprietary rights. In addition, in the future we may need to obtain one or more licenses to the intellectual property of others, and the failure to obtain such licenses could prevent us from manufacturing or selling the affected products.

Our INFINITI system utilizes a wide variety of technologies and we cannot assure you that we have identified or can identify all inventions and patents that may be infringed by the development, manufacture, sale and use of our INFINITI system, including its various components. If relevant patents are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our system unless we can obtain a license to use technology or ideas covered by such patents or are able to redesign our INFINITI system to avoid infringement. A license may not be available at all or on commercially reasonable terms, and we may not be able to redesign our INFINITI system to avoid infringement.

The landscape for intellectual property rights in the field of genetics is complex. Although a significant amount of intellectual property in the field of genetics is already in the public domain, some of our existing and future tests for the INFINITI system could require modification, or the acquisition of certain rights from third parties related to those tests which we have not yet obtained, to avoid infringement. We may not be able to make such modifications or obtain such rights at all or on terms that are commercially acceptable. If we sell an otherwise infringing test without such modifications or such rights, a third party patent holder may sue us for patent infringement. If a court finds that we infringed the third party’s patent and that the infringement was

 

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willful, we could be ordered to pay treble damages and the patent holder’s attorneys’ fees, and we may be enjoined from further selling our tests, which may materially impact our business, financial condition or results of operations.

We also enter into collaborative agreements with research and academic institutions for the development of additional or enhanced tests to be run on our system. Under these agreements, the institution typically retains the intellectual property rights to any inventions or discoveries made solely by the institution, while we receive a right to negotiate a license to these intellectual property rights. If these institutions independently develop intellectual property that is necessary for us to sell new tests that arise from the collaboration, there can be no assurance that we will be able to obtain a license through our negotiation rights. Acquisition of any necessary intellectual property rights from third parties related to any of our existing or future tests, including licenses to patents, could also be time-consuming and expensive, and could require us to pay significant royalties to third parties. And likewise any such rights may not be available on commercially reasonable terms or at all.

We cannot assure you that any third party intellectual property rights to use technology or biomarkers that we determine are necessary to our business and the development of new tests for the INFINITI system can be acquired on commercially reasonable terms or at all. Resulting limitations on our ability to offer certain tests or expand our menu of tests could have a material adverse effect on our business, financial condition and results of operations and negatively impact a key basis upon which we compete.

We have hired and will continue to hire individuals who have experience in molecular diagnostics and these individuals may have confidential trade secret or proprietary information of third parties. We cannot assure you that these individuals will not use this third-party information in connection with performing services for us or otherwise reveal this third-party information to us. Thus, we could be sued for misappropriation of proprietary information and trade secrets. Such claims are expensive to defend and could divert our attention and result in substantial damage awards and injunctions that could have a material adverse effect on our business, financial condition or results of operations.

We may need to initiate lawsuits to protect or enforce our patents or other proprietary rights, which would be expensive and, if unsuccessful, may cause us to lose some of our intellectual property rights.

To protect or enforce our patent rights, it may be necessary for us to initiate patent litigation proceedings against third parties, such as infringement suits or interference proceedings. These lawsuits would be expensive, take significant time and would divert management’s attention from other business concerns. In the event that we seek to enforce any of our patents against an infringing party, it is likely that the party defending the claim will seek to invalidate the patents we assert, which could put our patents at risk of being invalidated, held unenforceable, or interpreted narrowly, and our patent applications at risk of not being issued. Further, these lawsuits may provoke the defendants to assert claims against us. The patent position of in vitro diagnostics firms is highly uncertain, involves complex legal and factual questions and recently has been the subject of much litigation. We cannot assure you that we will prevail in any of such suits or proceedings or that the damages or other remedies awarded to us, if any, will be commercially valuable.

We are subject to litigation, which, if adversely determined, could cause us to incur substantial losses.

We are, from time to time, during the normal course of operating our businesses, subject to various litigation claims and legal disputes. Some of the litigation claims may not be covered under our insurance policies or our insurance carriers may seek to deny coverage. As a result, we might be required to incur significant legal fees, which may have a material adverse impact on our financial position. In addition, because we cannot predict the outcome of any action, it is possible that, as a result of current and/or future litigation, we will be subject to adverse judgments or settlements that could significantly reduce our earnings or result in losses.

 

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If our products contain undetected defects or errors or do not operate as expected, we could incur significant unexpected expenses, experience product returns and lost sales, suffer damage to our brand and reputation and be subject to product liability or other claims and product recalls and other field or regulatory actions.

Our products are complex and may contain undetected defects, errors or failures, particularly when first introduced or when new versions are released. Some errors and defects may be discovered only after a product has been installed and used by the customer. To the extent our products incorporate technologies of third parties, we will be dependent on the reliability of these technologies. If our products contain undetected defects or errors or do not operate as expected, we could experience decreased sales and increased product returns, loss of customers and market share and increased service, warranty and insurance costs. In addition, our reputation and brand could be damaged, and we could face potential legal claims regarding our products and be subject to product recalls or corrections and other field or regulatory actions. A successful product liability or other claim or product recall could result in negative publicity and further harm our reputation, result in unexpected expenses and materially adversely impact our business, financial condition and results of operations. In addition, we may be subject to claims resulting from false identification of genetic variations or other misdiagnoses made in connection with our tests. Litigating any such claims could be costly. We could expend significant funds during any litigation proceeding brought against us. Further, if a court were to require us to pay damages to a plaintiff or if we agree to pay damages in settlement of a claim, the amount of such damages could materially adversely affect our business, financial condition and results of operations.

The imposition of new healthcare legislation could significantly impact our earnings and negatively impact our results of operations and cash flows.

In March 2010, significant reforms to the healthcare system in the form of the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 were adopted as law in the United States. This legislation includes provisions that, among other things, reduce or limit Medicare reimbursement, require all individuals to have health insurance (with limited exceptions) and impose increased taxes. Specifically, this legislation requires the medical device industry to subsidize healthcare reform in the form of a 2.3% excise tax on U.S. sales of most medical devices, including our products, beginning in January 2013. This significant increase in the tax burden on our industry could have a material, negative impact on our results of operations and our cash flows, and directly and adversely impact our gross profit. Other elements of this legislation, such as comparative effectiveness research, new requirements to report certain financial arrangements with physicians and teaching hospitals, an independent payment advisory board, payment system reforms, including shared savings pilots, and other provisions, could meaningfully change the way health care is developed and delivered, and may materially impact numerous aspects of our business. Because many parts of this legislation remain subject to implementation, the long-term impact on us is uncertain. However, this new legislation, or any future legislation, could reduce medical procedure volumes, lower reimbursement for our products, and impact the demand for our products or the prices at which we sell our products. In addition, various healthcare reform proposals have also emerged at the state level. We cannot predict with certainty what healthcare initiatives, if any, will be implemented at the state level, or what the ultimate effect of federal healthcare reform or any future legislation or regulation may have on us or on our customers’ purchasing decisions regarding our products and services.

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

While we do not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, many healthcare laws and regulations apply to our business. For example, we are subject to healthcare fraud and abuse regulation and enforcement by both the federal government and the states in which we conduct our business. These healthcare laws and regulations include, for example:

 

   

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

 

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

 

   

the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, which established new federal crimes for knowingly and willfully executing a scheme to defraud any healthcare benefit program or making false statements in connection with the delivery of or payment for healthcare benefits, items or services, and which imposed certain requirements relating to privacy, security, and transmission of individually identifiable health information; and

 

   

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

If our operations, or our sales techniques or product placement strategies, are found to be in violation of, or to encourage or assist the violation by third parties of, any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from the Medicare and Medicaid programs, and the curtailment or restructuring of our operations. We currently do not have a comprehensive compliance program concerning our relationships with healthcare providers and we may need to implement such a program as our operations grow. Any penalties, damages, fines, exclusions, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of these laws are broad and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.

If third-party payors do not reimburse our customers for the use of our clinical diagnostic products or if they reduce reimbursement levels, our ability to sell our products will be harmed.

We sell our products primarily to reference laboratories and hospital laboratories, substantially all of which receive reimbursement for the healthcare services they provide to their patients from third-party payors, such as Medicare and Medicaid, private insurance plans and managed care programs. These third-party payors may deny reimbursement if they determine that a medical product was not used in accordance with cost-effective treatment methods, as determined by the third-party payor, or was used for an unapproved indication. Third-party payors also may refuse to reimburse for procedures and devices deemed to be experimental, or medically unnecessary.

In the United States, the American Medical Association assigns specific Current Procedural Terminology, or CPT, codes, which are necessary for reimbursement of diagnostic tests. Once the CPT code is established, the Centers for Medicare and Medicaid Services establish reimbursement payment levels and coverage rules under Medicaid and Medicare, and private payors independently establish rates and coverage rules. Although there are previously assigned CPT codes for the tests that we offer and our tests are therefore approved for reimbursement by Medicare and Medicaid as well as most third-party payors, certain of our future products may not be approved for reimbursement.

Third-party payors are increasingly attempting to contain healthcare costs by limiting both coverage and the level of reimbursement for medical products and services. Increasingly, Medicare, Medicaid and other third-party payors are challenging the prices charged for medical services, including clinical diagnostic tests. Levels of reimbursement may decrease in the future, and future legislation, regulation or reimbursement policies of third-party payors may adversely affect the demand for and price levels of our products. If our customers are not reimbursed for our products, they may reduce or discontinue purchases of our products, which would cause our revenue to decline.

 

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Our ability to use our net operating loss and research and development credit carryforwards may be subject to limitations.

As of September 30, 2012, we had approximately $66.1 million of net operating loss carryforwards and $1.1 million or research and development credit carryforwards for U.S. federal tax purposes. As of December 31, 2011, we had approximately $67.9 million of net operating loss carryforwards and $1.0 million of research and development credit carryforwards for U.S. federal income tax purposes. Realization of any tax benefit from our carryforwards is dependent on: (i) our ability to generate future taxable income, and (ii) the absence of certain “ownership changes” of our common stock. An “ownership change,” as defined in the applicable federal income tax rules, could place significant limitations, on an annual basis, on the amount of our future taxable income that may be offset by our carryforwards. Such limitations, in conjunction with the net operating loss expiration provisions, could effectively eliminate our ability to utilize a substantial portion of our carryforwards.

Although we have not conducted a study to make this determination, it is possible that we have incurred one or more “ownership changes” in the past, in which case our ability to use our carryforwards may be limited. In addition, the issuance of shares of our common stock (including due to this offering) could cause an “ownership change” which could also limit our ability to use our carryforwards. Other issuances of shares of our common stock which could cause an “ownership change” include the issuance of shares of common stock upon future conversion or exercise of outstanding options and warrants.

We may be unsuccessful in our long-term goal of expanding our product offerings outside the United States.

For the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2011 and 2012, 52%, 22%, 32% and 6%, respectively, of our net revenue was from customers in countries outside the United States, including countries in Europe, Asia, the Middle East and South America. We are dependent on third-party distributor relationships in these countries to market, sell and provide customer and technical support for our products. Distributors may not commit the necessary resources to market, sell and support our products to the level of our expectations. If distributors do not perform adequately, or we are unable to locate distributors in particular geographic areas, our ability to realize long-term international revenue growth would be materially adversely affected.

Furthermore, there are risks inherent in doing business internationally, including:

 

   

imposition of governmental controls and changes in laws, regulations or policies;

 

   

political and economic instability;

 

   

changes in U.S. and other national government trade policies affecting the markets for our products;

 

   

changes in regulatory practices, tariffs and taxes; and

 

   

currency exchange rate fluctuations, devaluations and other conversion restrictions.

Any of these factors could have a material adverse effect on our business, results of operations or financial condition.

Manufacturing risks, shortages and inefficiencies may adversely affect our ability to produce products.

We must manufacture or engage third parties to manufacture components of our products in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs and complying with regulatory requirements. In determining the required quantities of our products and the manufacturing schedule, we must make significant judgments and estimates based on historical experience, inventory levels, current market trends and other related factors. Because of the inherent nature of estimates, there could be significant differences between our estimates and the actual amounts of products we require.

 

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We may also experience unforeseen technical complications in the processes we use to develop, manufacture, customize or receive orders for our products. Such complications could materially delay or limit the use of products we attempt to commercialize, substantially increase the anticipated cost of our products or prevent us from implementing our processes at appropriate quality and scale levels, thereby causing our business to suffer.

We have relationships with suppliers who are sources of raw materials and components for our product offerings. We do not have long-term agreements with our suppliers and have not arranged for alternate suppliers. It may be difficult to find alternate suppliers in a timely manner and on terms acceptable to us. Additionally, the availability of some components of the INFINITI system may be limited as only a few outside vendors produce them. In the event that we become subject to a shortage of components or raw materials, our business, financial condition and results of operations could be materially adversely affected.

We have limited experience with the specialized film coating process needed to produce our BioFilmChip microarrays, and there are limited alternative sources for this aspect of our manufacturing process.

Our BioFilmChip microarrays are formed by coating polyester film with several layers of emulsion. To date, we have outsourced the special film coating process needed to produce our BioFilmChip microarrays. In connection with the establishment of manufacturing operations at our Vista, California facility, we purchased the film coating equipment required to conduct this process ourselves. We have not yet installed this equipment and have no experience as a company conducting the film coating process. If we are unable to successfully operate and maintain this equipment and produce the coated film necessary for our BioFilmChip microarrays, we will have to continue to outsource this operation to a third party. Film coating capacity is limited and is becoming less available in the marketplace as film vendors move away from analog formats and focus increasingly on digital formats. Although we believe we have adequate coated film for the foreseeable future, we cannot guarantee that we would be able to obtain an alternative supply if we are unable to manufacture the coated film ourselves.

We will need to expand manufacturing capacity by ourselves or with third parties.

We will need either to continue to build internal manufacturing capacity or contract with one or more manufacturing partners, or both. We currently rely solely on internal manufacturing of our end products. Due to the complexity of our manufacturing process and the advanced technologies we employ, we may encounter difficulties in manufacturing our end products. We may not be able to build manufacturing capacity internally or find one or more suitable manufacturing partners, or both, to meet the volume, regulatory and quality requirements necessary to be successful in the market. If our products do not consistently meet our customers’ performance expectations or the requirements of the FDA and authorities in other countries, we may be unable to generate sufficient revenue to become profitable. Significant additional resources, implementation of additional manufacturing equipment and changes in our manufacturing processes and organization may be required for the scale-up of each new product prior to commercialization or to meet increasing customer demand once commercialization begins, and this work may not be successfully or efficiently completed. Any delay in establishing or inability to expand our manufacturing capacity could delay our ability to develop or sell our products, which would result in lost revenue and materially adversely harm our business, financial condition and results of operations.

Our business and future operating results may be adversely affected by events outside of our control.

We develop and manufacture the INFINITI system in our facility located in Vista, California. Any damage to our facilities or the manufacturing equipment we use would be costly and could require substantial lead-time to repair or replace. Our business and operating results may be harmed due to interruption of our manufacturing by events outside of our control, including earthquakes and fires. Other possible disruptions may include power loss and telecommunications failures. In the event of a disruption, we may lose customers and we may be unable to regain those customers thereafter. Our insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.

 

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We use hazardous chemicals and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and development and manufacturing processes involve the controlled use of hazardous materials, including chemicals, and biological materials. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. We may be sued for any injury or contamination that results from our use or the use by third parties of these materials, and our liability may exceed our insurance coverage and our total assets. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these hazardous materials and specified waste products, as well as the discharge of pollutants into the environment and human health and safety matters. Compliance with environmental laws and regulations may be expensive, and may impair our research, development and production efforts. If we fail to comply with these requirements, we could incur substantial costs, including civil or criminal fines and penalties, cleanup costs, or capital expenditures for control equipment or operational changes necessary to achieve and maintain compliance. In addition, we cannot predict the impact on our business of new or amended environmental laws or regulations, or any changes in the way existing and future laws and regulations are interpreted and enforced.

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

We will incur significant legal, accounting, and other expenses as a public company, including costs resulting from public company reporting obligations under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the rules and regulations regarding corporate governance practices, including those under the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, and the listing requirements of the NASDAQ Global Market.

Our management and other personnel will need to devote a substantial amount of time to ensure that we comply with all of these requirements. Moreover, despite recent reforms made possible by the JOBS Act, the reporting requirements, rules, and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly, particularly after we are no longer an “emerging growth company.” Any changes that we make to comply with these obligations may not be sufficient to allow us to satisfy our obligations as a public company on a timely basis, or at all.

We also expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These factors could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, particularly to serve on our audit and compensation committees, or as executive officers.

As a public company, we will be subject to the requirements related to Section 404 of the Sarbanes-Oxley Act. If we are unable to comply with these requirements in a timely manner, it may affect the reliability of our internal control over financial reporting and negatively impact our business and stock price.

Beginning with our annual report on Form 10-K for the year ending December 31, 2013, we will be required to furnish a report by management on the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act. In addition, our independent registered public accounting firm will be required to attest to the effectiveness of our internal controls over financial reporting beginning with our annual report on Form 10-K following the later of the year following our first annual report required by the Securities and Exchange Commission, or the SEC, and the date on which 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 this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our

 

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common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

The process of designing and implementing effective internal controls and procedures is a continuous effort that requires us to anticipate and react to changes in our business and economic and regulatory environments. We cannot assure you that our efforts will be adequate to satisfy our reporting obligations as a public company or that we will be able to successfully complete the procedures and certification and attestation requirements related to Section 404 of the Sarbanes-Oxley Act or that we or our independent registered public accounting firm will not identify additional material weaknesses or significant deficiencies in our internal control over financial reporting. If we identify any reason that we cannot certify as to the effectiveness of our internal control over financial reporting, we could incur additional costs remedying the cause of our failure to certify as to the effectiveness of our internal control over financial reporting, and our reputation, investor perceptions of us and the price of our common stock could be materially adversely affected and you may not be able to rely on our financial statements.

Our international operations are subject to trade and anti-corruption laws and regulations.

Due to the international scope of our operations, we are subject to a complex system of import- and export-related laws and regulations, including U.S. regulations issued by the Bureau of Industry and Security and the Office of Foreign Assets Control, as well as the counterparts of these agencies in other countries. Any alleged or actual violations of these U.S. and foreign regulations may subject us to government scrutiny, investigation and civil and criminal penalties, and may limit our ability to import or export our products or to provide services outside the United States. We cannot predict the nature, scope or effect of future regulatory requirements to which our operations might be subject or the manner in which existing laws might be administered or interpreted.

In addition, the U.S. Foreign Corrupt Practices Act and similar foreign anti-corruption laws generally prohibit companies and their intermediaries from making improper payments or providing anything of value to improperly influence foreign government officials for the purpose of obtaining or retaining business, or obtaining an unfair advantage. Recent years have seen a substantial increase in the global enforcement of anti-corruption laws. Our international distributors are domiciled in areas of the world with laws, rules and business practices that differ from those in the United States. As a result, we face the reputational and legal risk that our international distributors will violate applicable laws, rules and business practices. If we or our international distributors are determined to be in violation of these laws, rules and business practices, it may result in severe criminal or civil sanctions for us or our distributors, could disrupt our business, and could result in an adverse effect on our reputation, business and results of operations or financial condition.

Risks Relating to this Offering and our Common Stock

There has been no prior market for our common stock, and an active trading market may not develop.

Prior to this offering, there has been no public market for our common stock. An active trading market may not develop following the closing of this offering or, if developed, may not be sustained. The lack of an active market may impair your ability to sell your shares at the time you wish to sell them or at a price that you consider reasonable. The lack of an active market may also reduce the fair market value and increase the volatility of your shares. An inactive market may also impair our ability to raise capital by selling shares and may impair our ability to acquire other companies or technologies by using our shares as consideration.

We are an “emerging growth company” and as a result of the reduced disclosure and governance requirements applicable to emerging growth companies, our common stock may be less attractive to investors.

We are an “emerging growth company” as defined in the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not

 

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emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. 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 this offering, (b) in which we have total annual gross revenue of at least $1.0 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

The price of our common stock may be volatile and fluctuate substantially, which could result in substantial losses for investors purchasing shares in this offering.

The initial public offering price for the shares of our common stock sold in this offering will be determined by negotiation between the representatives of the underwriters and us. This price may not reflect the market price of our common stock following this offering. In addition, the market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors, including:

 

   

actual or anticipated fluctuations in our results of operations;

 

   

variance in our financial performance from the expectations of market analysts;

 

   

conditions and trends in the markets we serve;

 

   

changes in our pricing policies or the pricing policies of our competitors;

 

   

legislation or regulatory policies, practices or actions;

 

   

the announcements of significant new products, contracts, acquisitions or strategic alliances by us or our competitors;

 

   

the commencement or outcome of litigation;

 

   

our ability to repay remaining indebtedness after completion of this offering;

 

   

our sale of common stock or other securities in the future or sales of our common stock by our significant stockholders;

 

   

changes in market valuation or earnings of our competitors;

 

   

the trading volume of our common stock;

 

   

the loss of key personnel;

 

   

changes in the estimated future size and growth rate of our markets;

 

   

general economic conditions; and

 

   

general volatility of the stock market.

 

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These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against that company. Such litigation, if instituted against us, could result in substantial costs and a diversion of management’s attention and resources, which could materially harm our financial condition and results of operations.

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

The trading market for our common stock will rely in part on the research and reports that equity research analysts publish about our business and us. The price of our stock could decline if one or more equity research analysts downgrade our stock or if those analysts issue other unfavorable commentary or cease publishing reports about our business or us.

We currently do not intend to pay dividends on our common stock and, consequently, your only opportunity to achieve a return on your investment is if the price of our common stock appreciates.

We currently do not plan to declare dividends on shares of our common stock for the foreseeable future. See “Dividend Policy” for more information. Consequently, your only opportunity to achieve a return on your investment in our company will be if the market price of our common stock appreciates and you sell your shares at a profit. There is no guarantee that the price of our common stock that will prevail in the market after this offering will ever exceed the price that you pay. In addition, the lack of dividends may limit the number of potential buyers of our common stock.

Future sales of our common stock may depress our share price.

After this offering, we will have 16,746,791 shares of common stock outstanding, based upon our outstanding shares as of December 31, 2012. Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales may occur, could cause the market price of our common stock to decline. After the lock-up agreements pertaining to this offering expire, additional stockholders will be able to sell their shares in the public market, subject to legal restrictions on transfer. As described in “Shares Eligible for Future Sale — Registration Rights,” we also have granted certain of our security holders registration rights which, subject to certain limitations, will permit them to cause us to file a registration statement with respect to the registrable securities held by them. As soon as practicable upon completion of this offering, we also intend to file a registration statement covering shares of our common stock issuable upon exercise of outstanding stock options or reserved for future issuance under our equity incentive and stock purchase plans. We may also sell additional shares of common stock in subsequent public offerings, which may materially adversely affect market prices for our common stock. See “Shares Eligible for Future Sale” for more information.

We have broad discretion in the use of the net proceeds from this offering, and our investment of these proceeds may not yield a favorable return.

Our management will have broad discretion in the application of the net proceeds from this offering, including for any of the purposes described in “Use of Proceeds.” Accordingly, you will have to rely upon the judgment of our management with respect to the use of the proceeds. Our management may spend a portion or all of the net proceeds from this offering in ways that our stockholders may not desire or that may not yield a significant return or any return at all. Of the net proceeds from this offering, we intend to use approximately $5.7 million to satisfy outstanding accounts payable to advisers and service providers incurred in connection with our prior capital raising activities conducted from 2008 through 2010, approximately $1.1 million to pay past due amounts owed to our landlord, and approximately $17.7 million to retire existing debt obligations. The payment of these amounts will not enhance our business operations or increase our revenues. The failure by our management to effectively apply the remaining net proceeds from this offering could harm our business. Pending their use, we may also invest the net proceeds from this offering in a manner that does not produce income or that loses value.

 

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As a new investor, you will experience immediate and substantial dilution as a result of this offering.

The initial public offering price of our common stock will be considerably more than the net tangible book value per share of our outstanding common stock. Accordingly, investors purchasing shares of common stock in this offering will:

 

   

pay a price per share that substantially exceeds the value of our assets after subtracting liabilities; and

 

   

contribute 48.4% of the total amount invested to fund our company, but will own only 35.8% of the shares of common stock outstanding after this offering and the use of proceeds therefrom.

To the extent that outstanding stock options and warrants are exercised, there will be further dilution to new investors. See “Dilution” for more information.

Certain provisions of our corporate governing documents and Delaware law could make an acquisition of our company more difficult.

Our certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors. For example, our certificate of incorporation and bylaws:

 

   

authorize the issuance of preferred stock that can be created and issued by our board of directors without prior stockholder approval, commonly referred to as “blank check” preferred stock, with rights senior to those of our common stock;

 

   

limit the persons who can call special stockholder meetings;

 

   

provide that a supermajority vote of our stockholders is required to amend our bylaws and some portions of our certificate of incorporation;

 

   

establish advance notice requirements to nominate persons for election to our board of directors or to propose matters that can be acted on by stockholders at stockholder meetings;

 

   

do not provide for cumulative voting in the election of directors; and

 

   

provide for the filling of vacancies on our board of directors between annual meetings by action of a majority of the directors and not by the stockholders.

These and other provisions in our organizational documents could allow our board of directors to affect your rights as a stockholder in a number of ways, including making it more difficult for stockholders to replace members of the board of directors. Because our board of directors is responsible for approving the appointment of members of our management team, these provisions could in turn affect any attempt to replace the current management team. These provisions could also limit the price that investors would be willing to pay in the future for shares of our common stock.

In addition, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, or DGCL, which, subject to certain exceptions, impose certain restrictions on mergers and other business combinations between any holder of 15% or more of our common stock and us. See “Description of Capital Stock — Provisions of our Certificate of Incorporation and Bylaws and Delaware Law that May Have an Anti-Takeover Effect.”

 

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Special Note Regarding Forward-Looking Statements

This prospectus contains forward-looking statements that reflect our current views with respect to, among other things, future events or our future financial performance. All statements in this prospectus other than statements of historical fact, including statements regarding future events, our future financial performance, business strategy and plans, predictions about our markets, and objectives of management for future operations, are forward-looking statements.

In some cases, you can identify forward-looking statements by terminology including “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “might,” “plans,” “potential,” “predicts,” “should,” “will” or “would,” or the negative of these terms or other comparable terminology. Forward-looking statements used in this prospectus address topics such as, among other things:

 

   

our business strategy;

 

   

our development of new products;

 

   

our anticipated growth strategies;

 

   

anticipated trends in our business, trends in the market for our products and trends in the adoption of new technologies;

 

   

competition and competitive factors or trends in our market;

 

   

uncertainty regarding our future operating results, including our projected sales, net sales, financial results, cash flows, pricing, and similar items;

 

   

our intended use of proceeds;

 

   

our ability to continue to control costs and maintain quality;

 

   

anticipated changes in our expenses over future periods;

 

   

the impact of U.S. health care reform legislation and other health care policy changes, including the imposition of significant new taxes on medical device makers in the form of a 2.3% excise tax on U.S. medical device sales beginning in January 2013;

 

   

the protection or acquisition of, investment in, or legal proceedings regarding, our intellectual property;

 

   

our ability to obtain FDA or other regulatory clearances or approvals;

 

   

the regulatory environment for our products and our business, and our ability to comply with and adapt to such environment; and

 

   

the plans, objectives, expectations and intentions expressed in this prospectus that are not historical facts.

These statements are only predictions. Actual events or results may differ materially. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in “Risk Factors.” We cannot guarantee future results, levels of activity, performance or achievements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, or to conform these statements to actual results or changes in our expectations.

Moreover, we operate in a competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

 

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Market, Industry and Other Data

Unless otherwise indicated, information contained in this prospectus concerning our industry and the market segments in which we operate, including our general expectations and market position, market opportunity and market size, is based on information from various sources, on assumptions that we have made that are based on that information and other similar sources and on our knowledge of the markets for our products. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to or reliance on such estimates. In addition, projections, assumptions and estimates of our future performance and the future performance of the industry in which we operate is necessarily subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors” and elsewhere in this prospectus. These and other factors could cause results to differ materially from those expressed in the estimates made by the independent parties and by us.

 

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Use of Proceeds

We estimate that our net proceeds (after deducting underwriting discounts and commissions payable to the underwriters and our estimated offering expenses) from this offering will be approximately $53.7 million ($62.0 million if the underwriters exercise their overallotment option in full), based upon an assumed initial public offering price of $10.00 per share, which is the midpoint of the range listed on the cover page of this prospectus. A $1.00 increase or decrease in the assumed initial public offering price of $10.00 per share would increase or decrease, as applicable, the net proceeds to us from this offering by approximately $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and our estimated offering expenses. Similarly, an increase or decrease in the number of shares we sell in the offering will increase or decrease, as applicable, our net proceeds by an amount equal to such number of shares multiplied by the public offering price, less underwriting discounts and commissions.

From the anticipated net proceeds from this offering, we anticipate that we will use (i) approximately $17.7 million to repay the principal and interest under our outstanding promissory notes, (ii) approximately $10.0 million to fund the expansion of our sales force, enhance our international distributor network, and increase our marketing and promotional activity and business development efforts, (iii) approximately $10.0 million in 2013 and 2014 in support of a PMA for our HPV-HR tests and of 510(k) and CE mark studies and submissions for several tests associated with womens’ health and personalized medicine, (iv) approximately $3.0 million to fund research and development activities to add new or enhanced tests to our menu, (v) approximately $3.0 million to fund the expansion of our manufacturing capacity and efficiency, including purchasing automation equipment, (vi) approximately $5.7 million to satisfy outstanding accounts payable to advisors and service providers incurred in connection with certain of our prior capital raising activities conducted from 2008 through 2010, and (vii) approximately $1.1 million to satisfy past due amounts owed to our landlord. We anticipate that we will use the remainder of the net proceeds from this offering for additional working capital and general corporate purposes.

As of December 31, 2012, there was an aggregate of $17.5 million of principal and accrued interest under outstanding promissory notes of which approximately $2.2 million in principal amount was in default. For each additional day that the notes remain outstanding, we were required to pay approximately $4,300 of additional interest under the notes. See “Note 3. Promissory Notes” included in our financial statements included as part of this prospectus. As of December 31, 2012, there was an aggregate of $1.1 million of principal and accrued interest outstanding under the notes we have issued to our directors, executive officers and holders of more than 5% of our common stock. See “Certain Relationships and Related Persons Transactions — Promissory Notes Financings.” In November 2012, the holders of $22.0 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes that were then past due or scheduled to come due in the immediate future exchanged these promissory notes for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock and $14.4 million in aggregate principal amount of new promissory notes due November 2015. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Promissory Notes”. We do not have sufficient cash to satisfy our indebtedness obligations absent the completion of this offering. Under the terms of our November 2012 promissory notes, we are required to use at least 50% of the net proceeds from this offering to repay our indebtedness. As a result, we intend to use $17.7 million of the net proceeds of this offering to repay all of the indebtedness owed under our outstanding promissory notes.

The expected use of the net proceeds of this offering represents our current intentions based upon our present plans and business condition. The amounts and timing of our actual expenditures may vary significantly and will depend upon numerous factors, such as the level of research and development investment required by our business (including for clinical studies and trials), cash flows from operations, the anticipated growth of our business and other factors. Pending the allocation of the net proceeds of this offering, we intend to invest the net proceeds in short-term, interest-bearing obligations, investment grade instruments, and certificates of deposit or guaranteed obligations of the U.S. government.

 

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Dividend Policy

We do not anticipate paying any cash dividends after this offering and for the foreseeable future. Instead, we anticipate that all of our earnings on our common stock will be used to provide working capital, to support our operations and to finance the growth and development of our business. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on our future earnings, capital requirements, financial condition, future prospects, financing arrangements, applicable Delaware law, which provides that dividends are only payable out of surplus or current net profits, and other factors our board of directors deems relevant.

 

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Capitalization

The following table sets forth our capitalization as of September 30, 2012 (i) on an actual basis, (ii) on a pro forma basis to reflect the conversion of all outstanding shares of our Series A, Series B, Series C, Series D, Series E and Series NC Convertible Preferred Stock into 7,891,020 shares of our common stock and (iii) on a pro forma as adjusted basis to additionally reflect the sale of 6,000,000 shares of our common stock in this offering at an assumed initial offering price of $10.00 per share, the midpoint of the range on the cover page of this prospectus, and after deducting underwriting discounts and commissions and our estimated offering expenses, and the application of approximately $17.7 million of the net proceeds of this offering to repay principal and interest under certain of our outstanding promissory notes, including notes to related parties.

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

 

     As of September 30, 2012  
         Actual             Pro forma         Pro forma
as

    adjusted (1)    
 
     (unaudited)  
     (in thousands, except share and per share data)  

Senior and subordinated promissory notes (2)

   $ 20,784      $ 17,057      $ —     

Convertible preferred stock, $0.01 par value, 30,000,000 authorized (3)

     —          —          —     

Series A Convertible Preferred Stock, $0.01 par value, 1,589,600 authorized, 1,579,227 issued and outstanding, actual, 0 issued and outstanding, pro forma and pro forma as adjusted

     4,990        —          —     

Series B Convertible Preferred Stock, $0.01 par value, 4,515,858 authorized, 4,468,369 issued and outstanding, actual, 0 issued and outstanding, pro forma and pro forma as adjusted

     12,288        —          —     

Series C Convertible Preferred Stock, $0.01 par value, 6,850,000 authorized, 6,417,680 issued and outstanding, actual, 0 issued and outstanding, pro forma and pro forma as adjusted

     17,647        —          —     

Series D Convertible Preferred Stock, $0.01 par value, 3,423,258 authorized, 3,423,258 issued and outstanding, actual, 0 issued and outstanding, pro forma and pro forma as adjusted

     11,126        —          —     

Series E Convertible Preferred Stock, $0.01 par value, 5,500,000 authorized, 732,555 issued and outstanding, actual, 0 issued and outstanding, pro forma and pro forma as adjusted

     1,381        —          —     

Series NC Convertible Preferred Stock, $0.01 par value, 4,318,363 authorized, 0 issued and outstanding, actual, pro forma and pro forma as adjusted

     —          —          —     

Stockholders’ equity (deficit):

      

Common stock, $0.01 par value, 220,000,000 authorized, 2,673,358 issued and outstanding, actual, 10,564,378 issued and outstanding, pro forma and 16,564,378 issued and outstanding, pro forma as adjusted

     81        326        386   

Additional paid-in capital (4)

     15,251        69,946        123,536   

Accumulated deficit

     (92,412     (92,412     (92,412
  

 

 

   

 

 

   

 

 

 

Total stockholders’ equity/(deficit)

     (77,080     (22,140     31,510   
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ (8,864   $ (5,083   $ 31,510   
  

 

 

   

 

 

   

 

 

 

 

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(1) A $1.00 increase or decrease in the assumed initial public offering price of $10.00 per share of our common stock in this offering would increase or decrease, as applicable, each of additional paid-in capital, total stockholders’ equity (deficit) and total capitalization by $5.6 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and our estimated offering expenses. Similarly, an increase or decrease in the number of shares we sell in the offering will increase or decrease, as applicable, our net proceeds by an amount equal to such increased or decreased number of shares multiplied by the public offering price, less underwriting discounts and commissions and our estimated offering expenses.
(2) Amounts include principal only. As of September 30, 2012, approximately $14.8 million in aggregate principal amount of our outstanding promissory notes payable was in payment default. The pro forma and pro forma as adjusted information presented as of September 30, 2012 gives effect to the exchange, in November 2012, of $22.0 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes that were then past due or scheduled to come due in the immediate future for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock and $14.4 million in aggregate principal amount of new promissory notes due November 2015.
(3) Our convertible preferred stock has been classified as temporary equity on our balance sheets instead of stockholders’ deficit due to the possibility of the occurrence of certain change in control events that are outside of our control, including our sale or transfer of control, which trigger the rights of holders of the convertible preferred stock to cause its redemption. Accordingly, these shares are considered contingently redeemable.
(4) Excludes, as of September 30, 2012, 1,769,712 shares of common stock issuable upon exercise of options outstanding at a weighted average exercise price of $4.82 per share, 2,794,696 shares of common stock issuable upon exercise of warrants outstanding at a weighted average exercise price of $10.73 per share and 381,300 shares of our preferred stock issuable upon exercise of warrants outstanding at a weighted average exercise price of $3.56 per share.

 

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Dilution

As of September 30, 2012, we had a net tangible book deficit of $77.1 million, or approximately $9.51 per share of common stock, not taking into account the conversion of all outstanding series of convertible preferred stock into common stock. Net tangible book deficit per share represents the amount of our total tangible assets less total liabilities, divided by the number of common shares outstanding.

Included in our total liabilities as of September 30, 2012 is approximately $24.7 million of indebtedness and accrued interest under promissory notes, of which approximately $14.8 million in principal amount was in payment default. In November 2012, the holders of $22.0 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes that were then past due or due to come owing in the immediate future exchanged these promissory notes for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock and $14.4 million in aggregate principal amount of new promissory notes due November 2015. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Promissory Notes”.

After giving effect to the indebtedness restructuring described immediately above, and to the conversion of all outstanding series of convertible preferred stock, including our Series NC Convertible Preferred Stock, into common stock as of September 30, 2012, we would have had a net tangible book deficit of $22.1 million, or $2.06 per share of common stock. Pro forma net tangible book deficit per share represents the amount of our total tangible assets less our total liabilities, after giving effect to the indebtedness restructuring described above, divided by the number of shares of common stock outstanding as of September 30, 2012 after giving effect to our reverse stock split effected in January 2013 and the conversion of all outstanding series of convertible preferred stock into shares of common stock, which will occur immediately prior to the completion of this offering.

After giving effect to the sale by us of shares of common stock in this offering at an assumed initial public offering price of $10.00 per share, which is the midpoint of the range listed on the cover page of this prospectus, and after deducting underwriting discounts and commissions and our estimated offering expenses, our pro forma net tangible book value as of September 30, 2012 would have been approximately $31.5 million, or approximately $1.88 per share. This amount represents an immediate increase in pro forma net tangible book value of $3.94 per share to our existing stockholders and an immediate dilution in pro forma net tangible book value of approximately $8.12 per share to new investors purchasing shares of common stock in this offering at the assumed initial public offering price. We determine dilution to new investors participating in this offering by subtracting the pro forma net tangible book value per share after this offering from the amount of cash that a new investor paid for a share of common stock in this offering.

Assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions and our estimated offering expenses, a $1.00 increase or decrease in the assumed initial public offering price of $10.00 per share would increase or decrease, as applicable, the pro forma net tangible book value by $0.34 per share to our existing stockholders, and the dilution in pro forma net tangible book value by $0.34 per share to new investors participating in this offering.

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

 

Assumed initial public offering price per share

     $ 10.00   

Pro forma net tangible book value per share as of September 30, 2012

   $ (2.06  

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

   $ 3.94     

Pro forma net tangible book value per share after this offering

     $ 1.88   
    

 

 

 

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

     $ 8.12   
    

 

 

 

The following table summarizes, as of September 30, 2012, the differences for our existing stockholders and new investors in this offering, with respect to the number of shares of common stock purchased from us, the total

 

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consideration paid and the average price per share paid at an assumed initial public offering price of $10.00 per share, which is the midpoint of the range listed on the cover page of this prospectus, after deducting underwriting discounts and commissions and our estimated offering expenses. The following table assumes the conversion of all series of convertible preferred stock, including our Series NC Convertible Preferred Stock, into common stock, which will be effected immediately prior to the completion of this offering.

 

     Shares purchased     Total consideration     Average price
per share
 
      Number      Percent     Amount      Percent    

Existing stockholders

     10,746,791         64.2   $ 57,259,713         51.6   $ 5.33  

New stockholders in this offering

     6,000,000         35.8   $ 53,650,000         48.4   $ 8.94   
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

     16,746,791         100   $ 110,909,713         100.0  
  

 

 

    

 

 

   

 

 

    

 

 

   

The discussion and tables above assume no exercise of the underwriters’ overallotment option. If the underwriters’ overallotment option is exercised in full:

 

   

the number of shares of common stock held by existing stockholders will represent 60.9% of the total number of shares of common stock to be outstanding after this offering and the number of shares of common stock held by investors participating in this offering will represent 39.1% of the total number of shares of common stock to be outstanding after this offering; and

 

   

our adjusted pro forma net tangible book value at September 30, 2012 would have been $40.5 million, or $2.30 per share of common stock, representing an immediate increase in pro forma net tangible book value of $4.36 per share of common stock to our existing stockholders and an immediate dilution of $7.70 per share to investors participating in this offering.

In addition, the above discussion and tables assume no exercise of stock options or warrants to purchase common stock or preferred stock. As of September 30, 2012, we had outstanding options to purchase a total of 1,769,383 shares of common stock, warrants to purchase a total of 2,794,697 shares of common stock and warrants to purchase 381,300 shares of our preferred stock convertible into 137,063 shares of common stock at a weighted average exercise price of $4.82 per share, $10.75 per share and $10.78 per share, respectively.

If all of the outstanding options and warrants as of September 30, 2012 with exercise prices at or below $10.00 per share, which is the midpoint of the range listed on the cover page of this prospectus, had been exercised (and the convertible preferred stock issuable upon the exercise of the preferred stock purchase warrants was converted into common stock), our pro forma net tangible book deficit would have been $2.79 per share of common stock, representing an immediate increase in pro forma net tangible book value of $4.85 per share of common stock and dilution in pro forma net tangible book value to investors in this offering would be $7.21 per share of common stock.

In addition, if all of the outstanding options and warrants were so exercised (and the convertible preferred stock issuable upon the exercise of the preferred stock purchase warrants was so converted) as of September 30, 2012, before deducting underwriting discounts and commissions and our estimated offering expenses, (i) existing stockholders would have purchased shares representing 70.3% of the total shares for $79.2 million, or approximately 59.6% of the total consideration paid, with an average price per share of $5.58 and (ii) using an assumed public offering price of $10.00 per share, 6,000,000 shares purchased by new stockholders in this offering would represent approximately 29.7% of the total shares for approximately $53.7 million, or approximately 40.4% of the total consideration paid.

 

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Selected Financial Data

The selected financial data set forth below is derived in part from and should be read in conjunction with our financial statements, the related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The statement of operations data for each of the years ended December 31, 2010, and 2011 and the statement of condition data as of December 31, 2010 and 2011 were derived from our audited financial statements appearing elsewhere in this prospectus. The statement of operations data for the nine months ended September 30, 2011 and 2012 and the statement of condition data as of September 30, 2012 were derived from our unaudited financial statements appearing elsewhere in this prospectus. The unaudited financial data, in management’s opinion, has been prepared on the same basis as the audited financial statements and related notes included elsewhere in this prospectus, and include all adjustments, consisting only of normal recurring adjustments, that our management considers necessary for a fair presentation of the information for the periods presented. The results of operations for the years ended December 2010 and 2011 and for the nine months ended September 30, 2011 and 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012 or any other period.

 

     Years ended December 31,     Nine months ended September 30,  
     2010     2011               2011                          2012             
                 (unaudited)  
     (in thousands, except share and per share data)  

Statement of operations data:

        

Net revenue

   $ 7,504      $ 8,005      $ 5,166      $ 14,473   

Cost of sales

     7,666        6,019        4,378        5,035   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit/(loss)

     (162     1,986        788        9,438   

Operating expenses

        

Research and development

     3,560        2,768        2,146        1,724   

General and administrative

     5,376        3,360        2,587        2,775   

Sales and marketing

     4,717        2,672        2,023        1,665   

Impairment of film coating equipment

     981        —          —          —     

Initial public offering costs — terminated offering

     1,752        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     16,386        8,800        6,756        6,154   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income/(loss) from operations

     (16,548     (6,814     (5,958     3,284   
        

Interest expense, net

     (4,109     (3,626     (2,598     (1,913

Other income/(expense), net

     36        (2     —          5   

Change in fair value of warrant liabilities

     926        445        434        (170
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income/(loss)

     (19,695     (9,997     (8,132     1,206   

Net income/(loss) per share attributable to common stockholders

        

Basic

   $ (7.63   $ (3.79   $ (3.09   $ 0.45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

         $ 0.13   
        

 

 

 

Shares used to compute net income/(loss) per share attributable to common stockholders

        

Basic

     2,581,708        2,634,385        2,633,929        2,651,833   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

           9,148,420   
        

 

 

 

 

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     As of December 31,     As of September 30,  
     2010     2011     2012  
                 (unaudited)  
     (in thousands)  

Balance sheet data:

      

Cash and cash equivalents

   $ 129      $ 61      $ 294   

Current assets

     3,559        3,749        7,104   

Total assets

     5,924        5,412        9,826   

Total debt (1)

     19,181        20,914        20,784   

Convertible preferred stock (2)

     46,044        47,343        47,432   

Total stockholders’ deficit

     (70,895     (79,250     (77,080

 

(1) Amounts include principal only. As of September 30, 2012, approximately $14.8 million in aggregate principal amount of our outstanding promissory notes payable was in payment default. In November 2012, the holders of $22.0 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes that were then past due or scheduled to come due in the immediate future exchanged these promissory notes for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock and $14.4 million in aggregate principal amount of new promissory notes due November 2015. After giving effect to these actions, as of November 27, 2012 we had outstanding total indebtedness and accrued interest under promissory notes of approximately $17.4 million, of which approximately $2.9 million was due and scheduled to come due in the immediate future. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Promissory Notes”. The information presented speaks as of the dates indicated and does not reflect this restructuring of indebtedness.
(2) Our convertible preferred stock had been classified as temporary equity on our balance sheets instead of in stockholders’ deficit due to the possibility of the occurrence of certain change in control events that are outside of our control, including our sale or transfer of control, which trigger the rights of holders of the convertible preferred stock to force its redemption. Accordingly, these shares are considered contingently redeemable.

 

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes appearing elsewhere in this prospectus. This discussion may contain forward-looking statements that are based upon current expectations that involve risks and uncertainties. Our actual results and the timing of many events could differ materially from those anticipated in forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and elsewhere in this prospectus.

Overview

We design, develop, manufacture and market the INFINITI molecular diagnostics system. The system includes an extensive and expanding menu of genetic tests and a family of highly automated analyzers. Our tests provide reference laboratories, hospitals and specialty clinics with genetic test results in a broad range of market segments, including personalized medicine, women’s health, oncology and infectious disease. As of December 31, 2012, our genetic test offering included 53 tests for use on our INFINITI analyzers, with more than 15 additional tests in development. We intend to continue increasing the number of tests offered in each of our target market segments, which we believe will further increase the utility of our INFINITI system to our customers.

In the United States, we offer our INFINITI analyzers for placement with customers through direct sales, monthly rental plans and our domestic placement plan. Under the domestic placement plan, an INFINITI analyzer is placed at the customer’s location at no initial cost to the customer. We expect to recover the cost of the instrument over time by generating significant recurring demand for our high-margin testing consumables. Outside the United States, we offer our INFINITI analyzers solely on a direct sale basis through our network of distributors. We plan to use a portion of the net proceeds of this offering to expand our domestic sales force and our international sales presence.

Our BioFilmChips and Intellipac Reagent Management Modules and other consumable sales are made primarily pursuant to standard purchase orders. We are able to manufacture our consumables to satisfy demand for new or rescheduled purchase orders on relatively short notice. Thus, we do not have a significant backlog.

We have in the past derived, and expect to continue to derive, a significant portion of our revenue from a few major customers. For fiscal years 2010 and 2011, we had two and three customers, respectively, that each represented between 12% and 14% of our revenue. For the nine months ended September 30, 2012, we had two customers that each represented more than 17% of our revenue, including one that represented 47% of our revenue during the period. Sales outside the United States accounted for 52%, 22% and 6% of product sales for the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2012, respectively. As of December 31, 2010, one customer accounted for 22% of our aggregate accounts receivable of $1.3 million. As of December 31, 2011, three customers accounted for 43%, 14%, and 10%, respectively, of our aggregate accounts receivable of $1.9 million. As of September 30, 2012, two customers accounted for 39% and 31%, respectively, of our aggregate accounts receivable of $3.9 million. Our concentration of net revenue with a single customer in our most recent fiscal periods is in part due to this customer being an early adopter of our INFINITI system and related technologies. We intend to take steps to attempt to alleviate our customer concentration following the completion of this offering, including by hiring additional sales and marketing personnel, which we believe will allow us to acquire additional customers and distributors and increase sales to existing customers. Our continued business relationship with these or any other major customers, and the amount of purchases and timing of payment by these or any other major customers, may be impacted by several factors beyond our control, including product offerings by our competitors, pricing pressures or the financial health of these or any other major customers. The loss of any of our major customers, or a significant decline in sales to or a delay in collection of payments from any of our major customers, could materially adversely affect our business, financial condition and results of operations. A key customer of our personalized medicine diagnostic testing products reduced its purchase volume with us during the

 

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three months ended December 31, 2012, which resulted in a substantial decrease in our net revenues as compared to the three months ended September 30, 2012. We believe this decrease in purchases was due to this customer having increased its purchases of equivalent products from one of our competitors. We have taken steps to recapture purchases by this key customer and we believe that the recent volume decrease was temporary, as consumables sales to this customer began to increase in December 2012; however, we can provide no assurance that either sales volume or net revenue from this key customer will return to levels we observed in the third quarter of 2012, or that either or both will not decrease, in future quarters. We also experienced a delay in the collection of payments from another key customer for the three months ended December 31, 2012, which resulted in a significant increase in our past due accounts receivable. We are in negotiations with this key customer to collect on the full amount of this past due amount; however, we do not know whether the receivable is collectable in full and how much, if any, will need to be reserved.

From our inception in April 1999 through our fiscal year ended March 31, 2005, we focused on the design and development of our microarray film technology, an initial offering of genetic tests and the INFINITI Analyzer. In 2005, we launched the INFINITI Analyzer and our first four tests. Our revenue has grown from $7.5 million in fiscal year 2010 to $8.0 million in 2011, and was $14.5 million for the nine months ended September 30, 2012. Since our inception, we have incurred significant operating losses, including net losses of $19.7 million and $10.0 million in the years ended December 31, 2010 and 2011, respectively. As of September 30, 2012, we had an accumulated deficit of $92.4 million. We may incur net operating losses for the immediate future as we seek to further expand our test menu and develop other products, conduct clinical studies and trials for certain of our tests, and invest in the continued commercialization of our INFINITI system. We also will incur substantial costs associated with the transition to operating as a public company. We are unable to predict the extent of any future losses or if we will be able to achieve sustained profitability.

Key Factors Affecting Performance

Genetic Test Consumables Sales. We generate most of our revenue through the sale of our genetic test consumables, and we expect this trend to continue for the foreseeable future. We closely track our genetic test consumables sales and the average revenue per microarray. For purposes of calculating average revenue per microarray, we consider a “microarray” to consist of a BioFilmChip and the portion of the associated Intellipac Reagent Management Module and related amplification mixture used with that BioFilmChip to perform a genetic test. We believe that taken together these metrics are key indicators of our performance. Our total genetic test consumables sales for fiscal years 2010 and 2011, and for the nine months ended September 30, 2012, were $3.9 million, $6.8 million and $13.2 million, respectively. Our average revenue per microarray for the same periods was $84, $83 and $84, respectively. Because our tests are sold at various prices, the average revenue per microarray is impacted by the mix of tests sold during each period.

We believe that while instrument placements play a role in the generation of revenue for our business, in particular in driving related test consumable sales, they do not provide a direct correlation to future revenue growth, and thus we do not view it as a key metric for our business. This is in part due to the wide variation in levels of customer utilization of our INFINITI system and in part due to the variability in throughput capability of the various models of our INFINITI analyzers. As of December 31, 2010, 2011 and 2012, we had a total of 168, 179 and 191 INFINITI analyzers placed with customers, respectively. We measure INFINITI analyzer placements based on the number of INFINITI analyzers located at our customers’ facilities at a particular measurement time.

Investment in Infrastructure and Growth. Our ability to increase our sales of genetic tests and to further penetrate our target market segments are dependent in large part on our ability to invest in our infrastructure and in our sales and marketing efforts. In order to drive further growth, we plan to hire additional sales personnel and invest in marketing our products to our target customers both in the United States and internationally. This will lead to corresponding increases in our operating expenses, and thus may negatively impact our operating results in the short term, although we anticipate that these investments will grow and improve our business over the long term. Marketing and selling to our target customers involves a substantial amount of time and effort, as it generally involves physical site visits and an investment in educating potential customers regarding the capabilities and benefits of molecular diagnostic testing in general and of our INFINITI system specifically. There can be a significant amount of time invested in marketing to a customer before that customer makes a

 

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purchasing decision. Once a purchasing decision is made by the customer, there can be a material amount of time invested by the customer in validating our INFINITI system. As a result, it will be difficult for us to determine whether and when our investments in sales and infrastructure will be recovered through sales to new customers or additional sales to existing customers. We will also incur substantial operating costs in connection with our transition to operating as a public company.

Utilization of our Products. Our ability to achieve sales growth is substantially dependent on the adoption of our INFINITI analyzers and utilization of our genetic tests. In order for us to continue to grow our business, it is important to acquire new customers, add new and enhanced tests and generate additional revenue from existing customers. We believe there is significant opportunity to increase the number and type of genetic tests we sell as awareness of opportunities in molecular diagnostic testing becomes more apparent to our targeted customer base. We have invested, and intend to continue to invest, significant time and effort to develop detailed marketing aids to be used by, and to educate, our customers’ sales and marketing networks. We believe that this will assist our customers in taking advantage of meaningful growth opportunities in molecular diagnostic testing in our target market segments, which may result in increased demand for our products. We have experienced some sales growth attributable to these co-marketing efforts, but the correlation is not direct either in volume or in timing of receipt of revenue. These investments in co-marketing increase our operating expenses, and it is uncertain as to whether these investments will positively impact our results going forward. We intend to invest in our sales and marketing organization and to pursue new customers in order to alleviate our current customer concentration. We believe that as more of our present and future customers realize the potential of molecular diagnostic testing generally, and pharmacogenomics specifically, our sales will continue to grow and diversify.

Regulatory Developments. Our INFINITI Analyzer and five of our genetic tests have been cleared by the U.S. Food and Drug Administration, or FDA, for sale in the United States under 510(k) clearance procedures. We have obtained Conformité Européenne, or CE, mark of conformity for 22 of our tests, which facilitates the marketing and sale of our INFINITI Analyzer, INFINITI Plus Analyzer and CE marked tests in the European Union and the European Economic Area as well as certain other international markets. The vast majority of the genetic tests that we currently sell, which together represented 87%, 92% and 96% of our net revenue for fiscal years 2010 and 2011 and the nine months ended September 30, 2012, respectively, have not been cleared or approved for clinical use in the United States by the FDA. These tests are labeled “For Research Use Only. Not for use in diagnostic procedures.” as required by FDA regulations. We refer to these tests as RUO tests.

Our decision to seek FDA approvals or clearances domestically, and CE marking internationally, for our genetic tests is made on a test-by-test basis, and is based on a variety of factors, including the regulatory environment for the use of genetic tests, the demand by our existing and target customers for particular genetic tests that have received regulatory approvals or clearances, the competitive environment for the use of genetic tests that have received regulatory approvals or clearances versus similar tests that have not, and the expense and time required to obtain regulatory approvals or clearances for particular genetic tests. If we decide to seek PMA approvals for a particular test, the time and expense involved could vary widely based on the type of test involved, although we would expect to spend on average approximately two to three years and approximately $10 to $15 million or more in seeking and obtaining such approval. If we decide to seek 510(k) clearance for a particular test, we expect to spend on average approximately six to 12 months and approximately $300,000 to $500,000 in seeking and obtaining such clearance. If we decide to seek CE marking for a particular test, we expect to spend on average approximately two to three months and approximately $100,000 in seeking and obtaining such clearance. For example, we have decided to seek a pre-market approval, or PMA, for our HPV-HR genetic tests, and we expect to spend approximately $8 million across 2013 and 2014 to conduct clinical trials and make related submissions to the FDA in connection with seeking a PMA for these tests. If the regulatory environment for the sale of RUO tests changes, we may be required to seek additional clearances or approvals from the FDA for the sale of our tests. In addition, if we determine that the diagnostic marketplace generally prefers, or requires, FDA clearance or approval of genetic tests as a condition for adoption of our INFINITI system or the purchase of our genetic tests, then we may decide to seek additional clearances or approvals from the FDA, beyond those that we currently intend to pursue in the near-term. This would require substantial time and investment, and could restrict or delay our ability to realize

 

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sales opportunities and/or maintain profitability. These expenditures are estimates based on information currently available to management and actual expenditures may vary from or exceed these estimates. If we invest capital to seek regulatory clearances or approvals, and do not receive these clearances or approvals, or do not realize sufficient returns on these investments in the form of additional sales, it would negatively impact our financial results and results of operations.

For a discussion of additional factors affecting our performance, see “Risk Factors.”

Financial Operations Overview

Revenue

We generate revenue from the sale of our products, which include our INFINITI analyzers and our high-margin consumables used to run tests on our analyzers, including our BioFilmChips, Intellipac Reagent Management Modules and various other disposable products consumed in the testing process. Generally, the pricing of our consumables for customers that participate in our domestic placement plans is higher than for our customers who own INFINITI analyzers; however, we may discount the price of consumables depending on the volume and nature of the products purchased by our customers. We expect that revenue generated through sales of our products in both domestic and international markets will be driven largely by the growth of the overall molecular diagnostic market, the breadth of our genetic test menu, increased utilization of our products by our existing customers, the expansion of our domestic sales force and international distribution network, the placement of additional INFINITI analyzers with new and with existing customers, and our development of additional and enhanced tests for sale in connection with our INFINITI system.

The variability of our revenue from period to period depends in part on our product sales mix of INFINITI analyzers and consumables. We anticipate that our revenue from the sale of consumables will become a larger portion of our total revenue over time as we increase our customer base and our customers increase their utilization of our INFINITI system. In the United States, we believe that for the foreseeable future our domestic placement plan will continue to account for more placements of INFINITI analyzers than direct sales.

Cost of Sales and Gross Profit

Cost of sales includes the expenses related to the production and estimated warranty costs of our various products. Included in these costs are materials, labor, general manufacturing overhead and other costs. Our general manufacturing overhead and other costs include indirect labor, facilities costs, and depreciation of capitalized manufacturing equipment. Cost of sales also includes depreciation (over a three year period) of capitalized INFINITI analyzers placed under our domestic placement plans, since we place the analyzers at the customers’ facility at no direct cost to the customer.

Research and Development

Research and development expenses include the cost of the personnel and consultants related to our activities in developing and improving our INFINITI analyzers and the development and expansion of our test menu. Also included in research and development costs are expenditures related to clinical studies and trials undertaken to validate and obtain FDA and other regulatory clearances for our tests. We expense all research and development costs in the period in which they are incurred. Continued development and improvement of our INFINITI analyzers and expansion of our test menu are key aspects of our business strategy and we expect that our research and development expenditures will increase for the foreseeable future.

We plan to incur significant expenditures in 2013 and 2014 for a clinical trial to support the submission of a PMA application to the FDA for our HPV-HR tests. We intend to submit a 510(k) notification to the FDA for our cystic fibrosis and our HPV genotyping tests in 2013. We are also conducting studies to support, and are preparing to submit, a pre-investigational device exemption, or pre-IDE, application for our CFTR and Flu A-sH1N1 tests. In addition, we have initiated clinical studies to support future submissions to the FDA for clearance of several of our other tests, including our 2D6, 3A4, 3A5, ureaplasma urealyticum, mycoplasma

 

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genitalium, mycoplasma hominis (Urogen Quad), bacterial vaginosis, or BV, candida vaginitis, or CV, chlymadia, gonorrhea and KRAS-BRAF genetic tests.

General and Administrative

General and administrative expenses include the costs of personnel and consultants charged to administration, finance and accounting, human resources and regulatory affairs. General and administrative expenses also include corporate, administration, accounting, patent, facility and other costs and depreciation. We expect general and administrative expenses to increase for the foreseeable future as a result of the need to hire additional personnel to support the anticipated growth of our business and as a result of additional legal and accounting expenses related to compliance with Securities and Exchange Commission and exchange listing requirements, directors’ and officers’ insurance premiums and investor relations expenses.

Sales and Marketing

Sales and marketing expenses include the costs of personnel related to selling and marketing the INFINITI system, customer support, advertising, trade show participation and other expenses. We expect our sales and marketing expenses to increase significantly for the foreseeable future as we expand our sales and marketing organization to drive the growth in sales of our consumable products, and as we increase our technical support personnel to support this additional growth.

Interest Income

Interest income includes interest earned on our cash balances. These balances are invested primarily in money market accounts.

Interest Expense

Interest expense relates to our outstanding promissory notes, which are more fully described in this prospectus under the heading “Use of Proceeds” and in “Note 3. Promissory Notes” of our financial statements that are included elsewhere in this prospectus.

Promissory Notes

We have issued promissory notes pursuant to a number of private placements since 1999. At times these promissory notes were issued with separate warrants to purchase shares of our common stock. The fair value of these warrants is allocated as a debt discount using the relative fair value allocation method determined using the Black-Scholes valuation model. The discount is amortized using the effective interest method over the term of the related promissory notes.

Change in the Fair Value of Warrant Liabilities

One of our outstanding warrants to purchase shares of our common stock provides for adjustment of the exercise price based upon subsequent issuances at prices per share that are below the exercise price of the warrant, and is classified as a liability and recorded at fair value regardless of the timing of the redemption feature or the redemption price or the likelihood of redemption. Our outstanding warrants to purchase shares of our convertible preferred stock are also classified as a liability and recorded at fair value regardless of the timing of the redemption feature or the redemption price or the likelihood of redemption. These warrants are subject to re-measurement at each balance sheet date and any change in fair value is recognized as a component of other interest income (expense), net. We will continue to adjust the liability for changes in fair value until the earlier of the conversion, exercise or expiration of the warrants.

All of our other outstanding warrants to purchase shares of our common stock that do not provide for exercise price adjustments were determined to be equity instruments and thus included in stockholders deficit upon issuance and are not subject to re-measurement.

 

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Results of Operations

The following tables set forth selected items in our statements of operations for the periods presented, together with the difference in amounts over such periods in dollars and in percentages. The financial data set forth below is derived in part from and should be read in conjunction with our financial statements and the related notes included elsewhere in this prospectus.

 

     Nine months ended
September 30,
    Change  
     2011     2012     $     %  
     (unaudited)  
     (in thousands, except for percentages)  

Net revenue

   $ 5,166      $ 14,473      $ 9,307        180.2

Cost of sales

     4,378        5,035        657        15.0
  

 

 

   

 

 

   

 

 

   

Gross profit

     788        9,438        8,650        1,097.7

Operating expenses:

        

Research and development

     2,146        1,724        (422     (19.7 )% 

General and administrative

     2,587        2,775        188        7.3

Sales and marketing

     2,023        1,655        (368     (18.2 )% 
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     6,756        6,154        (602     (8.9 )% 
  

 

 

   

 

 

   

 

 

   

Income/(loss) from operations

   $ (5,968   $ 3,284      $ 9,252        *   

Interest expense, net

     (2,598     (1,913     685        (26.4 )% 

Other income/(expense), net

     —          5        5        *   

Change in fair value of warrant liabilities

     434        (170     (604     *   
  

 

 

   

 

 

   

 

 

   

Net income/(loss)

   $ (8,132   $ 1,206      $ 9,338        *   
  

 

 

   

 

 

   

 

 

   

 

  * Percentage change is not meaningful.

 

     Years ended
December 31,
    Change  
     2010     2011     $     %  
     (unaudited)  
     (in thousands, except for percentages)  

Net revenue

   $ 7,504      $ 8,005      $ 501        6.7

Cost of sales

     7,666        6,019        (1,647     (21.5 )% 
  

 

 

   

 

 

   

 

 

   

Gross profit/(loss)

     (162     1,986        2,148        *   

Operating expenses:

        

Research and development

     3,560        2,768        (792     (22.2 )% 

General and administrative

     5,376        3,360        (2,016     (37.5 )% 

Sales and marketing

     4,717        2,672        (2,045     (43.4 )% 

Impairment of film equipment

     981        —          (981     *   

Initial public offering costs — terminated offering

     1,752        —          (1,752     *   
  

 

 

   

 

 

   

 

 

   

Total operating expenses

     16,386        8,800        (7,586     (46.3 )% 
  

 

 

   

 

 

   

 

 

   

Loss from operations

   $ (16,548   $ (6,814   $ 9,734        58.8

Interest expense

     (4,109     (3,626     483        11.8

Other income/(expense), net

     36        (2     (38     *   

Change in fair value of warrant liabilities

     926        445        (481     (51.9 )% 
  

 

 

   

 

 

   

 

 

   

Net loss

   $ (19,695   $ (9,997   $ 9,698        49.2
  

 

 

   

 

 

   

 

 

   

 

* Percentage change is not meaningful.

 

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Comparison of the Nine Months Ended September 30, 2012 and 2011

Net revenue

Net revenue for the nine months ended September 30, 2012 was $14.5 million compared to $5.2 million for the nine months ended September 30, 2011. Net revenue for the nine months ended September 30, 2012 consisted of $1.1 million from the sale of INFINITI analyzers, $13.2 million from the sale of consumables, including sales to one customer of $6.4 million, and $0.2 million in non-product revenue. Net revenue for the nine months ended September 30, 2011 consisted of $0.7 million from the sale of INFINITI analyzers, $4.3 million from the sale of consumables, and $0.2 million in non-product revenue. Sales of RUO products to laboratories operating under CLIA guidelines comprised 96% and 92% of our total net revenues in the nine months ended September 30, 2012 and 2011, respectively. The increase in net revenue is primarily attributable to increased utilization of the INFINITI system by our customers in general and in additional high-volume sales to a few customers of our personalized medicine and women’s health diagnostic testing products, specifically, which are for the most part sold on an RUO basis.

As a percentage of total net revenues, revenue from markets outside the United States continued to decline, and was 6% for the nine months ended September 30, 2012, as compared to 32% for the nine months ended September 30, 2011. This ongoing and increasing weakness in international sales is a result of tumultuous economic conditions in international markets and of our shift to a focus on domestic activities due to constraints in our resources that limited our ability to service international markets.

Cost of Sales and Gross Profit

Cost of sales for the nine months ended September 30, 2012 was $5.0 million compared to $4.4 million for the nine months ended September 30, 2011. The increase in cost of sales is due primarily to an increase in consumables sold. The increase in gross profit is due primarily to an increase in gross margins from the sale of high margin testing consumables.

Operating Expenses

Research and Development

Research and development expenses consisting primarily of personnel costs and development materials for the nine months ended September 30, 2012 were $1.7 million compared to $2.1 million for the nine months ended September 30, 2011. The decrease is attributable to reduced headcount as we focused on growing sales of existing products during a period of resource constraints. We expect our research and development expenses to grow in future periods following the completion of this offering, as we seek to further expand and enhance our test menu and conduct studies to support regulatory approvals for our products.

General and Administrative

General and administrative expenses consisting of personnel, professional services and other administrative expenses for the nine months ended September 30, 2012 were $2.8 million compared to $2.6 million for the nine months ended September 30, 2011. The increase is primarily attributable to increased professional fees incurred in 2012 related to annual financial audits.

Sales and Marketing

Sales and marketing expenses for the nine months ended September 30, 2012 were $1.7 million compared to $2.0 million for the nine months ended September 30, 2011. The decrease in sales and marketing costs is due primarily to reduced headcount as we more narrowly focused our sales and marketing efforts on a targeted group of customers. We expect our sales and marketing expenses to grow in future periods following the completion of this offering, as we hire additional sales representatives and expand our international sales and marketing presence.

 

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Profit/(Loss) from Operations and Net Profit/(Loss)

Profit from operations for the nine months ended September 30, 2012 was $3.3 million compared to a loss of $6.0 million for the nine months ended September 30, 2011. The profit from operations for the nine months ended September 30, 2012 was comprised of net sales revenue of $14.5 million less cost of sales of $5.0 million and aggregate operating expenses of $6.2 million. The loss from operations for the nine months ended September 30, 2011 was comprised of net sales revenue of $5.2 million less cost of sales of $4.4 million and aggregate operating expenses of $6.8 million.

Net profit for the nine months ended September 30, 2012 was $1.2 million compared to a net loss of $8.1 million for the nine months ended September 30, 2011. The net profit for the nine months ended September 30, 2012 was comprised of a profit from operations of $3.3 million less interest expense from debt financing of $1.9 million and changes in the fair value of preferred and common stock warrant liabilities of $0.2 million. The net loss for the nine months ended September 30, 2011 was comprised of a loss from operations of $6.0 million and interest expense from debt financing of $2.6 million offset by changes in the fair value of preferred and common stock warrant liabilities of $0.4 million.

Interest Income

We had no meaningful interest income for the nine months ended September 30, 2012 and September 30, 2011.

Interest Expense

Interest expense for the nine months ended September 30, 2012 was $1.9 million compared to interest expense of $2.6 million for the nine months ended September 30, 2011. The decrease in interest expense is due primarily to the repayment of interest-bearing debt and the fair value associated with common stock warrants recorded as debt discount and amortized as interest expense under the effective interest method.

Other Income (Expense), Net

Other income for the nine months ended September 30, 2012 was $5,000 compared to no other income or expense for the nine months ended September 30, 2011. The increase in other income is due primarily to non-operating activities.

Change in the Fair Value of Warrant Liabilities

The change in the fair value of warrant liabilities decreased our net income by $0.2 million for the nine months ended September 30, 2012 and decreased our net loss by $0.4 million for the nine months ended September 30, 2011. The increase in the fair value of warrant liabilities is due to the increase in the fair value of our common stock and underlying preferred stock and to the extension of the term of certain preferred stock warrants resulting in an increase to the contractual life over which the associated warrant liabilities are marked to market.

Comparison of the Years Ended December 31, 2011 and 2010

Net revenue

Net revenue for the year ended December 31, 2011 was $8.0 million compared to $7.5 million for the year ended December 31, 2010. Net revenue for the year ended December 31, 2011 consisted of $0.9 million from the sale of INFINITI analyzers and $7.1 million from the sale of consumables. Net revenue for the year ended December 31, 2010 consisted of $3.4 million from the sale of INFINITI analyzers and $4.1 million from the sale of consumables. Sales of RUO products to laboratories operating under CLIA guidelines comprised 92% and

 

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87% of our total net revenues in the years ended December 31, 2011 and 2010, respectively. The decrease in revenue from sales of INFINITI analyzers year-over-year is due primarily to a weakening in capital sales in the industry in general and in our international distributor network, specifically. The increase in consumable revenue year-over-year is primarily due to our increased installed base and in additional high-volume sales to a few customers of our personalized medicine and women’s health diagnostic testing products which are for the most part sold on an RUO basis.

As a percentage of total net sales, revenue from markets outside the United States were 22% and 52% for the years ended December 31, 2011 and 2010, respectively. The decrease in net revenues from sales outside the United States was due primarily to sales in 2010 of the INFINITI analyzer to our distributors in European and Asian markets not repeated in 2011 as a result of a weakening of economic conditions in the European region and a focusing of Company resources on domestic sales generation due to constrained resources.

Cost of Sales and Gross Profit

Cost of sales for the year ended December 31, 2011 was $6.0 million compared to $7.7 million for the year ended December 31, 2010. The decrease in cost of sales and increase in gross margin percentage year-over-year is due primarily to an increase in the sales mix of higher margin testing consumables over analyzers.

Operating Expenses

Research and Development

Research and development expenses consisting of personnel costs and costs to develop our diagnostic testing products and future generations of testing platforms for the year ended December 31, 2011 were $2.8 million compared to $3.6 million for the year ended December 31, 2010. The decrease in research and development expenses is due primarily to reduced headcount as we focused on growing sales of existing products during a period of resource constraints. We expect our research and development expenses to grow in future periods following the completion of this offering.

General and Administrative

General and administrative expenses for the year ended December 31, 2011 were $3.4 million compared to $5.4 million for the year ended December 31, 2010. The decrease primarily was driven by a reduction of management salaries and other general operating expenses in response to constrained resources, and legal, consulting and audit fees not incurred in 2011. In 2010, we incurred $0.9 million in legal and audit fees in connection with our then-planned initial public offering that was subsequently terminated.

Sales and Marketing

Sales and marketing expenses for the year ended December 31, 2011 were $2.7 million compared to $4.7 million for the year ended December 31, 2010. The decrease was driven primarily by reduced headcount as we more narrowly focused our sales and marketing efforts on a targeted group of customers, and by extraordinary stock compensation costs not incurred in 2011.

Impairment of Film Coating Equipment

During the year ended December 31, 2010, we recognized $1.0 million of impairment cost related to film coating equipment that had not been installed as of the end of the fiscal year.

Initial Public Offering — Terminated Offering

During the year ended December 31, 2010, we recognized $1.8 million in legal and accounting costs associated with a proposed initial public offering that was not completed in 2010.

 

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Loss from Operations and Net Loss

Loss from operations for the year ended December 31, 2011 was $6.8 million compared to a loss of $16.5 million for the year ended December 31, 2010. The loss from operations for the year ended December 31, 2011 was comprised of net sales revenue of $8.0 million less cost of sales of $6.0 million and aggregate operating expenses of $8.8 million. The loss in operations for the year ended December 31, 2010 was comprised of net sales revenue of $7.5 million less cost of sales of $7.6 million and aggregate operating expense of $16.4 million.

Net loss for the year ended December 31, 2011 was $10.0 million compared to a net loss of $19.7 million for the year ended December 31, 2010. The net loss for the year ended December 31, 2011 was comprised of a loss from operations of $6.8 million and interest expense from debt financing of $3.6 million offset by changes in the fair value of preferred and common stock warrant liabilities of $0.4 million. Net loss for the year ended December 31, 2010 was comprised of a loss from operations of $16.5 million and interest expense from debt financing of $4.1 million, offset by changes in the fair value of preferred and common stock warrant liabilities of $0.9 million.

Interest Expense

Net interest expense for the year ended December 31, 2011 was $3.6 million compared to $4.1 million for the year ended December 31, 2010. The decrease was attributable primarily to the issuance of senior promissory notes during 2011 and associated common stock warrants recorded as a debt premium and amortized as a credit interest expense under the effective interest method.

Other Income (Expense), Net

Other expenses net for the year ended December 31, 2011 were $2,000 compared to other income of $36,000 in non-operating revenue for the year ended December 31, 2010. This change is primarily due to non-operating activities.

Change in the Fair Value of Warrant Liabilities

The change in the fair value of warrant liabilities decreased our net loss by $0.4 million for the year ended December 31, 2011 and decreased our net loss by $0.9 million for the year ended December 31, 2010. The change is attributable to a decrease in the fair value of our common stock and in the contractual life over which the associated preferred stock warrant liabilities are marked to market.

Liquidity and Capital Resources

Historical Cash Flows

From our inception in April 1999 through September 30, 2012, we have financed our operations primarily through sales of privately placed shares of convertible preferred stock and promissory notes.

Our primary uses of cash are to fund operating expenses, inventory purchases and the acquisition of machinery and equipment. Cash used to fund operating expenses excludes the impact of non-cash items such as the provision for excess and obsolete inventory, write-off of equipment depreciation, stock-based compensation and non-cash interest expense and is impacted by the timing of when we pay these expenses as reflected in the change in our outstanding accounts payable and accrued expenses. Acquisitions of machinery and equipment primarily consist of our cost to manufacture INFINITI analyzers utilized in our domestic placement plans, purchases of laboratory equipment, computer hardware and software and facility improvements.

As of September 30, 2012, we had cash and cash equivalents of $0.3 million compared to $0.1 million and $61,000 as of September 30, 2011 and December 31, 2011, respectively.

 

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The following table summarizes our cash flows for each of the periods indicated:

 

     Years ended
December 31,
    Nine months ended September 30,  
     2010     2011         2011             2012      
                 (unaudited)  
     (in thousands)  

Net cash provided by/(used in) operating activities

   $ (6,736   $ (2,846   $ (2,617   $ 608   

Net cash provided by/(used in) investing activities

     (260     (5     (3     (136

Net cash provided by/(used in) financing activities

     6,503        2,783        2,600        (239
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (493   $ (68   $ (20   $ 233   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Activities

Net cash used in operating activities for the year ended December 31, 2010 of $6.7 million consisted of a net loss of $19.7 million, a decrease of $0.9 million related to the change in the fair value of preferred and common stock warrant liabilities and a decrease of $0.3 million in the reserve for doubtful accounts offset by $4.2 million of changes in working capital, $3.8 million of non-cash interest expense and amortization of debt discount/premium related to our promissory notes, $2.9 million in stock compensation expense, $1.0 million in impairment costs related to film coating equipment, $0.8 million of depreciation and amortization, $0.9 million in deferred rent expense and tenant improvement allowances related to our corporate headquarters, $0.4 million of amortization of deferred financing costs and an increase of $0.3 million in reserves for excess and obsolete inventory. The primary changes in working capital were increases of $0.7 million of prepaid and other current assets, $0.4 million in accounts receivable and decreases of $1.9 million in other current liabilities and accrued expenses offset by increases of $5.7 million in accounts payable and decreases of $1.4 million in inventory.

Net cash used in operating activities for the year ended December 31, 2011 of $2.8 million consisted of a net loss of $10.0 million and a decrease of $0.4 million related to changes in the fair value of preferred and common stock warrant liabilities offset by $3.3 million of non-cash interest expense and amortization of debt discount/premium related to our promissory notes, $1.7 million in stock compensation expense, $1.3 million of changes in working capital, $0.7 million of depreciation and amortization, $0.4 million of amortization of deferred financing costs and $0.3 million in deferred rent expense related to our corporate headquarters. The primary changes in working capital were an increase of $2.0 million in accounts payable offset by increases of $0.6 million in accounts receivable and decreases of $0.1 million in other current liabilities and accrued expenses.

Net cash used in operating activities for the nine months ended September 30, 2011 of $2.6 million consisted of a net loss of $8.1 million, a decrease of $0.4 million related to changes in the fair value of preferred and common stock warrant liabilities and a decrease of $0.1 million in reserves for excess and obsolete inventory offset by $2.3 million of non-cash interest expense and amortization of debt discount/premium related to our promissory notes, $1.3 million of changes in working capital, $1.3 million in stock compensation expense, $0.6 million of depreciation and amortization, $0.3 million of amortization of deferred financing costs and $0.2 million in deferred rent expense related to our corporate headquarters. The primary changes in working capital consisted of increases of $1.2 million in accounts payable and decreases of $0.4 million in accounts receivable offset by decreases of $0.2 million in inventory and other current assets.

Net cash provided by operating activities for the nine months ended September 30, 2012 of $0.6 million consisted of a net profit of $1.2 million, $1.8 million of non-cash interest expense and amortization of debt discount/premium related to our promissory notes, $0.7 million in stock compensation expense, $0.5 million of depreciation and amortization, $0.3 million in deferred rent expense related to our corporate headquarters, $0.2

 

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million related to changes in the fair value of preferred and common warrant liabilities and $0.1 million in amortization of deferred financing costs offset by $4.2 million of changes in working capital. The primary changes in working capital consisted of increases of $2.0 million in accounts receivable, $1.6 million in prepaid and other assets, and $1.0 million in inventory offset by increases of $0.4 million in other current liabilities and accrued expenses and $0.1 million in accounts payable.

Investing Activities

Net cash used in investing activities for all periods noted above consisted primarily of invested capital and facility investment to manufacture INFINITI analyzers utilized in our domestic placement plans and purchases of machinery and equipment, including furniture, computer equipment and software, in support of all functional areas of the business.

Financing Activities

For the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2011 and 2012, net cash provided by financing activities consisted primarily of net proceeds from the sale of promissory notes and shares of Series E Convertible Preferred Stock issued in private placement transactions of $6.1 million, $2.8 million, $2.6 million and $1.8 million, respectively. We also made payments on promissory notes and accrued interest in the amount of $2.1 million in the nine months ended September 30, 2012. We used the proceeds from the issuances of the notes for general corporate purposes. Certain of these promissory notes limit our ability to incur additional indebtedness.

Promissory Notes

As of September 30, 2012, we had an aggregate of $24.7 million of principal and accrued interest under outstanding promissory notes, including those described above, of which approximately $14.8 million in aggregate principal amount was in default. For each additional day that the notes remain outstanding, we were required to pay approximately $4,600 additional interest under the notes. As of September 30, 2012, there was an aggregate of $4.0 million of principal and accrued interest outstanding under promissory notes we have issued to our directors, executive officers and holders of more than 5% of our common stock. We do not have sufficient cash to satisfy our indebtedness obligations absent the completion of this offering.

The following table describes the components of our outstanding indebtedness as of the following dates:

 

    December 31,     September 30,
2012
 
    2010     2011    
                (unaudited)  
    (in thousands)  
                   

Subordinated Promissory Notes, 13% interest, due July 2011

  $ 5,071      $ —        $ —     

Subordinated Promissory Notes, 6% interest, due November to December 2011

    595        —          —     

Senior Promissory Notes, 13% interest, due December 2011

    —          400        —     

Senior Promissory Note, 13% interest, due February 2012

    —          3,500        2,100   

Short Term Notes Payable, 12% interest, due April & May 2012

    —          175        695   

Short Term Notes Payable, 10% interest, due June 2012

    —          —          1,150   

Subordinated Promissory Notes, 6% interest, due February to June 2012

    10,715        10,794        10,794   

Subordinated Promissory Notes, 6% interest, due December 2012

    2,000        2,345        2,345   

Subordinated Promissory Notes, 7% interest, due December 2012

    300        1,200        1,200   

Subordinated Promissory Notes, 8% interest, due December 2012

    500        500        500   

Subordinated Promissory Notes, 13% interest, due December 2012

  $ —        $ 2,000      $ 2,000   
 

 

 

   

 

 

   

 

 

 

Total

  $ 19,181      $ 20,914      $ 20,784   

Unamortized premium/(discount)

    (2,522     (281     78   

Accrued interest

    2,120        2,882        3,863   
 

 

 

   

 

 

   

 

 

 

Outstanding balance

  $ 18,779      $ 23,515      $ 24,725   
 

 

 

   

 

 

   

 

 

 

 

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In February and March 2010, we issued $525,000 aggregate principal amount of subordinated promissory notes to certain accredited investors. The notes bear interest at the rate of 6.0% per annum, with the principal and accrued interest balances generally due two years after the date of issuance, depending on the provisions of the note. In connection with the issuance of these notes, we also issued warrants to purchase 49,203 shares of our common stock with an exercise price of $12.12 per share. The warrants are now fully exercisable and have a term of five years from their date of issue.

In March 2010, we issued $5,250,000 aggregate principal amount of subordinated notes in a private placement to certain accredited investors. The notes bear interest at the rate of 6.0% per annum, with the principal and accrued interest balances due two years after the date of issuance. In the private placement, we also issued warrants to purchase 519,750 shares of our common stock with an exercise price of $15.15 per share. The warrants are now fully exercisable and have a term of five years from their date of issue.

In April 2010, we and the applicable note holder amended a subordinated promissory note with a principal amount of $1,000,000 set to mature in August 2010 by extending the maturity date to April 2011. In connection with this amendment, we cancelled a warrant to purchase 93,720 shares of our common stock at an exercise price of $21.21 per share held by the note holder which was to expire five years after the issuance date, and reissued a warrant to purchase 93,720 shares of our common stock at an exercise price of $15.15 per share to the note holder which will expire six and one-half years after the original issuance date. Also in April 2010, we and the applicable note holders amended certain subordinated promissory notes with an aggregate principal amount of $5,040,000 set to mature between August 2010 and December 2011 by extending the maturity dates to April 2012. In connection with these amendments, we cancelled warrants to purchase 472,349 shares of our common stock at an exercise price of $21.21 per share held by the note holders which were to expire five years after the issuance date and reissued warrants to purchase 472,349 shares of our common stock at an exercise price of $15.15 per share to the note holders which will expire six and one-half years after the original issuance date.

In November 2010, we and the applicable note holder amended certain promissory notes with an aggregate principal amount of $2,500,000 set to mature in April 2010, February 2011, May 2011 and November 2011, by extending the maturity dates to December 2012. In connection with these amendments, we cancelled warrants to purchase 234,300 shares of our common stock at exercise prices of $12.12, $15.15 and $21.21 per share held by the note holder and reissued warrants to purchase 234,300 shares of our common stock at an exercise price of $9.09 per share to the note holder which will expire in January 2016.

From December 2010 through May 2011, we issued $1,300,000 aggregate principal amount of promissory notes to certain accredited investors. The notes bear interest at the rate of 7.0% per annum, and generally mature in December 2012. In connection with this offering, we also issued warrants to purchase 128,700 shares of our common stock with an exercise price of $9.09 per share. The warrants have a term of five years from their date of issue.

In June 2011, we and the applicable note holder amended a certain promissory note with an aggregate principal amount of $2,000,000 set to mature in July 2011, by extending the maturity date to December 2012. In connection with this amendment, we cancelled a warrant to purchase 187,440 shares of our common stock at an exercise price of $12.12 per share held by the note holder and reissued a warrant to purchase 187,440 shares of our common stock at an exercise price of $9.09 per share to the note holder which will expire in August 2014.

In August 2011, we and the applicable note holder exchanged promissory notes with an aggregate principal amount of $3,071,000 that matured in July 2011, for promissory notes with an aggregate principal amount of $3,900,000, set to expire December 2011 and February 2012. In connection with this exchange, we cancelled warrants to purchase 281,160 shares of our common stock at an exercise price of $12.12 per share held by the note holder and reissued a warrant to purchase 429,000 shares of our common stock at an exercise price of $9.09 to the note holder which will expire in August 2016.

 

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In October and December 2011, we and the applicable note holders amended promissory notes with an aggregate principal amount of $595,000 that were set to expire in November and December 2011, by extending the maturity dates to dates in 2012. In connection with this amendment, we amended warrants to purchase 55,763 shares of our common stock by reducing the exercise price from $12.12 per share to $9.09 per share.

From November 2011 through January 2012, we issued $695,000 aggregate principal amount of promissory notes to certain accredited investors. The notes bear interest at the rate of 12.0% per annum, and generally matured in April 2012. In connection with the issuance of these notes, we issued warrants to purchase 114,675 shares of our common stock at an exercise price of $5.24 per share to the note holders which will expire five years from their date of issue.

In February 2012, we and the applicable note holder amended a certain promissory note with a principal amount of $250,000 set to mature in April 2012, by extending the maturity date to June 2012. In connection with this amendment, we amended a warrant to purchase 23,430 shares of our common stock at an exercise price of $15.15 per share held by the note holder, by reducing the exercise price to $9.09 per share and extending the term of the warrant until June 2017.

In February 2012, we and the applicable note holders amended certain promissory notes with an aggregate principal amount of $400,000 set to mature in February 2012, by extending the maturity dates to April 2012. In connection with these amendments, we amended warrants to purchase 37,488 shares of our common stock at an exercise price of $12.12 per share held by the note holder, by reducing the exercise price to $9.09 per share and extending the term of the warrant until April 2017.

In March 2012, we issued $1,150,000 aggregate principal amount of promissory notes to certain accredited investors. The notes bear interest at the rate of 10.0% per annum, with the principal and accrued interest balances matured in June 2012. In connection with the issuance of these notes, we issued warrants to purchase 113,850 shares of our common stock with an exercise price of $5.24 per share which will expire five years from their date of issue.

In November 2012, the holders of $7.5 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes with rates of interest ranging from six percent to 12% that were then past due or scheduled to come due in the immediate future surrendered their right to payment of those promissory notes in exchange for an aggregate of 4,287,074 shares of our Series NC Convertible Preferred Stock. In connection with this surrender and issuance, these noteholders surrendered warrants for the purchase of an aggregate of 637,813 shares of our common stock with exercise prices ranging from $5.24 per share to $15.15 per share in exchange for warrants of a like tenor for the purchase of an aggregate of 637,813 shares of our common stock with exercise prices of $4.55 per share. Also in November 2012, the holders of $14.4 million in aggregate principal amount of and accrued interest on our outstanding subordinated promissory notes with rates of interest ranging from six percent to 13% that were then past due or scheduled to come due in the immediate future surrendered their right to payment of those promissory notes in exchange for new promissory notes in aggregate principal amount of $14.4 million with eight and one-half percent rates of interest and November 2015 maturity dates. In connection with this surrender and issuance, these noteholders surrendered warrants for the purchase of an aggregate of 1,156,013 shares of our common stock with exercise prices ranging from $5.24 per share to $15.15 per share in exchange for warrants of a like tenor for the purchase of an aggregate of 1,734,020 shares of our common stock with exercise prices of $5.30 per share. As of November 27, 2012, after giving effect to these actions, we had outstanding total indebtedness and accrued interest under promissory notes of approximately $17.4 million, of which approximately $2.9 million was due and scheduled to come due in the immediate future, and outstanding warrants to purchase an aggregate of 3,372,711 shares of our common stock.

Our outstanding subordinated promissory notes are secured by the grant of a security interest in our trade receivables. We are required to use up to 50% of the net proceeds to us from the offering referred to in this prospectus to pay down our indebtedness under these subordinated promissory notes, and as a result we expect to retire all of our existing promissory note indebtedness in connection with the completion of this offering. If, after

 

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completion of this offering, we have any indebtedness outstanding under our November 2012 notes, we will be required to use 80% of the free cash that we have at the end of each fiscal quarter to pay down these notes pro rata until they are paid in full. For this purpose, “free cash” means our available cash after (i) payment or accrual of operating expenses (including tax liabilities) and all scheduled or required payments on our senior indebtedness (including amounts owed to our landlord) for that fiscal quarter just ending and (ii) establishing reserves for operating expenses and scheduled or required payments on our indebtedness (including amounts owed to our landlord) for the immediately following fiscal quarter as determined by us in good faith. These subordinated promissory notes restrict our ability to incur additional senior or pari passu indebtedness unless we use 50% of the net proceeds to us from the incurrence of that senior or pari passu indebtedness to pay down our indebtedness under these subordinated promissory notes. These subordinated promissory notes also restrict our ability to make cash dividends during the period of time that they remain outstanding.

In January 2013, we issued and sold a subordinated promissory note in the amount of $2.4 million to one of our existing investors, who is a holder of more than 5% of our capital stock. This promissory note has a maturity date of March 31, 2013, an annual interest rate of 8.5%, and is prepayable at any time without premium or penalty. We used the proceeds of this sale to retire the outstanding principal and interest owed under our outstanding promissory notes with Tregale Group Ltd. On December 28, 2012, Tregale Group Ltd filed a request for judicial intervention and motion for summary judgment in lieu of complaint, demanding payment of the principal and interest outstanding under promissory notes held by it, as well as reimbursement of certain legal and other expenses. See “Business — Legal Proceedings” elsewhere in this prospectus.

See the description of our outstanding indebtedness described elsewhere in this prospectus under the heading “Use of Proceeds” and “Note 3. Subordinated Promissory Notes” and “Note 12. Subsequent Events (unaudited)” of our financial statements that are included elsewhere in this prospectus.

Contractual Obligations

As of September 30, 2012, the annual amounts of future minimum payments under certain of our contractual obligations were:

 

     Payments due by period  
   Total      Less than
1 year
     1-3 years      3-5 years      More than 5
years
 
     (in thousands)  

Contractual obligations:

              

Subordinated promissory notes (1)

   $ 24,647       $ 24,647       $ —         $ —         $ —     

Operating lease (2)

     41,995         1,590         3,585         3,966         32,854   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 66,642       $ 26,237       $ 3,585       $ 3,966       $ 32,854   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) From September 2008 through March 2012, we issued $24.3 million aggregate principal amount of promissory notes in private placements to certain accredited investors of which $4.0 million in aggregate principal amount was issued to directors, executive officers, and holders of more than 5% of our common stock. The notes bear a weighted average annual interest rate of 6.8%, with the principal and accrued interest (shown above accrued through September 30, 2012). These notes were exchanged and their maturities extended in November 2012. See “Note 12. Subsequent Events (unaudited)” of our financial statements that are included elsewhere in this prospectus. We may elect to prepay our outstanding promissory notes at any time without penalty.
(2) Our lease for our corporate offices in Vista, California commenced on February 1, 2009 and will expire in December 2029. This facility houses our research and development, manufacturing and warehousing operations and our administrative offices. We are required to make a payment to the landlord in the amount of $1.1 million by February 4, 2013. We will not be able to satisfy this obligation absent the completion of this offering. See “Rick Factors” and “Note 12. Subsequent Events (unaudited)” of our financial statements that are included elsewhere in this prospectus.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements or any special-purpose entities.

 

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Working Capital Commitments and Liquidity

We have a history of operating losses and negative cash flows since our inception. We may not be able to achieve profitability on an annual basis or maintain profitability over any periods. If we do not consummate this offering or obtain additional capital from other external sources, we do not have sufficient working capital to fund our planned operations, and repay the current portion of our promissory notes, through the immediate future. As a result, our independent registered public accounting firm included an explanatory paragraph relating to our ability to continue as a going concern in its report on our audited financial statements for the year ended December 31, 2011.

We anticipate that our current cash and cash equivalents and cash provided by this offering and our operating activities will be sufficient to meet our currently estimated cash requirements for at least the next 12 months. We anticipate that we will use the net proceeds from this offering to (i) repay the principal and interest under our outstanding promissory notes, (ii) fund the expansion of our sales force, enhance our international distributor support network, and increase our marketing and promotional activity and business development efforts, (iii) support a PMA for our HPV-HR test and 510(k) and CE mark studies and submissions for several tests associated with womens’ health and personalized medicine, (iv) fund research and development activities to add new or enhanced tests to our menu, (v) fund the expansion of our manufacturing capacity and efficiency, including purchasing automation equipment, (vi) satisfy outstanding accounts payable to advisors and service providers incurred in connection with certain of our prior capital raising activities conducted from 2008 through 2010, and (vii) make payment of past due amounts owed to our landlord. We anticipate that we will use the remainder of the net proceeds from this offering for additional working capital and general corporate purposes. See “Use of Proceeds.”

We expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure, commercialization, manufacturing and research and development activities, and as a result we may need additional capital financing. The amount of additional capital we may need to raise depends on many factors, including:

 

   

the level of research and development investment required to maintain and improve our technology, including efforts to expand our molecular diagnostic test menu, to fund clinical studies and trials of our tests and to invest in the development of new analyzers;

 

   

the amount of future cash provided by or used in operating activities;

 

   

whether or not we are able to pay down our outstanding promissory notes from the proceeds of this offering or from our quarterly free cash flow, as required by the terms of the notes;

 

   

the costs of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

 

   

our need or decision to acquire or license complementary technologies or acquire complementary businesses; and

 

   

changes in regulatory policies or laws that affect our operations.

We cannot be certain that additional capital will be available when and as needed or that our actual cash requirements will not be greater than anticipated. If we require additional capital at a time when investment in diagnostics companies or in the marketplace in general is limited by the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter. In addition, if we raise additional funds through the issuance of common stock or securities convertible into shares of common stock, the percentage ownership of our stockholders could be significantly diluted, and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. If we obtain additional debt financing, a substantial portion of our operating cash flow may be dedicated to the payment of principal and interest on such indebtedness, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technologies or products, or grant licenses on terms that are not favorable to us.

 

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In the United States, market and economic conditions continue to be challenging with relatively tight credit conditions and slow economic growth. Continued concerns regarding economic growth, recessionary conditions in certain international economies, healthcare reforms, including changes in reimbursement policies and the scope of health insurance coverage, the levels of sovereign debt in the United States and Europe, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage and real estate market and recent tax increases have contributed to relatively low expectations for the U.S. economy. These conditions, combined with relatively low business and consumer confidence and high levels of unemployment could continue to contribute to adverse market and economic conditions. As a result of these conditions, the cost and availability of credit may continue to be adversely affected by illiquid credit markets and wider credit spreads. Continued uncertainty with respect to these conditions may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability to timely satisfy maturing liabilities, and access the capital markets to meet liquidity needs and invest in new technologies and products, resulting in adverse effects on our financial condition and results of operations.

Critical Accounting Policies, Significant Judgments and Estimates

Our financial statements and related notes included elsewhere in this prospectus have been prepared in accordance with United States generally accepted accounting policies, or GAAP. The preparation of these statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs, and expenses and related disclosures. We base such estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Changes in accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by company management. We evaluate our estimates and assumptions on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our future financial statement preparation, financial condition, results of operations and cash flows will be affected.

The following accounting policies involve a greater degree of judgment and complexity than our other accounting policies. Accordingly, these are the policies we believe to be most critical to understanding and evaluating our financial condition and results of operations.

Revenue Recognition

Our revenue is primarily derived from sales of our INFINITI analyzers and the BioFilmChip, Intellipac Reagent Management Module, and various disposable items consumed by our diagnostic testing process, collectively referred to as consumables. Our INFINITI analyzers and all consumables are offered through direct sale in domestic markets and through distributors in international markets. Our INFINITI analyzers also are available to domestic customers through our domestic placement plan. In such arrangements, customers receive an analyzer at no direct cost in return for a commitment to purchase minimum quantities of consumables based on an agreed pricing schedule over the contract period, which is usually two years, and which may be extended at the option of the customer or us. We reserve the option to cancel the arrangement and repossess the analyzer if minimum quantities of consumables are not purchased. These analyzers are recorded in our financial records as capitalized assets and are depreciated over an estimated useful life of, typically, three years. When the analyzer is returned to us it is placed back into inventory at its then net book value. Analyzers that are returned are subject to a review and refurbishment process designed to enable the return of the analyzer to the field as soon as practicable. Any costs associated with the refurbishment of an analyzer are capitalized and added to our cost basis in the analyzer. The new basis, including refurbishment costs, either is amortized to cost of sales over the useful life of the analyzer once the refurbished unit is placed with a new customer under the domestic placement plan, or is charged to cost of sales upon the sale of the refurbished analyzer. Throughout the term of the placement agreement, we retain title to the analyzer.

 

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We recognize revenue when persuasive evidence of an arrangement exists, the price to the buyer is fixed or determinable, collectability is reasonably assured and risk of loss transfers, normally upon shipment. For sales that include customer specific acceptance criteria, revenue is recognized when the acceptance criteria have been met. Credit is extended based upon the evaluation of the customer’s financial condition. Collectability is assessed based on a number of factors, including payment history and the creditworthiness of a customer. If we determine that collection is not reasonably assured, we do not recognize revenue until collection becomes reasonably assured, which is generally upon receipt of cash. We do not request collateral from our customers. We recognize revenue when the products have been shipped and the title and risk of loss have been transferred.

In instances where final acceptance of the product or system is required, we defer revenue until all the acceptance criteria have been met. The rights granted in the domestic placement plan in exchange for a minimum annual purchase commitment constitutes a leasing arrangement. When a customer enters into a domestic placement plan agreement, the lease revenue is dependent on purchases of consumables, which is not measurable at the inception of the lease, and thus is accounted for as contingent rentals in their entirety. Accordingly, lease revenues are excluded from minimum lease payments but included in revenue as the consumables are purchased. The cost of the leased equipment is depreciated over its useful life and the expense included in cost of sales.

Arrangements to sell products to customers frequently include multiple deliverables, including the sale of the INFINITI analyzer combined with the sale of consumables. Sales to foreign distributors include training of their field agents whom will be responsible for installation, training, and maintenance for their customers internationally. We do not provide any price protection, rights of return, or extended payment terms to the distributors. Prior to January 1, 2011 we recognized revenue upon completion of training as we could not establish vendor-specific objective evidence (“VSOE”) of the training. Beginning on January 1, 2011, we adopted new authoritative guidance on multiple-element arrangements, using the prospective method for all arrangements entered into or materially modified from the date of adoption. Under this new guidance, we allocate arrangement consideration in multiple-element revenue arrangements at the inception of an arrangement to all deliverables or those packages in which all components of the package are delivered at the same time, based on the relative selling price method in accordance with the selling price hierarchy, which includes: (i) VSOE if available; (ii) third-party evidence (“TPE”) if VSOE is not available, and (iii) best estimate of selling price (“BESP”) if neither VSOE nor TPE is available. In 2011, we established selling price using management’s best estimate, considering internal factors such as historical selling prices, pricing practices and controls, and customer segment pricing strategies.

Implementation of this new authoritative guidance had an insignificant impact on reported revenue as compared to revenue under previous guidance.

Warranty

We provide a one-year warranty on our INFINITI analyzers. Accruals are provided for the estimated warranty expense at the time the associated revenue is recognized. The estimates of warranty expense are based on actual expenses incurred historically to service our INFINITI analyzers. We do not accrue warranty expense for international sales because our international distributors are responsible for servicing any INFINITI analyzers they sell to customers. Because we do not recognize revenue on the placement of our INFINITI analyzers through our domestic placement plans, we also do not accrue any associated warranty expense. Warranty expense accruals inherently require the use of management judgment. If we were to experience an increase in warranty claims or if our cost of servicing these warranties increased, our gross margins would be affected adversely. We periodically review our actual warranty expense to ensure that it is not materially different than actual results.

Income Taxes

We account for income taxes utilizing the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss

 

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carryforwards. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income or expense in the period that includes the enactment date. Future tax benefits are recognized to the extent that realization of such benefit is more likely than not.

At September 30, 2012, we had federal tax net operating loss carryforwards of $66.1 million and state tax net operating loss carryforwards of $55.2 million. At December 31, 2011, we had federal tax net operating loss carryforwards of $67.9 million and state tax net operating loss carryforwards of $56.8 million. The federal tax net operating loss carryforwards will begin to expire in 2020. The state tax net operating loss carryforwards began to expire in 2012. At September 30, 2012 and at December 31, 2011 we had federal research and development credit carryforwards of $1.1 million and state research credit carryforwards of $1.3 million. The federal research and development credit carryforwards will begin to expire in 2022. The state research credit carryforwards do not expire.

Utilization of net operating loss carryforwards, credit carryforwards and certain deductions may be subject to substantial annual limitation as a result of ownership change limitations provided by the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, and similar state provisions. The tax benefits related to future utilization of federal and state net operating loss carryforwards, credit carryforwards and other deferred tax assets may be limited or lost if cumulative changes in ownership exceed 50% within any three-year period. We have not completed a study to assess whether an ownership change has occurred or whether there have been multiple ownership changes since our formation as a result of the complexity and cost associated with such a study, and the fact that there may be additional ownership changes in the future. Such a limitation may occur as a result of a change in ownership resulting from this offering. If we have experienced an ownership change at any time since our formation, utilization of the net operating loss or credit carryforwards to offset future taxable income and taxes, respectively, would be subject to an annual limitation under Section 382 of the Internal Revenue Code, which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term, tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of all or a portion of the net operating loss or credit carryforwards before utilization. Until a study is completed and any limitation known, all domestic net operating losses and tax credit carryforwards are being considered as an uncertain tax position and disclosed as unrecognized tax benefits under current guidance. No tax benefits from our domestic net operating losses and tax credit carryforwards have been realized to date.

Convertible Preferred Stock Warrant Liabilities

We use the Black-Scholes valuation model to calculate the fair value of our preferred stock warrants. The inputs utilized in this valuation model are discussed below. Each of these inputs is subjective and generally requires significant judgment to determine.

 

   

Fair Value of Our Preferred Stock. Because our stock is not publicly traded, we must estimate the fair value of our preferred stock, as discussed below.

 

   

Expected Term. The expected term is the remaining contractual life of the applicable preferred stock warrant.

 

   

Volatility. As we do not have a trading history for our preferred stock, the expected stock price volatility for our preferred stock is estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the preferred stock warrants. Industry peers consist of several public companies similar in size, stage of life cycle and financial leverage. We do not rely on implied volatilities of traded common stock in our industry peers’ common stock because the volume of activity has been relatively low.

 

   

Risk-free Interest Rate. The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the contractual term of the preferred stock warrants.

 

   

Dividend Yield. We have not historically paid cash dividends or distributions and do not intend to pay cash dividends or distributions in the foreseeable future. Consequently, we used an expected dividend yield of zero.

 

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The fair value of the preferred stock warrants was estimated at the balance sheet dates using the following assumptions (fair value and exercise price are presented on a common stock equivalents basis):

 

     December 31,    September 30, 2012
     2010    2011   
               (unaudited)

Fair value

   $8.65    $11.13    $13.63

Exercise Price

   $7.65 - $10.57    $9.04 - $10.57    $9.74 - $11.27

Expected Term (in years)

   0.08 - 0.99    0.55 - 0.63    0.2 - 0.9

Stock Price Volatility

   76.84    60.17    53.95

Risk-free interest rate

   0.29%    0.12%    0.18%

Dividend yield

        

The fair value of the preferred stock underlying the warrants has historically been determined by our board of directors. Because there has been no public market for our stock, our board of directors has determined the fair value of the preferred stock at the time of issuance by considering a number of objective and subjective factors including valuations performed by unrelated third-party specialists, which included valuations of comparable companies, operating and financial performance, lack of liquidity of capital stock and general and industry-specific economic outlook, among other factors. For each period in which the fair value of preferred stock warrant liabilities was asssessed, the our business enterprise value was first determined. This enterprise value then was allocated across our capital structure using a Probability Weighted Expected Return Method (PWERM) model as the primary approach and an Option Pricing Model (OPM) analysis as a confirming approach. Under the PWERM model, various future potential liquidity scenarios were forecasted and the allocable value to each class of security in our capital structure in each respective scenario was determined. The probability that each potential liquidity event would occur was then assessed. The future proceeds were then discounted to determine the present value of proceeds in each scenario for each security class. The probability weighted present value of each security class was then determined to conclude the value of the preferred stock. Under the confirming OPM analysis, the Black Scholes option pricing framework was used to determine the proceeds allocable to each security class. A series of option tranches was established whereby each tranche represented the value allocable to various security classes between computed breakpoints. Breakpoints are the value inflection points, or indifference points, whereby the allocation to securities change based on the underlying economic rights of each security class. The breakpoints served as the strike prices in the Black Scholes option calculations and tranche values were determined based on the difference between option values in each tranche. The proceeds of the value of each option tranche were then allocated to each respective security class based on the economic rights to the security class between breakpoints. The value allocable to each respective security class was then totaled across all option tranches to conclude the fair value of each security class.

We have classified our convertible preferred stock warrants as a liability and have re-measured the liability to estimated fair value at December 31, 2011 and 2010 and September 30, 2012 using the Black-Scholes valuation model.

Stock-Based Compensation

Compensation expense related to stock-based transactions, including employee stock options, is measured and recognized in the financial statements based on fair value.

The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service period and classified in the statement of operations based on the department to which the related employee reports. Determining the fair value of stock-based awards at the grant date requires judgment. We use the Black-Scholes valuation model to determine the fair value of grants. The determination of the grant date fair value of grants using a valuation model is affected by assumptions regarding a number of complex and subjective variables. These variables include the fair value of our common stock, the expected term of our options, our

 

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expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates, and expected dividends, which are estimated as follows:

 

   

Fair Value of Our Common Stock. Because our stock is not publicly traded, we must estimate the fair value of our common stock, as discussed in “Common Stock Valuations” below.

 

   

Expected Term. We estimate the expected term of our options using the simplified method allowed under SEC guidance.

 

   

Volatility. As we do not have a trading history for our common stock, the expected stock price volatility for our common stock is estimated by taking the average historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock options. Industry peers consist of several public companies similar in size, stage of life cycle and financial leverage. We do not rely on implied volatilities of traded options in our industry peers’ common stock because the volume of activity has been relatively low. We intend to continue to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock price becomes available, or until circumstances change such that the identified companies are no longer similar to us, in which case more suitable companies whose share prices are publicly available would be utilized in the calculation.

 

   

Risk-free Interest Rate. The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the options for each option group.

 

   

Dividend Yield. We have not historically paid cash dividends or distributions and do not intend to pay cash dividends or distributions in the foreseeable future. Consequently, we used an expected dividend yield of zero.

The following table presents the weighted average assumptions used to estimate the fair value of grants during 2010 and 2011 and for the nine months ended September 30, 2012:

 

     Years ended December 31,      Nine months ended
September 30, 2012
 
         2010              2011         
                   (unaudited)  

Fair value

     $6.09 - $8.30            $5.24            $5.24      

Risk-free interest rate

     1.35% - 2.93%         0.80% - 1.23%         0.90%   

Dividend yield

     —              —              —        

Expected life of options (years)

     5.00 - 6.25            5.08 - 6.25            5.50      

Volatility

     68.65% - 71.59%         69.89% - 75.00%         69.89%   

Information for the first six months of fiscal year 2011 is not included in the above chart as there were no option grants during that period. We estimate forfeitures at the time of grant and revise, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We utilized our historical forfeitures to estimate our future forfeiture rate at 4.0% for the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2011 and 2012.

The weighted average exercise price per share of employee stock options granted during the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2012 was $5.48, $5.24 and $5.24, respectively.

Common Stock Valuations

We are required to estimate the fair value of the common stock underlying our stock-based awards when performing the fair value calculations with the Black-Scholes valuation model. The fair value of the common stock underlying our stock-based awards was determined on each grant date by our board of directors, with input from management. This fair value has been calculated on an as-converted basis for each period, assuming for such

 

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purposes that all outstanding convertible preferred stock has been converted into common stock without taking into account any dividend or liquidation preferences. All options to purchase shares of our common stock granted under our incentive stock option plans are intended to be granted with an exercise price per share no less than the fair value per share of our common stock underlying those options on the date of grant, based on the information known to us on the date of grant. In the absence of a public trading market for our common stock, on each grant date, we develop an estimate of the fair value of our common stock in order to determine an exercise price for the option grants. We have determined the fair value of our common stock using methodologies, approaches and assumptions consistent with the American Institute of Certified Public Accountants, or AICPA, Audit and Accounting Practice Aid Series: Valuation of Privately Held Company Equity Securities Issued as Compensation, or the AICPA Practice Guide. In addition, our board of directors considered various objective and subjective factors, along with input from management to determine the fair value of our common stock, including: the prices at which we sold shares of preferred stock, the superior rights and preferences of the preferred stock relative to our common stock at the time of each grant, our results of operations, financial position and status of our research and development efforts, our stage of development and business strategy, the lack of an active public market for our common and our preferred stock, and the likelihood of achieving a liquidity event such as an initial public offering, or IPO, or sale of our company in light of prevailing market conditions. The determination of fair value of our common stock also involves complex and subjective judgments including estimates of revenue, earnings, assumed market growth rates and estimated costs, as well as appropriate discount rates. At the time of each of the below-referenced valuations, the significant estimates used in the discounted cash flow approach included our best estimates of our revenue and revenue growth rates for several years into the future. Although each time we prepared such forecasts we did so based on assumptions that we believed to be reasonable and appropriate at that time, there can be no assurance that any such estimates for earlier periods or for future periods will prove to be accurate.

Our board of directors utilizes the methodologies described above to calculate our implied enterprise value as of each stock option grant date, taking into account our ability or inability to achieve certain milestones, principally among which was the completion of an initial public offering. A probability-weighted expected return methodology, or PWERM, analysis is then used to allocate a portion of this implied enterprise value based on six possible scenarios: (i) an initial public offering of our common stock in the immediate future at a price per share of our common stock based on an implied enterprise value equal to a multiple of our management’s estimate of our then current-year revenue; (ii) an initial public offering of our common stock at the end of the subsequent fiscal year at a price per share of our common stock based on an implied enterprise value equal to a multiple of our management’s estimate of our next fiscal year’s revenue; (iii) a merger or sale of our company at a date that is approximately two and one-half years in the future at a price per share of our common stock based on an implied enterprise value equal to a multiple of our management’s estimate of that future fiscal year’s revenue; (iv) a merger or sale of our company at the end of the second future fiscal year ending after the then-current fiscal year at a price per share of our common stock based on an implied enterprise value equal to a multiple of our management’s estimate of that future fiscal year’s revenue; (v) a dissolution of our company with no value available to be distributed to the holders of our common stock; and (vi) remaining a private company. For the initial public offering scenarios, the value assigned to our common stock was determined using the number of outstanding shares of our common stock assuming the conversion of all outstanding shares of our preferred stock into shares of our common stock. For the merger or sale scenarios, a break point analysis was used to determine the various enterprise values at which holders of each series of our outstanding shares of preferred stock would elect to convert their shares of our preferred stock into shares of our common stock and the points at which the holders of outstanding options and warrants to acquire shares of our common stock would exercise their options or warrants. The values allocated to our common stock as of a future date under each scenario by the PWERM analysis are then discounted using a weighted average cost of capital to calculate an implied present value of the value allocated to our common stock under the PWERM analysis.

There is inherent uncertainty in these estimates and if we had made different assumptions than those described above, the fair value of the underlying common stock and amount of our stock-based compensation expense, net income (loss), and net income (loss) per share amounts would have differed.

 

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The following is a summary of our stock option activity since January 1, 2011:

 

Grant date (1)

   Number of
options
granted
     Exercise
price
($ per share)
     Fair
market value
($ per share) (2)
 

June 22, 2011

     29,370         5.24         5.24   

August 3, 2011

     198,072         5.24         5.24   

May 17, 2012

     90,750         5.24         5.24   

January 14, 2013

     232,617         9.85         9.85   

 

(1) The grant date for options represented in the above table is considered to be the date the key terms and conditions of the award are approved by our board of directors or compensation committee, as applicable.
(2) Represents the fair market value of our common stock at the date of grant as estimated by our board of directors on the date of grant.

Significant factors considered by our board of directors in determining the fair value of our common stock at these grant dates include:

June 2011 Grant. On June 22, 2011, our board of directors determined that the fair value of our common stock was $5.24 per share. As part of this determination, our board of directors considered a retrospective valuation analysis as at December 31, 2010 that was finalized in May 2011. This valuation analysis used the following valuation methodologies to calculate our enterprise value: (i) a selected companies analysis using publicly available information regarding historical and projected future financial performance, including last twelve months, or LTM, and projected next fiscal year revenues for 14 companies in the molecular diagnostics industry with publicly traded equity securities, (ii) a selected transactions analysis using publicly available information regarding the historical financial performance, including LTM revenues, for 27 companies in the molecular diagnostics industry that had been acquired and (iii) a discounted cash flow analysis to determine the net present value of our future cash flows based on our management’s best estimates of our future financial performance from January 2012 to December 2016. We then utilized a PWERM analysis to allocate a portion of this implied enterprise value to our common stock on the same principles described above. For purposes of this PWERM analysis, the present values calculated for our common stock under each of the possible outcomes were weighted based on management’s estimates of the probability of each scenario occurring (initial public offering - early: 15.0%, initial public offering - late: 20.0%, merger/sale - high: 5.0%; merger/sale - low: 10.0%; dissolution: 25.0%; and staying private: 25%).

Finally, because our stock was not publicly traded, the implied present value of the value allocated to our common stock under the PWERM analysis was discounted 15% for lack of marketability based on the Black-Scholes valuation model to take into account variables including an expected time to liquidity under the six possible scenarios described above, the potential share price volatility of our common stock, and a risk-free rate of return. The foregoing analysis resulted in an estimate of the fair market value of our common stock as of December 31, 2010 of $5.24 per share. We believe that this estimate, which is lower than the fair value determined by our board of director for our 2010 stock option grants, is reasonable in light of the fact that between the dates of the 2010 stock option grants and December 31, 2010, the Company abandoned its former initial public company offering, was faced with large accounts payable and then-current notes payable obligations, and was not operating on a profitable basis, all of which significantly negatively affected the value of the Company.

Our board of directors then considered whether there were any significant internal or external positive or negative value-changing events since the date of the December 2010 valuation. During that six-month period, we continued to experience significant capital constraints due to the withdrawal of our initial public offering in the fourth quarter of 2010 and the slowdown in the economy generally, both of which contributed to our being in default at the June 2011 measurement date under a significant amount of our indebtedness. Our ability to continue as a going concern continued to be in question as we did not have cash on hand, or expected net profits in the foreseeable future, sufficient to satisfy our indebtedness that was then in default or that was then expected

 

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to come due in the immediate future and there was no material change in our sales or net revenues during that period of time. As a result, our board of directors concluded that no significant net change in value had taken place between the December 31, 2010 valuation and the date of this stock option grant.

August 2011 Grant. On August 3, 2011, our board of directors determined that the fair value of our common stock was still $5.24 per share. As part of this determination, our board of directors concluded that no significant internal or external value-changing events had taken place since the June 2011 grant date. Between June 22 and August 3, 2011 we continued to experience significant capital constraints due to outstanding promissory note obligations then in default and expected to come due in the immediate future and due to and the continued economic slowdown, with no material change in our sales or net revenues during that intervening period.

May 2012 Grant. On May 17, 2012, our board of directors determined that the fair value of our common stock was still $5.24 per share. As part of this determination, our board of directors considered whether there were any significant internal or external positive or negative value-changing events since the August 2011 grant date. Between August 3, 2011 and May 17, 2012, we had experienced increased acceptance and utilization of our INFINITI system and meaningful growth in our sales and net revenue. These positive results were significantly offset, however, by the continued worldwide economic slowdown, a lack of available capital resources and significant working capital and cash constraints, the incurrence of continued and increasing defaults under outstanding indebtedness, which amounts in default totaled more than $14.9 million as of this May 2012 measurement date, our then existing default of our payment obligations under our real property lease at our Vista facility, and accounts payable balances that were in excess of ordinary course working capital commitments, the payment of which were in substantial question as of this May 2012 measurement date. Our ability to continue as a going concern as of this measurement date was therefore in question as we did not have cash on hand, or expected net profits in the foreseeable future, sufficient to satisfy our then current obligations, including our indebtedness that was then in default or that was then expected to come due in the immediate future. As a result, our board of directors concluded that no significant net change in value had taken place since the August 2011 grant date.

January 2013 Grant. On January 14, 2013, our board of directors determined that the fair value of our common stock had increased to $9.85 per share. As part of this determination, our board of directors considered whether there were any significant internal or external positive or negative value-changing events since the May 2012 grant date, when our board of directors determined that the fair value of our common stock was $5.24 per share, and since the September 30, 2012 valuation date discussed below, which resulted in an estimated fair market value of our common stock of $5.58 per share.

As is described under “—June 2011 Grant” above, our determinations of fair value per share of common stock at June 2011, August 2011 and May 2012 utilized, among other things, a retrospective analysis of the fair value per share of our common stock as of December 31, 2010 that gave a probability estimate for an initial public offering - early of 15% and for an initial public offering - late of 20%, as well as a 15% discount for lack of marketability. A subsequent retrospective analysis of the fair value per share of our common stock as of September 30, 2012 that was conducted in October 2012 gave a probability estimate for an initial public offering - early of 10% and for an initial public offering - late of 20%, and again used a 15% discount for lack of marketability. These probability estimates reflected the fact that we had just initiated the initial public offering process reflected in the offering referred to in this prospectus, and did not yet have substantial confidence in the offering being able to be completed, in part due to our past experience with having withdrawn our 2008 through 2010 initial public offering activity. The September 2012 retrospective analysis determined that the fair value per share of our common stock as of September 30, 2012 was $5.58 per share. See “—Subsequent Retrospective Valuations” below. The fair value of our common stock was significantly depressed at that time due to a variety of factors, perhaps most significantly of which were the continuing (and increasing amount of) payment defaults under our then outstanding indebtedness during the period and our ability to continue as a going concern being in question.

 

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Our board of directors considered several significant positive value changing events that occurred between the September 2012 retrospective valuation date and January 14, 2013. These included the initial filing in September 2012 of a registration statement in support of the initial public offering referred to in this prospectus, which advanced significantly during the fourth quarter of 2012. Most significantly, our board of directors analyzed the effect of the exchange in November 2012 of our outstanding and in-default indebtedness for equity and/or new indebtedness with extended maturity dates. Prior to the exchange, we were in payment default under a substantial portion of our debt obligations and did not have sufficient cash resources to pay the defaulted obligations. As a result, we faced a substantial risk of bankruptcy or the seizure of our assets and suspension of our operating activities. This risk had created significant downward pressure on the fair market value of our common stock prior to the exchange. In addition to lessening our aggregate outstanding indebtedness by $7.5 million, another effect of this exchange was to extend the maturity date of our outstanding indebtedness that participated in the exchange from being past due or coming due in the immediate future to being due in November 2015. Our board of directors considered these factors to have added significant positive value to the fair value of our common stock as of January 2013.

Additionally, in January 2013, we had received quantitative input from the underwriters as to our valuation in an initial public offering, with a potential offering range of $9.00 to $11.00 per share of common stock. Our board of directors also determined that the probability of completing the offering referred to in this prospectus was much higher at the January 14, 2013 grant date than it had been at the September 30, 2012 retrospective valuation date or the May 17, 2012 grant date. As a result, our board of directors considered the likelihood of an initial public offering - early exit scenario to have increased significantly, and the likelihood of a dissolution or staying private scenario to have decreased significantly. In addition, our board of directors considered that the lack of marketability discount on the fair value of our common stock needed to be decreased due to the belief that an initial public offering was imminent. This change in probability weighting, and decrease in the discount for lack of marketability, was determined to have added significant positive value to the fair value of our common stock as of January 2013 compared to September 30, 2012.

Our board of directors also considered negative factors affecting the fair market value of our common stock since September 30, 2012, including the apparent downturn in our net revenue during the fourth quarter of 2012, due primarily to decreased sales to one of our key customers (which was offset in part by increased sales of INFINITI analyzers), and a significant increase in our accounts receivable past due more than 90 days due, the collectability of which had not yet been assessed. Taking into account these positive and negative factors, our board of directors concluded that a significant and material positive net change in value had taken place since September 30, 2012, driven primarily by the substantial reduction of bankruptcy risk effected through our November 2012 debt exchange and the perceived likelihood of a near-term initial public offering with a price to the public of between $9.00 and $11.00 per share.

Subsequent Retrospective Valuations

In August 2012, we conducted a retrospective valuation of our common stock as of December 31, 2011, and used the following valuation methodologies to calculate our enterprise value: (i) a selected companies analysis using publicly available information regarding historical and projected future financial performance, including LTM and projected next fiscal year revenues for 14 companies in the molecular diagnostics industry with publicly traded equity securities, (ii) a selected transactions analysis using publicly available information regarding the historical financial performance, including LTM revenues, for 30 companies in the molecular diagnostics industry that had been acquired and (iii) a discounted cash flow analysis to determine the net present value of our future cash flows based on our management’s best estimates of our future financial performance from January 2012 to December 2018, utilizing a discount rate based on our weighted average cost of capital.

A PWERM analysis then was used to allocate a portion of the implied enterprise value for our company based on those analyses to our common stock utilizing the same principles described above. For purposes of this PWERM analysis, the present values calculated for our common stock under each of the possible outcomes were

 

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weighted based on management’s estimates of the probability of each scenario occurring (initial public offering - early: 5.0%, initial public offering - late: 15.0%, merger/sale - high: 10.0%; merger/sale - low: 20.0%; dissolution: 30.0%; and staying private: 20%).

Finally, because our stock was not publicly traded, the implied present value of the value allocated to our common stock under the PWERM analysis was discounted 15% for lack of marketability based on the Black-Scholes put option valuation model to take into account variables, including an expected time to liquidity under the six possible scenarios described above, the potential share price volatility of our common stock, and a risk-free rate of return. The foregoing analysis resulted in an estimate of the fair market value of our common stock as of December 31, 2011 of $3.82 per share which was lower than the $5.24 per share exercise price at which we granted stock options in June 2011, August 2011 and May 2012. In light of this new information from an independent party, we decided to give more weight to the identified offsetting negative factors than was initially given to such factors, and determined, for stock compensation expense purposes, to value the Company’s common stock at $3.82 as of the date of the May 2012 stock option grants. Our Black-Scholes calculations for purposes of stock-based compensation expense as presented above therefore utilized a $3.82 fair value in calculating this expense.

Subsequently, in September 2012, we commissioned another independent retrospective valuation of our common stock as of June 30, 2012, and used the following valuation methodologies to calculate our enterprise value: (i) a selected companies analysis using publicly available information regarding historical and projected future financial performance, including LTM and projected next fiscal year revenues for 13 companies in the molecular diagnostics industry with publicly traded equity securities, (ii) a selected transactions analysis using publicly available information regarding the historical financial performance, including LTM revenues, for 31 companies in the molecular diagnostics industry that had been acquired and (iii) a discounted cash flow analysis to determine the net present value of our future cash flows based on our management’s best estimates of our future financial performance from June 30, 2012 to December 2018, utilizing a discount rate based on our weighted average cost of capital.

A PWERM analysis then was used to allocate a portion of the implied enterprise value for our company based on those analyses to our common stock utilizing the same principles described above. For purposes of this PWERM analysis, the present values calculated for our common stock under each of the possible outcomes were weighted based on management’s estimates of the probability of each scenario occurring (initial public offering - early: 10.0%, initial public offering - late: 20.0%, merger/sale - high: 10.0%; merger/sale - low: 20.0%; dissolution: 20.0%; and staying private: 20%).

Finally, because our stock was not publicly traded, the implied present value of the value allocated to our common stock under the PWERM analysis was discounted 15% for lack of marketability based on the Black-Scholes valuation model to take into account variables including an expected time to liquidity under the six possible scenarios described above, the potential share price volatility of our common stock, and a risk-free rate of return. The foregoing analysis resulted in an estimate of the fair market value of our common stock as of June 30, 2012 of $5.18 per share, which was again lower than the $5.24 per share exercise price at which we granted stock options in June 2011, August 2011 and May 2012. While we did not downward adjust our prior fair value determinations for stock-based compensation purposes based on these retrospective valuations, we believe they confirm the conclusion that our stock option grants discussed above were all granted at exercise prices that were equal to or greater than the fair values as of their respective grant dates.

Subsequently, in October 2012, we commissioned another independent retrospective valuation of our common stock as of September 30, 2012, and used the following valuation methodologies to calculate our enterprise value: (i) a selected companies analysis using publicly available information regarding historical and projected future financial performance, including LTM and projected next fiscal year revenues for 13 companies in the molecular diagnostics industry with publicly traded equity securities, (ii) a selected transactions analysis using publicly available information regarding the historical financial performance, including LTM revenues, for 31 companies in the molecular diagnostics industry that had been acquired and (iii) a discounted cash flow

 

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analysis to determine the net present value of our future cash flows based on our management’s best estimates of our future financial performance from September 30, 2012 to December 2018, utilizing a discount rate based on our weighted average cost of capital.

A PWERM analysis then was used to allocate a portion of the implied enterprise value for our company based on those analyses to our common stock utilizing the same principles described above. For purposes of this PWERM analysis, the present values calculated for our common stock under each of the possible outcomes were weighted based on management’s estimates of the probability of each scenario occurring (initial public offering - early: 10.0%, initial public offering - late: 20.0%, merger/sale - high: 10.0%; merger/sale - low: 20.0%; dissolution: 20.0%; and staying private: 20%).

Finally, because our stock was not publicly traded, the implied present value of the value allocated to our common stock under the PWERM analysis was discounted 15% for lack of marketability based on the Black-Scholes valuation model to take into account variables including an expected time to liquidity under the six possible scenarios described above, the potential share price volatility of our common stock, and a risk-free rate of return. The foregoing analysis resulted in an estimate of the fair market value of our common stock as of September 30, 2012 of $5.58 per share.

We recognized employee stock-based compensation in the statements of operations as follows:

 

     Years ended 
December 31,
     Nine months ended
September 30,
 
         2010              2011              2011              2012      
                   (unaudited)  
     (in thousands)  

Cost of sales

   $ 227       $ 236       $ 195       $ 90   

Research and development

     432         395         358         126   

General and administrative

     901         780         661         282   

Sales and marketing

     1,203         166         150         52   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 2,763       $ 1,577       $ 1,364       $ 550   
  

 

 

    

 

 

    

 

 

    

 

 

 

The total compensation cost related to unvested stock option grants not yet recognized as of September 30, 2012 was $1.9 million, and the weighted average period over which these grants are expected to vest was 1.2 years.

Based on the initial public offering price of $10.00 per share, the intrinsic value of stock options outstanding at September 30, 2012 would have been $9.2 million, of which $8.5 million and $0.7 million would have been related to stock options that were vested and unvested, respectively, at that date.

In most cases, the fair value of the equity securities granted is more reliably determinable than the fair value of the goods or services received. The fair value of an equity award granted to a non-employee generally is determined in the same manner as an equity award granted to an employee. Stock-based compensation expense related to non-employee consultants totaled $0.2 million and $0.1 million in the years ended December 31, 2010 and December 31, 2011, respectively, and $0 for each of the nine months ended September 30, 2011 and 2012.

Inventory Valuation

We report our inventories net of our reserve for slow-moving and obsolete parts. Inventory is valued using the lower of cost or market value and includes direct labor, materials and manufacturing overhead. Our inventory includes raw materials, work-in-process and finished goods in instrument and reagent production. We periodically review inventory for evidence of slow-moving or obsolete parts and expired reagents, and a reserve is recorded based on management’s reviews of inventories on hand, compared to estimated future usage and sales, and assumptions about the likelihood of obsolescence.

 

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Recently Issued Accounting Standards Not Yet Adopted

In May 2011, the Financial Accounting Standards Board, or FASB, issued an amendment to the accounting guidance on fair value measurements to ensure that GAAP and International Financial Reporting Standards have common requirements for fair value measurement and disclosures, including a consistent definition of fair value. The guidance is effective for interim and annual periods beginning on or after December 15, 2011. We adopted this guidance and it did not have a material impact on our financial statements for the period ended September 30, 2012.

In June 2011, the FASB issued an amendment to the accounting guidance on the presentation of comprehensive income. The guidance eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity, and instead requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We adopted this guidance and it did not have a material impact on our financial statements for the period ended September 30, 2012.

In December 2011, the FASB issued an amendment to the accounting guidance on disclosures about offsetting assets and liabilities. The guidance requires an entity to disclose both gross and net information about financial instruments and derivative instruments that are eligible for offset in the balance sheet or subject to an enforceable master netting arrangement or similar agreement. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. We do not expect the adoption of this guidance will have a material impact on our financial statements.

Under Section 107(b) of the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this exemption from new or revised accounting standards and, therefore, we will be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Ernst & Young LLP resigned from acting as our independent registered public accounting firm in August, 2010, and so was not asked to report on our financial statements for our fiscal year 2010. We did not have any disagreements with Ernst & Young LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure that was not resolved to the satisfaction of Ernst & Young LLP or that would have caused Ernst & Young LLP to make reference to the subject matter of the disagreement(s) in connection with its reports on our financial statements.

Prior to its resignation, Ernst & Young LLP had identified the following issues in its audit of our balance sheets as of December 31, 2008 and 2009, and the related statements of operations, convertible preferred stock and stockholders’ deficit, and cash flows for the year ended December 31, 2007 and for each of the two years in the period ended December 31, 2009:

 

   

we had incurred recurring operating losses and had insufficient working capital to support our then planned operations, which raised substantial doubt about our ability to continue as a going concern;

 

   

we had material weaknesses in our internal control over financial reporting that resulted from two different internal control deficiencies. The first involved the failure to appropriately document negotiated terms and conditions that deviated from our standard terms and conditions, and to consistently and accurately communicate the negotiated terms so that the transactions could be properly recorded in the accounting records. The second related to the misapplication of generally accepted accounting principles with respect to the timing of recognition of revenue for product sales characterized by multiple deliverables or additional elements; and

 

   

we had a material weakness in our internal control over financial reporting related to our financial statement closing process, which resulted from having identified numerous post-closing accounting

 

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adjustments that we were required to record in connection with the preparation of our 2009 financial statements, and we discovered in the first quarter of 2010 certain errors related to our accounting for warrants issued with our subordinated promissory notes. These errors involved calculating and allocating the fair value of the warrants and calculating the amortization of the related interest expense.

In response to the identification of these material weaknesses, we terminated one of our sales employees that had contributed to the failure to communicate negotiated terms and conditions, substantially revised our sales and revenue recognition policies and procedures and trained our personnel with respect to these revised policies and procedures, and amended our code of ethics and have since required all of our employees to certify compliance with this code. We believe that these actions substantially remediated the material weaknesses and significant deficiencies identified in 2010 other than our financial statement closing process, with respect to which we continue to experience material weaknesses. See also “—Internal Control over Financial Reporting” below.

We engaged Marcum LLP as our independent registered public accounting firm in December 2010. Our audit committee of our board of directors approved this engagement. Prior to Ernst & Young LLP’s resignation and prior to the appointment of Marcum LLP, we did not consult with Marcum LLP regarding the application of accounting principles to a specific completed or contemplated transaction or any matter that was either the subject of a disagreement or a reportable event, or regarding the type of audit opinion that might be rendered on our financial statements.

Qualitative and Quantitative Disclosures about Market Risk

Our exposure to market risk is currently confined to our cash and cash equivalents. We have not used derivative financial instruments for speculation or trading purposes. In addition, we have not invested in auction rate securities. Our subordinated promissory notes have a weighted average fixed annual interest rate of 6.8%.

The primary objective of our investment activities is to preserve our capital for the purpose of funding operations while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve these objectives, we invest our cash primarily in liquid money market funds. As a result, we believe we have minimal interest rate risk. Due to our limited funds invested in interest bearing accounts, a one percentage point change in the average interest rate on invested funds would have had a minimal effect on interest income for the years ended December 31, 2010 and 2011 and the nine months ended September 30, 2012.

Our international sales are all denominated and paid in U.S. dollars and as a result we believe we are not exposed to foreign exchange currency risk.

Internal Control over Financial Reporting

Overview

In connection with the audits of our financial statements for the years ended December 31, 2010 and 2011, and the review of our financial statements for the period ended September 30, 2012, both our independent registered public accounting firm and our management discovered several conditions that we deemed to be material weaknesses and significant deficiencies in our internal controls under the standards established by the Public Company Accounting Oversight Board, or PCAOB.

According to the PCAOB’s definitions, a deficiency in internal control over financial reporting exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis. A deficiency in design exists when (a) a control necessary to meet the control objective is missing or (b) an existing control is not properly designed so that, even if the control operates as designed, the control objective would not be met. A deficiency in operation exists when a properly designed control does not operate as designed or when the person

 

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performing the control does not possess the necessary authority or competence to perform the control effectively. A significant deficiency is defined as a deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of a company’s financial reporting. A material weakness is defined as a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

We are committed to maintaining effective internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. We believe that the actions we have taken to date and that we expect to take in the future, as set forth in greater detail below, to enhance the reliability and effectiveness of our internal control over financial reporting will substantially remediate our material weaknesses and significant deficiencies in our internal control over financial reporting. We also intend to continue to enhance our internal control over financial reporting following the completion of this offering. However, our independent registered public accounting firm has not evaluated the measures we have taken to address our material weaknesses, and will not be able to confirm to us that these material weaknesses have been remediated until our independent registered public accounting firm has completed its next audit of our financial statements. There can be no assurance that our internal control over financial reporting, as modified or remediated, will allow us to identify or avoid future material weaknesses or significant deficiencies. The material weaknesses described below are primarily related to the lack of personnel with the appropriate skills and experience, particularly with respect to technical accounting matters, and the lack of policies and procedures related to the financial reporting and period closing processes.

Material Weaknesses

 

   

We noted several issues related to effective oversight by management primarily attributed to lack of significant prior audit experience and expertise relating to complex accounting issues (such as debt and equity accounting and valuation). A lack of sufficient controls over debt/equity accounting and recordkeeping of equity and debt holders’ transactions resulted in material adjustments.

 

   

We lack a comprehensive, consistent and supportable methodology to capture the cost of manufacturing our inventory, specifically as it relates to labor and overhead charges and inventory reserves. In addition, updates to our costing system were not performed timely to ensure accurate recordkeeping.

 

   

A lack of qualified accounting and finance resources as well as effective oversight by those in charge of governance resulted in insufficient controls over timely financial statement preparation and review as well as the inability to timely and accurately account for complex transactions. A lack of technical knowledge and expertise attributed to non-compliance with certain GAAP accounting disclosure requirements.

 

   

Improper revenue recognition as it relates to properly recording negotiated terms and conditions in customer agreements that deviate from standard terms and conditions and the related misapplication of the proper guidance related to the timing of revenue recognition for product sales characterized by multiple deliverables or additional elements.

In response to the identification of these material weaknesses, we (i) have hired two new employees to augment our accounting staff and intend to hire additional finance and accounting personnel in addition to providing more assistance on equity accounting, and have engaged a third party finance specialist to perform certain accounting functions for us, (ii) have established a series of internal controls over critical financial processes designed to ensure the proper oversight, accuracy and timeliness of entries made by our finance personnel and to ensure that periodic financial reporting is completed within requisite timeframes, and (iii) terminated, in 2010, one of our sales employees who had contributed to the failure to communicate negotiated

 

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terms and conditions, revised our sales and revenue recognition policies and procedures and trained our personnel with respect to the revised policies and procedures, and amended our code of ethics and have since required all employees to certify compliance with this code.

Significant Deficiencies

We have noted that our design of monitoring controls used to assess the design and operating effectiveness of our internal controls is inadequate and constitutes a significant deficiency. We also do not have an adequate internal process to report deficiencies in internal control to management on a timely basis. We intend to address our significant deficiency in the design of monitoring controls by establishing better operating controls and involve our board of directors in this process, which will involve establishing formal procedures to communicate deficiencies in internal controls on a timely basis, and request that our board of directors more actively participate in guiding management as it relates to such matters.

Conclusion

Although we plan to take steps to substantially remediate, and have identified the means by which we intend to substantially remediate, the material weaknesses and significant deficiencies that have been identified to date, all as further described above, our remediation efforts may not be successful, or we may in the future have additional material weaknesses or significant deficiencies in our internal control over financial reporting. Failure to implement and maintain effective internal control over financial reporting could result in material misstatements in our financial statements. For more information, see the section titled “Risk Factors — We have identified material weaknesses and significant deficiencies in our internal controls, and we cannot provide assurances that these weaknesses and deficiencies will be effectively remediated or that additional material weaknesses and significant deficiencies will not occur in the future. If our internal control over financial reporting or our disclosure controls and procedures are not effective, we may not be able to accurately report our financial results, prevent fraud, or file our periodic reports in a timely manner, which may cause investors to lose confidence in our reported financial information and may lead to a decline in our stock price,” included elsewhere in this prospectus above.

 

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Business

Overview

We design, develop, manufacture and market the INFINITI molecular diagnostics system. The system includes an extensive and expanding menu of genetic tests and a family of highly automated analyzers. Our products are sold to reference laboratories, hospital laboratories and specialty clinics that produce genetic test results in a broad range of markets, including personalized medicine, women’s health, oncology and infectious disease. Genetic tests are performed on our INFINITI analyzer utilizing our high-margin and test-specific consumables, which include our proprietary BioFilmChip microarrays and our proprietary Intellipac Reagent Management Modules. In the United States, we market and sell our genetic tests that have been cleared by the U.S. Food and Drug Administration, or FDA, for use in the indications specified in those clearances. The remainder of our genetic tests are marketed and sold on a research use only, or RUO, basis. Our RUO tests may be used for clinical purposes in the United States only by customers that are certified under the Clinical Laboratory Improvements Amendments of 1988, or CLIA, and that have incorporated our test into the customer’s laboratory-developed tests, or LDTs, pursuant to guidelines issued by the College of American Pathologists.

Our INFINITI analyzers are capable of both mid- to high-volume testing and generating many different laboratory results from one patient sample at the same time, which is commonly referred to as multiplexing, while providing a high level of accuracy and reproducibility. Our INFINITI system is easy to use, as it eliminates the need for multiple, specialized instruments and automates many of the traditionally discrete processes of genetic testing.

As of December 31, 2012, we offered 53 tests for use on our INFINITI analyzers and had more than 15 additional tests in development. Our current and in-development tests are focused on the areas of personalized medicine (including pain management, mental health and cardiovascular health assessment), women’s health, oncology, infectious disease, genetic disorders, newborn screening and blood banking, which we believe represent large and growing market opportunities in genetic testing. We believe the depth and breadth of our test menu is a significant competitive advantage that will allow laboratories to utilize laboratory space, labor and capital investment more efficiently and to conduct additional molecular diagnostic tests. The proprietary design of our INFINITI system allows us to introduce new and enhanced tests to our genetic test menu without the need to modify our INFINITI analyzers. We intend to increase the number of tests offered in each of our target market segments, which will further increase the utility of our INFINITI system to our customers. Our internal test development efforts are generally driven by our customers’ current and anticipated needs, our analysis and projections for the molecular diagnostics market, and our ability to leverage our core competencies such as automation and multiplexing. We have entered into, and expect to continue to enter into, collaborative relationships with leading research and academic institutions for the development of additional or enhanced tests to further increase the depth and breadth of our genetic test menu. Since the initial launch of our INFINITI system in 2007 we have introduced more than five new or enhanced tests per year.

In February 2007, we received 510(k) clearance from the FDA for the commercial sale of our INFINITI Analyzer. We have also received 510(k) clearance for our Warfarin sensitivity test, our CYP450 2C19 test, which is designed to determine the varied efficacy and toxicity of certain highly prescribed drugs based on certain genetic variants, and our Factor II, Factor V and Factor II-V panel tests, which aid in the determination of an individual’s risk for the development of blood clots. The balance of our tests are currently offered for sale in the United States under the RUO designation. These RUO tests are labeled “For Research Use Only. Not for use in diagnostic procedures.” as required by FDA regulations. We are not permitted to market these products for in vitro diagnostic use, and must maintain distribution controls to assure that these products are not used for diagnostic purposes. We therefore train our personnel to only market these products to laboratories for research or investigational use in the collection of research data, and to not promote any off-label uses of our products.

 

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We intend to seek regulatory clearance or approval, as necessary, for our tests. For example:

 

   

we have submitted notification to the FDA for 510(k) clearance for our uridine diphosphate glucuronosyltransferaseisoform 1A1, or UGT1A1, test, which is designed to help determine the initial dosing of irinotecan, a leading drug for a broad variety of cancers;

 

   

we intend to submit a 510(k) notification to the FDA for our cystic fibrosis and our human papillomavirus, or HPV, genotyping tests in 2013;

 

   

we are conducting studies in support of and are preparing to submit a pre-investigational device exemption, or pre-IDE, application for our CFTR and Flu A-sH1N1 tests;

 

   

we have initiated clinical studies to support future submissions to the FDA for clearance of several of our other tests, including our 2D6, 3A4, 3A5, ureaplasma urealyticum, mycoplasma genitalium, mycoplasma hominis (Urogen Quad), bacterial vaginosis, or BV, candida vaginitis, or CV, chlamydia, gonorrhea and KRAS-BRAF genetic tests; and

 

   

we are finalizing the protocol for a clinical trial necessary to support a premarket approval, or PMA, application to the FDA for our HPV-HR tests and intend to commence the clinical trial in 2013;

We obtained the Conformité Européenne, or CE, mark for our INFINITI Analyzer in June 2008, our INFINITI Plus Analyzer in September 2012, our Factor II, Factor V, Factor II-V panel, MTHFR and FII-FV-MTHFR panel tests in August 2008, our HPV Quad test in October 2008 and our CFTR-31 assay in November 2008. In total, 22 of our tests are CE marked, with the marking supported by completed clinical and validation studies that demonstrated the analytical performance of each CE marked test. The CE mark facilitates the marketing and sale of our INFINITI Analyzer and CE marked tests in the European Union and the European Economic Area as well as other international markets.

Sales of products for which we have received 510(k) clearance accounted for 13%, 8% and 4% of our net revenue for 2010, 2011 and the first nine months of 2012, respectively. The balance of our product sales for those same periods, representing 87%, 92% and 96% of our net revenue for 2010, 2011 and the first nine months of 2012, respectively, were derived from sales of RUO products. These products are offered for sale to allow for the collection of research data, and may only be used in the United States for clinical purposes by laboratories certified under CLIA that have incorporated these products into their LDTs pursuant to guidelines issued by the College of American Pathologists. We believe that nearly all of our RUO product sales are incorporated into LDT’s. In order to develop an LDT utilizing our products, these certified laboratories and other facilities must develop and validate a test protocol that includes specimen collection, DNA extraction, PCR amplification, hybridization and detection, and data analysis, interpretation and reporting. Our products provide components that can be used by these certified laboratories and other facilities for the PCR amplification, hybridization and detection portions of these LDTs. We sell each of these components individually, as ordered by the customer in its discretion, and not as a kit or system. The validation process engaged in by these certified laboratories and other facilities can involve validation of the sample collection and extraction process, establishing limits of detection and analytical sensitivity, testing for specificity and cross-reactivity, including interfering substances, validation for assay accuracy, precision and reproducibility, and establishing reportable ranges of test results for the test system and reference values that will be measured against as controls. This validation process also requires verifying the result from the LDT against known standard samples or the results of a high-standard laboratory testing method such as sequencing, and can involve the testing of a large number of patient samples. Depending on the availability of patient samples, this process may take from several weeks to several months or more to complete and this requires a significant investment by the customer. This validation process must be completed for each of our RUO genetic test components that a customer wishes to incorporate into one of its LDTs.

We believe that all sales of our RUO products in the United States are to customers that are either certified in the manner described above and have incorporated our products into their LDTs or that use such products for research only. The FDA has not adopted these guidelines and we are not permitted to represent our RUO

 

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products as effective in vitro diagnostic products. Our decision to seek FDA approvals or clearances domestically, and CE marking internationally, on our genetic tests is made on a test-by-test basis, and is based on a variety of factors, including:

 

   

the regulatory environment for the use of genetic tests, in particular the FDA’s requirements and limitations on marketing RUO tests, which may not be marketed as in vitro diagnostic products;

 

   

the demand by our existing and target customers, as expressed to us, for particular genetic tests that have received regulatory approvals or clearances;

 

   

the competitive environment for the use of genetic tests that have received regulatory approvals or clearances versus similar tests that have not; for example, certain of our competitors provide FDA cleared or approved tests in the area of HPV testing, and to compete with those competitors we intend to obtain FDA clearance or approval for certain of our HPV tests as well; and

 

   

the size of the available market for the particular test, given the relatively significant expense and time required to obtain regulatory approvals or clearances.

For those of our tests for which we have not obtained FDA regulatory clearance or approval, we experience delays of anywhere from a few weeks to several months or more in obtaining revenue from customers that desire to utilize our RUO test consumables during the period of time that the customer is developing its own LDT that incorporates our RUO test.

We believe that we are in compliance with existing FDA rules and regulations governing our business, including those governing the marketing and sale of RUO tests; however a significant change in existing laws, or their enforcement, may require us to change our business model or our business practices to maintain compliance with these laws. For instance, in June 2011 the FDA issued a Draft Guidance entitled “Commercially Distributed In Vitro Diagnostic Products Labeled for Research Use Only or Investigational Use Only: Frequently Asked Questions,” which, if enforced, would limit our marketing of RUO tests to general discovery laboratories and would require us to halt sales to clinical laboratories that validate and use our RUO tests as part of their LDTs. The FDA has generally exercised its enforcement discretion to not enforce applicable regulations with respect to LDTs. However, the FDA has indicated, since 2010, that it intends to reconsider its policy regarding enforcement and to begin drafting an oversight framework for such tests. If the FDA imposes significant changes to the regulation or enforcement of LDTs, including our RUO tests that are used as LDTs, it may require us to suspend sales of our RUO tests, which together represented 96% of our net revenues for the nine months ended September 30, 2012, and it would require us to seek FDA clearance or approval for our RUO tests, which would in turn require significant time and capital investments on our part and reduce our revenues or increase our costs and adversely affect our business, prospects, results of operations or financial condition. We have not undertaken any specific efforts to comply with this draft guidance. If we were to voluntarily elect to comply with this draft guidance, we would be required to seek regulatory approval for all of our RUO tests that are sold in the United States, which would require significant time and capital investments on our part, significantly reduce our revenues until we obtained regulatory approvals, and significantly increase our capital costs, which could in turn adversely affect our business, prospects, results of operations or financial condition during the affected fiscal periods. Our management currently believes that finalization or enforcement of this draft guidance in its present form is unlikely given the significant adverse effect it would have on a variety of industry participants, and on the ability of physicians to provide effective healthcare.

If we decide to seek PMA approvals for a particular test, the time and expense involved could vary widely based on the type of test involved, although we would expect to spend on average approximately two to three years and approximately $10 to $15 million or more in seeking and obtaining such approval. If we decide to seek 510(k) clearance for a particular test, we expect to spend on average approximately six to 12 months and approximately $300,000 to $500,000 in seeking and obtaining such clearance. If we decide to seek CE marking for a particular test, we expect to spend on average approximately two to three months and approximately

 

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$100,000 in seeking and obtaining such clearance. These expenditures are estimates based on information currently available to management and actual expenditures may vary from or exceed these estimates.

We believe that compared to traditional genetic testing methods, our INFINITI system can significantly improve laboratory productivity, workflow and throughput while reducing the cost per reportable result. We believe that these and other attributes of our INFINITI system decrease the cost and complexity of genetic testing and reduce the need for specialized laboratory personnel, training, equipment and facilities. Our INFINITI system has been designed to enable a broad range of reference laboratories, hospital laboratories and specialty clinics to start performing, or to more cost-effectively perform, molecular diagnostic tests, which we believe will facilitate the adoption of our INFINITI analyzers and the utilization of our genetic tests.

We experienced meaningful revenue growth in the first nine months of 2012, with revenue of $14.5 million during this period, $13.2 million of which was derived from sales of our genetic test consumables, as compared to revenue of $7.5 million and $8.0 million for fiscal years 2010 and 2011, respectively, of which $3.9 million and $6.8 million was derived from sales of our genetic test consumables, respectively. We expect to continue to generate the substantial majority of our revenue through the sale of our genetic test consumables for the foreseeable future. As of December 31, 2012, we had 191 INFINITI analyzers placed with customers.

Market Opportunity

Industry Background

Molecular diagnostic testing is used to measure or detect genetic biomarkers associated with a predisposition to, or the presence of, a particular disease or condition, or other genetic variance such as drug response. The information provided by molecular diagnostic testing may enable physicians to achieve better patient outcomes and better contain health care costs through, for example, earlier diagnosis of disease, improved monitoring of disease progression and more personalized treatment. According to Kalorama Information, an independent market research firm, the global molecular diagnostics market is expected to grow from an estimated $4.8 billion in 2010 to $8.1 billion in 2015, which represents a compound annual growth rate of approximately 11%, which we believe will exceed the growth of the overall diagnostics market.

Current practices in developing and running molecular diagnostic tests typically involve manual and complex procedures that require significant expertise, time and expense. We believe the resource and time constraints of traditional testing methods have limited the growth of the molecular diagnostics market and that the recent availability of more automated and integrated testing methods will result in accelerated use of molecular diagnostic testing. The growth of the molecular diagnostics market will also depend on increasing physician education on the use of genetic testing and greater coverage of tests by insurance carriers. Growing understanding of the utility of genetic information for the diagnosis and treatment of disease, as well the increase in identification of new biomarkers, may lead to increased growth in the molecular diagnostics market.

Our Target Markets

We believe there are additional factors that will continue to drive growth in the molecular diagnostics market segments we target including:

 

   

Personalized medicine and companion diagnostics. The matching of treatment options to a patient’s specific genetic profile has emerged as an important trend in medicine. Better targeted and more effective pharmacogenomic-based treatments have the potential to improve healthcare outcomes and lower healthcare costs, which may lead to increased use of molecular diagnostic testing.

 

   

Healthcare providers are able to better treat patients by optimizing potential efficacy while minimizing the potential for adverse side effects by conducting molecular diagnostic tests prior to prescribing drugs.

 

   

Many pharmaceutical researchers, companies, and pharmacy benefit companies are screening drugs for differences in efficacy and toxicity among individuals with varied genetic profiles.

 

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Regulatory agencies have revised drug labels to improve safety and efficacy based on information provided by molecular diagnostic testing.

 

   

Pain Management. Pharmacogenomics is playing an integral role in the administration and management of pain medication, as gene mutations can be key factors in determining the most appropriate drug to determine efficacy and safety.

 

   

At least 116 million adult Americans suffer from acute or chronic pain each year. Drugs are the “first line” of treatment for most forms of pain. The goal of successful pain management is to effectively control patient pain without causing excess side effects from the medication prescribed. However only 58% of patients taking prescription medication reported pain relief and fewer than 41% of patients taking over-the-counter pain medication reported relief.

 

   

In order to improve clinical outcomes physicians are using genetic markers to enhance pain management and optimize dosing strategy. Opioids are the most frequently prescribed class of pain management drugs in the United States. These drugs, including Hydrocodone, Codeine, Oxycodone, and Morphine, are often indicated for the relief of chronic and moderate to severe post-surgical pain, in addition to pain experienced by cancer patients. According to the IMS Health National Prescription Audit, hydrocodone alone accounted for more than 136.7 million prescriptions in 2011.

 

   

We believe key factors accounting for the rising use of these drugs include the expanding population of cancer patients and patients undergoing surgical, including orthopedic, procedures.

 

   

Mental Health. Mental health represents a major component of overall pharmaceutical sales. According to the Centers for Disease Control and Prevention, or CDC, as much as 11% of the U.S. population is taking antidepressants at a given time, while as many as 23% of women between the age of 40 and 59 are on psychiatric medication. Improving care for mental health patients by tailoring treatment options to their specific genetic profile may continue to drive the expansion of the molecular diagnostics industry.

 

   

An increase in the diagnoses of autism and attention deficit hyperactivity disorder has further expanded the need for treatment to children and adolescents. Because of potential developmental issues that could result from psychiatric drug treatment for minors, doctors must take precautions in choosing medications for young patients.

 

   

One of the biggest challenges in treating depression is the lack of reliable efficacy and potential adverse effects of various therapeutic options. Approximately 40% of patients don’t respond to the first medication prescribed. The resulting trial and error process delays effective treatment for patients and increases healthcare costs.

 

   

Cancer and Companion Diagnostics. Because of the high cost of many cancer therapeutics, and the varied levels of efficacy and toxicity across different patients, tests to direct cancer treatment are becoming increasingly important. In addition, tests to diagnose or determine the predisposition to various forms of cancer are becoming more common. We believe molecular diagnostic testing to determine a particular patient’s expected response to various cancer therapeutics will continue to drive expanded demand for molecular diagnostics.

 

   

The FDA has required or recommended that molecular diagnostic tests be performed before the administration of certain drugs, including Herceptin and Erbitux.

 

   

Tests such as Colorectal KRAS-BRAF, KRAS, BRAF, BRAF XP, and EGFR have experienced meaningful clinical adoption due to their ability to improve patient outcomes and decrease costs. For example, Erbitux, a leading treatment for colorectal cancer, costs approximately $61,000 per course of treatment. There are approximately 28,700 colorectal cancer patients in the United States and KRAS mutations occur in up to 45% of colorectal carcinomas. The presence of KRAS mutations suggest that anti-EGFR therapies (Erbitux/Vectibix) will not be effective. If all of these patients had KRAS testing over $600 million in unnecessary treatment expense could be avoided.

 

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Cardiovascular Health Assessment. According to the World Health Organization, or WHO, cardiovascular diseases were responsible for 30% of global deaths in 2008. It is estimated that by 2030, 23.6 million people will die from some form of cardiovascular disease. Due to the increasing prevalence of cardiovascular diseases and the information generated by molecular diagnostic testing, risk assessment for and the treatment of cardiovascular diseases is an area of growth within molecular diagnostics.

 

   

Based on recent research, it is now widely accepted that the efficacy and tolerability of two of the most commonly used drugs in the prevention of cardiovascular disease (Lipitor (atorvastatin) for cholesterol regulation and prevention of cardiovascular disease and Plavix (clopidogrel) for prevention of stent thrombosis and cardiovascular death following acute coronary syndrome) are heavily influenced by a patient’s genetics. Lipitor (atorvastatin) is the top selling drug of its class and was dispensed in more than 40.0 million prescriptions in the United States in 2011. Plavix (clopidogrel) was dispensed in more than 25.0 million prescriptions in the United States in 2010.

 

   

Women’s Health. We believe the women’s health diagnostics market will continue to grow and represent a substantial market opportunity. Non-molecular tests are commonly employed in this market, but the use of molecular diagnostics is expanding significantly due to increased applications, better performance and better clinical discriminatory capabilities.

 

   

Key tests that have seen rapid adoption of molecular methodologies include HPV testing and sexually transmitted disease, or STD, testing. Current regulations from the U.S. Preventive Services Task Force recommend that molecular HPV tests be utilized in conjunction with cytology (Pap test) in standard 5 year intervals.

 

   

Infectious Diseases. According to the WHO, infectious diseases caused approximately 20% of all recorded deaths in 2008. Within this group, HIV, tuberculosis, or TB, and respiratory infections were the top three contributors to overall mortality in adults aged 15-59, at 35%, 21% and 10%, respectively.

 

   

Historically, many of these infections required 2 stages of testing: a rapid screening test to confirm the presence of a general infection, followed by a lengthy type-specific culture to assess other clinically significant attributes such as antimicrobial susceptibility. The new paradigm offered by molecular diagnostics, via multiplexing capabilities and gene specific differentiation, allows for simultaneous detection of each infection and the identification of subtypes and drug resistances, all within a clinically acceptable turnaround time.

 

   

Genetic Disorders. Genetic and inherited disease testing is a cornerstone of molecular diagnostic testing. Molecular diagnostic tests offer significant advantages over prior, often subjective, forms of diagnosis.

 

   

We believe that growth in this area has been, and will continue to be, focused on large markets for testing such as Familial Mediterranean Fever, Thalassemia and sickle-cell anemia, where large-scale populations exhibiting these genetic traits provide an opportunity for high-volume testing.

 

   

The adaptability of molecular technologies to the detection of genetic disorders is aided by the ability to simultaneously identify multiple pertinent genetic markers to form a more complete diagnosis.

 

   

Newborn Screening. Many common newborn screening panels such as cystic fibrosis and various ethnically dependent ailments require the identification of multiple (often five or more) genetic markers which makes traditional testing impractical. Classic testing algorithms are limited in that they utilize subjective analysis of a newborn’s parental health history with little to no genetic evaluation.

 

   

For example, because various Ashkenazi Jewish inherited disorders (such as Tay Sachs) are autosomal recessive, meaning not all parents who carry the necessary genes to produce the disease exhibit symptoms, a targeted genetic evaluation of the affected genes would inform the clinician if the newborn is at risk for developing the disease in question.

 

   

Blood Banking. As genetic testing products have become more prevalent, more accurate and more cost-effective, the use of genetic tests in screening in the blood banking market has grown, and is expected to continue to grow.

 

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Traditional testing algorithms follow a tiered procedure where tests are performed in stages, with prominent blood bank “disqualifier tests” being performed first. While the tiered approach reduces unnecessary procedures and eases the overall testing burden, these tests are still being performed individually during each tier. Genetic test multiplexing allows for multiple typing and screening tests within the same run, which can reduce the time and expense involved in satisfying each tier of blood banking tests.

 

   

Key tests in this segment include blood typing/grouping and infectious disease screening (e.g., hepatitis B virus/hepatitis C virus, syphilis, and HIV 1/2).

As of December 31, 2012, we offered for use on our INFINITI system 23 genetic tests for use in the area of personalized medicine and companion diagnostics, three of which have received FDA 510(k) clearance, five RUO genetic tests for use in the area of pain management, 11 genetic tests for use in the area of mental health, two of which have received FDA 510(k) clearance, 16 genetic tests for use in the area of cardiovascular health assessment, five of which have received FDA 510(k) clearance, 15 RUO genetic tests for use in the area of women’s health, 23 RUO genetic tests for use in the area of cancer and companion diagnostics, 15 RUO genetic tests for use in the area of infectious diseases, six RUO genetic tests for use in the area of genetic disorders, four RUO genetic tests for use in the area of newborn screening, and no tests for use in the area of blood banking. Although we have genetic tests available for use in the areas of genetic disorders and newborn screening, we did not have any material sales or net revenue from sales of genetic tests in these target markets, and no sales in the blood banking market, during the year ended December 31, 2012. As is noted in the tables appearing in “Business—Our Current Test Menu”, many of our 53 genetic tests may be utilized in more than one of our target markets, resulting in particular genetic tests being counted multiple times in the information presented above.

The Limitations of Current Testing Methods

Scientists have developed a variety of genetic analysis methods, including DNA sequencing, gene expression and genotyping, to detect genetic biomarkers. These analytical methods are performed using various genetic testing technologies, the most common being real time polymerase chain reaction, or RT-PCR, which involves amplifying the DNA sequence in question and then detecting the DNA with the use of fluorescent dyes.

These existing testing methods have a number of drawbacks, which we believe have significantly limited their use, including:

 

   

High cost per reportable result. Because many existing systems require specialized personnel and/or specialized training to complete complex and extensive protocols, the tests can be time-consuming and result in high labor costs. These processes may also use a significant amount of reagent, which can be costly. The use of supplementary, discrete instrumentation to perform semi-manual tests also increases costs, as compared to a system that automates the discrete processes of genetic testing.

 

   

Centralization of molecular diagnostics market. There may be a reluctance on the part of providers to take advantage of molecular diagnostic testing in those instances where it is not readily available in the geographic region in which the provider is situated. The molecular diagnostic testing market is dominated by large reference laboratories and large hospital laboratories. As a result, healthcare providers may be required to ship patient samples to laboratories not locally situated, which can lead to delays in receiving test results.

 

   

Limited testing menu. Many existing diagnostic systems have limited test menus. As a result, a laboratory may need to purchase many different systems to satisfy its testing needs. This requires separate training of operators on the use and maintenance of each system and may require a significant amount of laboratory bench space. The combination of these factors often makes molecular diagnostic testing in-house impractical.

 

   

Inability to multiplex. In many cases, the predisposition to a genetic disorder, or the presence of a particular disease, condition or genetic variance affecting therapy, is caused by multiple genetic

 

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mutations that necessitate testing for multiple biomarkers to diagnose those diseases, conditions or variances. Many existing technologies are only able to examine one biomarker at a time, and, in order to make a diagnosis, the laboratory must perform repeated tests on a sample. Serial testing is expensive, significantly increases the amount of workflow and requires higher sample volumes.

 

   

Limited automation and throughput capability. While a number of companies offer systems that can perform molecular diagnostic tests, these systems tend to automate only certain steps in the testing process. Some of these systems require sequential processing through multiple instruments prior to generating results. In addition, most of these systems do not allow for the testing of multiple patient samples in a single microarray, which does not allow for the cost-benefits of higher throughput. Consequently, utilizing these systems requires a significant amount of time, capital and specialized labor.

 

   

Specialized labor. Specialized laboratory technicians and in some cases specialized training are required to properly perform and evaluate the quality and accuracy of the results of most existing molecular diagnostics technologies. We believe that there is a labor shortage of specialized laboratory technicians in the clinical laboratory market, which, in addition to the cost of this labor, has limited the availability of molecular diagnostic testing and has restrained the growth of the market.

 

   

Inaccurate results and challenges with reproducibility. The additional handling of samples required to operate manual or semi-automated systems can lead to an increased risk of sample contamination and human error. The lack of automation also can lead to problems related to reproducibility of results. In addition, many existing testing systems are not capable of simultaneous target and signal amplification (methods for increasing the detectability of genes) when running a sample, which limits the sensitivity and specificity of these systems and could result in the need for a larger sample size.

These limitations have created the need in the molecular diagnostics market for a highly integrated system to perform a large menu of automated, cost-effective and easy to use tests with a high degree of accuracy and reproducibility.

The AutoGenomics Solution

We believe our INFINITI system addresses many of the limitations of current molecular diagnostic technologies. Our INFINITI system has been designed to enable a broad range of reference laboratories, hospital laboratories and specialty clinics to start performing, or to more cost-effectively perform, molecular diagnostic testing, which we believe will drive adoption and use of our INFINITI system as well as expand the potential of the molecular diagnostic testing market.

To use our system, an operator only needs to load prepared test samples into an INFINITI analyzer, along with the specific BioFilmChip and Intellipac Reagent Management Module, for the desired test. Once the INFINITI analyzer is loaded and the test is initiated, no further action by the operator is required. After the test is completed, the system generates an electronic report that can be transmitted directly to a laboratory information system.

Our INFINITI system has a number of key advantages, including:

 

   

Enhanced cost-efficiency. Our system eliminates the need for complex protocols and manual intervention once a test is initiated, which is intended to reduce the laboratory’s cost of testing by simplifying workflow and reducing the need for highly skilled technicians.

 

   

Ability to decentralize molecular diagnostics. We believe that medium-sized reference laboratories, hospital laboratories and specialty clinics are increasingly seeking to add or expand molecular diagnostics capabilities to treat patients more efficiently and provide a more comprehensive offering, lower the cost of providing healthcare, and participate in the value provided by diagnostic testing. We believe that this trend is being facilitated in part by new technologies like ours that are more automated,

 

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easier to use, more cost effective and require less bench space in a laboratory than traditional genetic testing methods.

 

   

Broad menu of tests. As of December 31, 2012, we offered 53 tests as part of our INFINITI system, of which five have received FDA clearance. The balance of our tests are sold on an RUO basis. We believe that this represents one of the broadest available test menus of on a single system. Our INFINITI system is designed to allow for the development of new and enhanced tests without modification to our platform or our INFINITI analyzers. As we increase the number of tests available for use on our INFINITI system, our customers will be able to broaden their molecular diagnostics offerings without additional capital investment or operator training. We believe the depth and breadth of our test menu is a meaningful competitive advantage that will allow laboratories to utilize laboratory space, labor and capital investment more efficiently. We also believe that our offering of five FDA cleared tests is comparable to similar testing system offerings of our competitors, which we believe based on publicly available information ranges from zero to seven FDA-cleared tests.

 

   

Ability to multiplex. Many diseases and patient responses to therapy are caused by multiple genetic mutations that necessitate testing for multiple biomarkers to diagnose those diseases or to predict and/or monitor therapy response. Our INFINITI system is able to detect up to 1,024 individual features of biochemical sensors within a single microarray, which reduces the amount of sample needed, reduces the time required to run the test, and often reduces the need for multiple tests. This capability is advantageous in genetic testing, for example, in HPV screening, which requires testing for numerous biomarkers and is often performed at the same time and using the same patient sample as the Pap test.

 

   

Multiple patient array technology. Our proprietary multiple patient array, or MPA, technology is designed to test up to eight patient samples on a single microarray. This significantly enhances throughput by up to 300% while reducing cost per sample by up to 75% as compared to our single patient microarrays. This MPA technology is particularly well suited for addressing high volume test markets such as those for HPV and TB, and affords us the flexibility to continue to offer competitive pricing while maintaining established margins.

 

   

Better workflow. Our broad offering of INFINITI analyzers combined with the integrated, “load and go” design of the INFINITI system is designed to address our target customers’ varied throughput and workflow requirements. We believe that we can substantially increase a laboratory’s throughput over existing laboratory-developed and other manual and semi-automated tests by enabling them to perform their tests on our highly integrated and automated system that has the ability to multiplex and run high volume MPAs, resulting in better workflow. The INFINITI system can run multiple different tests simultaneously which reduces or eliminates the need for laboratories to run tests in batches. It also eliminates the need for complex protocols and manual intervention once a test is initiated.

 

   

Increased accuracy of results. Human handling of samples is the most common cause of contamination and error in existing technologies. By reducing the risk of human error and contamination, we believe our INFINITI system can provide more accurate and more reproducible test results compared to other, less automated systems. In addition, where certain systems only use target or signal amplification (e.g., PCR), we believe our combined target and signal amplification technologies can increase the sensitivity and specificity over these widely-used stand-alone amplification methods.

Our Strategy

Our objective is to become a leading provider of genetic tests to a broad array of customers within our target

market segments. We believe our INFINITI system will allow us to achieve this objective by facilitating molecular diagnostic testing by reference laboratories, hospital laboratories and specialty clinics. To achieve our

objective, we intend to:

 

   

Capitalize on the capabilities of our INFINITI system to increase penetration within our target market segments. We believe that our INFINITI system’s high level of automation, ability to multiplex and

 

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broad test menu are attractive to our target customers in our target market segments as our genetic tests provide an easy to use solution with greater breadth of diagnostic information at a lower cost per reported result than many competing systems.

 

   

Develop and launch new and enhanced tests. We believe that developing a broad menu of genetic tests to run on our system will increase the value of our INFINITI system, drive additional placements of our INFINITI analyzers and increase our consumables sales. We launched our INFINITI system in 2007 with an introductory panel of four tests. As of December 31, 2012, we offered 53 genetic tests and had more than 15 additional tests in development. We believe that the depth and breadth of our test menu is a significant competitive advantage that will allow customers to increase their ability to conduct molecular testing and utilize laboratory space, labor and capital investment more efficiently, as well as generate supplementary revenue. In addition, the depth and breadth of our test menu diversifies our revenue so that we are not dependent on the performance of any single test. The majority of tests that we offer, are developing and intend to develop have established market demand and reimbursement by public and private payors.

 

   

Target molecular diagnostic laboratories with high potential utilization of our INFINITI system. We believe that our INFINITI system’s automation, broad genetic test menu and family of analyzers designed to address various throughput requirements will generate demand from both larger reference laboratories seeking a more flexible and efficient molecular diagnostic platform and from smaller reference laboratories, hospital laboratories and specialty clinics for whom it has not previously been cost-effective to develop their own tests. We offer our family of INFINITI analyzers to our customers through direct sales and rentals, and through our domestic placement plans, in which the customer’s choice of our INFINITI analyzers is placed at the customer’s location at no direct cost to the customer. We believe that our targeted customer base will generate significant recurring demand for our high margin BioFilmChips and Intellipac Reagent Management Modules consumables.

 

   

Expand our domestic sales force and international distribution of our products. We are marketing and selling the INFINITI system in the United States through our own sales and marketing organization, which, as of December 31, 2012, was comprised of ten sales persons located in key metropolitan cities in the United States. We believe there is a meaningful opportunity to further penetrate existing markets and customers as well as enter new markets by adding to the size and scope of our US salesforce. We have established distributor relationships for the marketing of our INFINITI system in 21 countries outside the United States, including Brazil, Canada, China, Mexico and countries in Europe and the Middle East. We also plan to expand our global distribution networks to address increasing international demand in addition to driving increased utilization with our existing distributors.

 

   

Pursue regulatory clearances, approvals and certifications for products and facilities, as necessary. We have received FDA 510(k) clearance for our INFINITI Analyzer and five of our genetic tests and we have obtained a CE mark for our INFINITI Analyzer, our INFINITI Plus Analyzer and 22 of our tests. These CE markings are supported by completed clinical and validation studies that demonstrated the analytical performance of the respective test. We believe that most of the tests we submit to the FDA will require 510(k) clearance rather than the more time-consuming and costly process of obtaining a PMA.

We intend to seek regulatory clearance or approval, as necessary, for our tests. Currently:

 

   

we have submitted notification to the FDA for 510(k) clearance for our UGT1A1 test which is designed to help determine the initial dosing of irinotecan, a leading drug for a broad variety of cancers;

 

   

we are finalizing the protocol for a clinical trial necessary to support a PMA application to the FDA for our HPV-HR tests and intend to commence the clinical trial in 2013;

 

   

we intend to submit a 510(k) notification to the FDA for our CF and our HPV genotyping tests in 2013;

 

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we are conducting studies in support of and are preparing to submit a pre-IDE application for our CFTR and Flu A-sH1N1 tests; and

 

   

we have initiated clinical studies to support future submissions to the FDA for clearance of several of our other tests, including our 2D6, 3A4, 3A5, ureaplasma urealyticum, mycoplasma genitalium, mycoplasma hominis (Urogen Quad), bacterial vaginosis (BV), candida vaginitis (CV), chlamydia, gonorrhea and KRAS-BRAF genetic tests.

 

   

Align with key opinion leaders at leading institutions and increase scientific awareness of our products. We align with key opinion leaders at leading institutions and clinical research laboratories, including ARUP Laboratories, Cleveland Clinic, Montreal Heart Institute, New York Presbyterian Hospital and San Francisco General Hospital. As either a customer or a collaborative partner, each of these opinion leaders has helped to increase awareness of our system, to demonstrate its benefits relative to existing technologies and to accelerate its adoption in the molecular diagnostics market. We also seek to increase awareness of our products through participation at trade shows and academic conferences where we sponsor lectures by leading scientific figures and through strategic placements of advertisements in various industry publications. We also conduct online webinars and hospital-based grand, or teaching, rounds in laboratories and hospitals to promote the utility of our products to our potential customers. In addition, our INFINITI system has been discussed in several published peer review articles.

Our Products

Our INFINITI Analyzers

Our INFINITI system includes a family of analyzers that we have developed and are marketing under the names INFINITI and INFINITI PLUS, and that we are developing and intend to market under the names INFINITI PLUS 96 and INFINITI HTS. These analyzers are the core of our INFINITI system. Each model is designed to address customer-specific needs based on the customer’s productivity, workflow and throughput requirements. Our INFINITI analyzers integrate and automate the discrete processes of sample handling, reagent management, hybridization, detection, results analysis and reporting in a self-contained system. They have been designed to operate on a “load and go” basis, which means that to run a genetic test, an operator loads prepared samples into the INFINITI analyzer along with the BioFilmChip microarrays and the Intellipac Reagent Management Modules specific to that test. Once an INFINITI analyzer is loaded and the tests are initiated, no supervision is required. From the perspective of the operator, the test protocols are identical for all of our genetic tests, which eliminates the need to repeatedly train operators when additional tests are added. After the test is completed, the INFINITI analyzer generates an electronic report that can be transmitted directly to a laboratory information system. Our BioFilmChips and Intellipac Reagent Management Modules are test-specific, but are not analyzer-specific so each of our INFINITI analyzers use substantially the same consumables.

The following table illustrates the test capabilities of our different INFINITI analyzers:

 

Analyzer

  

Capacity per run

  

Patient results *

INFINITI

   24 samples    up to 96 per day

INFINITI PLUS

   48 samples    up to 192 per day

INFINITI PLUS 96 (in beta testing)

   96 samples    up to 288 per day

INFINITI HTS (in beta testing)

   384 samples    up to 1152 per day

 

* numbers presented are based on average time to complete an HPV-HR Quad test run

 

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Our Tests

In developing our menu of genetic tests, we are focused on a broad range of markets, with a particular emphasis on the areas of personalized medicine (including pain management, mental health and cardiovascular health assessment), women’s health, oncology, infectious disease, genetic disorders, newborn screening and blood banking, which we believe represent large and growing market opportunities in genetic testing. We believe that by offering a wide variety of tests for each of these markets, each of which can be run on all of our INFINITI analyzers, we will provide significant value to reference and hospital laboratories and specialty clinics in these areas by allowing them to consolidate multiple testing platforms, expand their testing capabilities, increase workflow and reduce costs, and limit additional investment in equipment, personnel and training.

Selected Key Tests in our Focus Market Segments

 

   

HPV. We have developed four HPV tests, which are designed for screening and/or genotyping and each of which addresses a different segment of the HPV testing market. Our HPV genetic test portfolio includes our HPV-HR Quad and HPV-HR Hex tests, designed to screen for and genotype 14 high-risk types of HPV simultaneously, our HPV Quad test, designed to screen for 13 high-risk and two low-risk types of HPV, and our HPV Genotyping test, designed to identify 26 high-and low-risk types of HPV. Importantly, our HPV tests identify and separately report on the type of HPV present, as opposed to reporting just on the existence of HPV generally, which assists in determining whether the HPV is a new, repeated or persistent infection. Our HPV-HR Quad, HPV-HR Hex and HPV Quad tests are designed to allow a laboratory to test samples from four to six different patients simultaneously on a single BioFilmChip. We believe our tests offer several competitive advantages over existing HPV screening and genotyping tests, such as the consolidation of multiple testing steps required in screening and genotyping, increased automation, reduction of sample requirements and enhanced accuracy and reproducibility. We plan to seek a PMA for our HPV-HR tests and 510(k) clearance for our HPV Genotyping test. Our HPV-HR Quad, HPV Quad and HPV Genotyping tests have been CE marked in accordance with applicable law.

 

   

Other STDs. We intend to capitalize on the significant market opportunity in the area of STD testing by providing solutions to address some of the inadequacies and inefficiencies of many current testing methods. Our panels are designed to screen for multiple STDs in a single sample and are well suited to test for these infections in a cost-effective manner. We have launched a variety of panels consisting of tests that our customers use to identify numerous organisms associated with STDs.

 

   

Breast Cancer. Breast cancer is the second most-common form of cancer in women. An estimated 227,000 women will be diagnosed with, and approximately 40,000 women will die of, breast cancer in 2012. We have developed tests such as our CHEK-2 and the Breast Cancer Panel-AJ tests, which are designed to determine individuals at greater risk for breast cancer, and our CYP450 2D6T test, which is designed to determine if a woman will benefit from tamoxifen, a frequently prescribed drug for the prevention of breast cancer recurrence. We believe that these tests could play an important role in improving the screening, early diagnosis and effective treatment of certain individuals with, or potentially at risk of developing, breast cancer.

 

   

Colorectal Cancer. The American Cancer Society estimated that, in 2012, there will be over 100,000 new cases of colon cancer and over 40,000 new cases of rectal cancer, and that these diseases will cause more than 50,000 deaths, making it the second leading cause of cancer-related deaths in the United States. Anti-EGFR drugs have emerged as prevalent anticancer therapeutics as they help neutralize EGFR over-activity that has been linked to several cancers, including colorectal cancer. However, certain genetic mutations are associated with poor response to anti-EGFR therapies. We have developed KRAS and KRAS-BRAF tests, which enable laboratories to identify these mutations. We believe that these tests could assist in reducing healthcare costs while providing better patient outcomes.

 

   

Personalized Medicine. We offer 21 tests that may be used by laboratories in the area of personalized medicine. One of our leading personalized medicine offerings is our CYP450 2C19 panel test, which is

 

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designed to enable laboratories to identify certain gene variants that affect the metabolism and efficacy of the anticoagulant drug Plavix (clopidogrel). Plavix is the most commonly prescribed anti-platelet drug in the United States, with more than 28 million total prescriptions filled in the United States in 2011, including more than 8 million new prescriptions, based on data from the IMS Health National Prescription Audit. As of March 2010, the FDA now requires the clopidogrel label to include language that informs doctors that patients with CYP450 2C19 mutations have a diminished response to the drug, and thus, such patients may be susceptible to a heart attack, stroke or cardiovascular death due to the ineffectiveness of the drug. This labeling requirement has increased, and future FDA requirements may increase, the demand for genetic tests such as ours. Our other leading tests in this area currently include our CYP450 2C19 Plus, Warfarin and CYP450 2D6I tests, which are designed to enable laboratories to identify certain gene variants associated with responsiveness to certain medications for psychiatric disorders, the oral anticoagulant Warfarin and certain antidepressants and cancer drugs, respectively. Warfarin is the most commonly prescribed anticoagulant in the United States, with more than 33 million total prescriptions filled in the United States in 2011, including more than 15 million new prescriptions, based on data from the IMS Health National Prescription Audit. We believe that our tests could improve patient care and reduce healthcare costs.

 

   

Infectious Disease. Infectious disease is a significant category of the molecular diagnostics market. This market segment continues to increase due to the greater necessity for multiplexed tests that can not only identify the presence of an infection but also provide guidance on therapy, namely subtyping to assist in patient management. Our Multidrug Resistance Tuberculosis (MDR-TB) test is one such application. Tuberculosis is the second most deadly infectious disease in the world and resulted in the death of 1.4 million people in 2011. Our MDR-TB product is designed to enable laboratories to identify Mycobacterium tuberculosis infections (as opposed to nontuberculous mycobacterium infections) while simultaneously determining resistance to the three front-line treatments: rifampin, isoniazid and pyrazinamide.

 

   

Genetic Disorders. The global genetic disorders testing market is expected to reach $2.2 billion by 2017. A key driver in the rapid adoption of molecular diagnostics in genetic and inherited diseases testing is the ability to multiplex multiple markers into a single test. One such test is our Familial Mediterranean Fever (FMF) panel. FMF is an autoinflammatory disease mutation that is carried by significant portions of populations of selected Mediterranean countries. Some countries, such as Turkey, have started testing broad segments of their populations to identify recessive carriers of the mutation and to better inform these individuals’ reproductive choices. FMF disease can cause recurrent fever and renal failure and is often misdiagnosed. In the United States, as many as 1 in 249 are carriers of this disease. The development of this disease has been attributed to mutations in the MEFV gene. Our FMF panel allows laboratories to simultaneously identify 13 common MEFV mutations, covering the five most common variations as well as eight other variations spanning 14 ethnicities.

 

   

Newborn Screening. Neonatal screening programs are increasingly available across the United States and internationally. However, traditional methods for newborn screening allow the testing of only one gene of a particular disease at a time, increasing the burden of testing and adversely affecting patient care by delaying the delivery of critical information. In some cases diagnosis is being performed via subjective evaluation of parental medical histories due to a lack of practical genetic evaluation techniques. As an example, our Ashkenazi Jewish Panel is capable of simultaneously detecting 31 genetic variants that account for eight diseases commonly found among those of Ashkenazi Jewish descent, which greatly facilitates newborn screening by shortening the testing period for these eight diseases from days to hours.

 

   

Blood Banking. Blood banking is a rapidly growing market segment where molecular diagnostic technologies are increasingly utilized to optimize current testing algorithms. We have several tests for blood typing and infectious disease screening currently in development that are intended to take advantage of our multiplexed automation capabilities take advantage of our key strength of multiplexed automation.

 

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Our Current Test Menu

As of December 31, 2012, we offered the following 53 genetic tests for use with our family of INFINITI analyzers:

 

Product (1)

 

Application

  Market Segments
                                              
   

Pain Management

(5 tests)

 

Mental Health

(11 tests)

 

Cardiovascular risk

assessment

(16 tests)

 

Other Personalized

medicine

(23 tests)

 

Women’s health

(15 tests)

 

Oncology

(23 tests)

 

Infectious disease

(15 tests)

 

Genetic disorders

(6 tests)

 

Newborn screening

(4 tests)

                                                    

5-FU (Fluorouracil)

  Metabolism of leading cancer drug/toxicity assessment               ¿       ¿            

ApoE

  Drug metabolism       ¿   ¿   ¿                    

Ashkenazi Jewish Panel

  Diseases more prevalent in the Ashkenazi Jewish population                               ¿   ¿

Bacterial Vaginosis

  Bacterial infection - Sexually transmitted disease                   ¿       ¿        

BRAF

  KRAS and BRAF amino acid changes - Metastatic Colorectal Cancer               ¿       ¿            

BRAF XP

  KRAS and BRAF amino acid changes - Metastatic Colorectal Cancer               ¿       ¿            

Breast Cancer Panel - AJ

  Breast cancer risk                   ¿   ¿       ¿    

Candida Vaginitis

  Fungal infection - Sexually transmitted disease                   ¿       ¿        

CFTR-15

  Cystic fibrosis gene mutation                               ¿   ¿

CFTR-31

  Cystic fibrosis gene mutation                               ¿   ¿

CHEK-2

  Familial breast cancer risk                   ¿   ¿       ¿    

CODX2

  Drug metabolism   ¿   ¿       ¿       ¿            

CT-NG Quad

  Gonorrhea, chlamydia                   ¿    <